Exemption Certificate Management (ECM)
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat discuss and answer questions about exemption certificate management.
Here’s a glimpse of what you’ll learn:
Why are certificate issues the leading cause of large assessments for companies required to collect them?
What is the importance of exemption certificate management documentation in an audit?
What is one of the biggest mistakes companies make when it comes to ECM?
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More, your go to resource for all things state tax related. Now, here is your host, Michael Fleming.
Michael Fleming: Mike Fleming here, founder of Sales Tax and More. And today's co host of the Sales Tax and More Podcast, where we talk about everybody's favorite topic, which is of course, sales tax. And today we're going to talk about exemption certificate management, or as we call it ECM.
But first, before we get started, let me introduce you to my co host Ellie Moffat.
Ellie Moffat: Hey, everyone. Great to be here. Great to be talking about everyone's favorite topic, sales tax, and especially [00:01:00] exemption certificate management. And before we get started, I'll do a quick introduction for Sales Tax and More.
So we are a full service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, exemption certificate management, which we're talking about today and like our name states more.
So if you have questions about our services or you'd like to work with us, let us know. We'd love to hear from you. We'd love to work with you as well. And because I forgot to say it, don't forget to like and subscribe to our podcast. So Mike I've heard you say that certificate issues are the leading cause of large assessments for companies required to collect them.
And we also, we put that out on social media a lot. We have that on our websites. Can you explain to everyone why that is?
Michael Fleming: Yeah, absolutely. Couple of reasons. [00:02:00] And one of them is because the states, perhaps the biggest reason why this is an issue is because it hasn't always been that big of an issue.
If we go back to the great recession, 2008. Prior to that certificates were not a huge issue. But at that time, the states were looking for more revenue. They all had the economy was bad. They're taxpayers, their citizens needed more services. They had to pay for those services.
So they started looking on the books for ways to increase revenue. And they said, look, we got all these exemption certificate laws in the books and we don't really enforce them. Why don't we do that? So they started. Prior to the 2008, 2009, 2010 period, we really had what's called substance over form.
And that means that if an auditor knew that a sale was for resale [00:03:00] or some type of exempt sale. They gave you a whole lot of leeway and sometimes a state wouldn't even audit companies like wholesalers or distributors because they said, why should we waste our time on this company when there really isn't any taxable sales with that?
What type of money are we going to get? When they started enforcing these laws virtually overnight in a lot of instances, we saw it go from substance over form to form over substance. And what that simply means is that every I has to be dotted, every T has to be crossed or the certificates getting kicked or set up in the audit.
So if it's on the wrong form, if it's not signed if it's not dated if the all of the information isn't in there if the names don't match. All of these things are important now whereas you were getting a lot of latitude before and you know at [00:04:00] first it was just a couple of states and they were very successful and they raised a whole bunch of new revenue so we saw that start to spread and more and more states took a more hardline approach to their certificates.
Their exempt sales when they're doing audits. It's become a much bigger part of the audit until now. It's the largest cause for large assessments in companies that are required to collect the the certificates. And you would think that when the economy got better, maybe the states would back off.
Unfortunately, they didn't, once they get a taste of that extra revenue, if anything, it's become even a bigger and bigger issue as time goes on. So I hope that, explains why certificates are such a big issue right now.
Ellie Moffat: Thank you so much, Mike, for explaining that to everyone. What is the importance then of [00:05:00] exemption certificate management documentation in an audit?
Michael Fleming: Yeah, in all of sales tax, documentation is important, like real estate location. When it comes to sales tax and defending yourself in an audit, it's all about documentation. And if it's not properly documented then either it didn't happen or it's getting set up in, in the audit.
If it's, we said this is a matter of form over substance. Now, by the way, most of sales tax is substance over form. So this is the exception to that. This is form over substance. And if you don't have all of the required information in there. If you don't have it on the right form, then that's being set up in the in the audit and here's one of the big problems
a lot of people think that, Hey, the sales tax on this one certificate isn't that big. It's only, five, six dollars on this [00:06:00] invoice. So if if it's not right on this one certificate, I only have to pay six dollars a tax. I can live with that, but it doesn't work that way because audits are done on a sample basis for the most part.
It's not just the tax that missing certificate for that one invoice, but what it represents in the samples. So the error percentage, when you extrapolate that out over the population it can have a huge impact. You may have heard me talk about this before. This is perhaps the most extreme example of it.
I was involved in an audit one time. And 60 percent of the audit was due to missing, incomplete, or invalid certificates, and we got all of the, all of these certificates, we collected them, and except for one, and it was an individual, I don't know why they didn't get a certificate at the point of sale, but they tried to track this individual down, we tried to track this individual down, we even [00:07:00] hired a skip tracing company to try to track this individual down because the tax on this one invoice would have been, 6, 000 dollars or so and actually a little bit higher than that, but right in that neighborhood and no one wants to pay that amount of money, but when they extrapolated it out.
Over the population. It was over 270, 000 dollar error and that's huge. We took this audit down from 3. 5 million to about 17, 000 dollars. But when we couldn't get the certificate, we had to add that back in and it was just under 300, 000 dollars. They would not let us detail it. A lot of times you can say let's have this removed from the sample.
But we had, push the envelope on just about everything else and getting this audit down to that 17, 000 dollars. And they would not let us remove this from the sample. So one missing certificate was a 270, 000 dollar [00:08:00] error. Now, generally, you're not going to have certificates that cover invoices that have 6, 000 dollars worth of tax.
You could, but they, it's the same concept. If you have a lot of little invoices that are done incorrectly or that are missing, they all lay it up. And it's the, when you extrapolate it out, the error percentage over the population, that's where the big number comes in. This is why documentation is so important because if you don't have it, you're going to end up paying a lot of money inside the audit.
Ellie Moffat: Mike, what is one of the biggest mistakes companies make when it comes to ECM?
Michael Fleming: The first there's, again, we can answer this a number of different ways, but the biggest mistake is not doing anything at all not collecting them so we come across a whole bunch of companies that just don't have a process for collecting certificates. Someone tells them they're exempt and they waive the taxes so that's number one.
Number two, a lot of companies [00:09:00] collect certificates, but no one's making sure that the certificate is valid. In other words, is that certificate going to survive an auditor's review? And what's the sense of collecting a certificate if it's not going to pass an auditor's review? So someone's got to be validating those certificates.
We're often asked to evaluate someone's certificates, and I'll go in there. And I joke about this, but if it says certificate on it, we've seen it, their marriage certificates, death certificates. It, just because something says certificate doesn't mean that you can accept that in order to document an exempt sale, it's gotta be on the the right type of certificate.
So we see companies accepting registration forms or pictures of the registration or documentation that someone's registered. No, that's not going to work. It has to be on the correct form in a [00:10:00] less than a handful of states that may work, but in most states, they actually want the certificate with all of the information on it.
So that's a big thing. No one is validating the certificates. They make you to make sure that it's going to survive an auditor's review in the audit. And then even for our clients that we're doing this exemption certificate management for sometimes you're gonna get a salesperson who says this is our biggest client we got to accept this.
And they run to whoever's in charge at the company and they say Hey, you got to override this. And we've got to do what our client tells us to do. So if the client says, accept it, we got to accept it. But a lot of times they don't realize what the impact is. So generally our exemption certificate department is going to do it, but after about the third or fourth time that this happens, I've got to get involved and I reach out [00:11:00] to whoever's making the decisions.
A lot of times it's the owner of the company, sometimes someone in, senior management, and I'll say, Hey, I just want to bring this to your attention that when you're waiving these certificate issues, it's not just the tax on that one invoice that if you get audited, you're going to have to worry about.
It goes back to how the audits are done. They're done on a sample basis. So missing certificates or invalid certificates are going to have an outsized impact on the amount of money that you're going to owe in the audit. And when I explained to them and I give them that example of the the 6, 000 dollars turning into over 270, 000 dollars.
I get an Oh, wow. Okay, we're not waiving any more certificates. So that perhaps is the biggest issue, not having a process in place, not validating them as part of the process, and then overriding [00:12:00] someone's whoever's validating the certificates would be a third part of it. So it's all about the process, not having a process or making exceptions to the process.
I think that is one of the biggest mistakes when it comes to ECM, exemption certificate management. Now, this is something that you can do on your own, but it's a lot of knowledge and states sometimes change this. There's more than one type of an exemption. You have resale exemptions, you have agricultural exemptions, you have manufacturing exemptions you have entity type exemptions.
And each state has their own idea as to what is exempt. So there's a lot of knowledge that, that you need in order to make sure that. Someone is validating these certificates correctly. So a lot of times companies say, okay, we'll collect the certificates, but we're going to send it to a third party like us to actually validate those certificates.
So [00:13:00] it is something that you can do internally, but sometimes it just is cheaper, makes more sense, has quicker turn times when you outsource it to a third party like ourselves.
Ellie Moffat: All right, Mike, anything else you want to add in here for everyone?
Michael Fleming: No I just want to reiterate this is if you have a responsibility to collect certificates, this is the biggest reason for large assessments when it comes to audits.
So it's something that everybody should be doing. And if you haven't been doing it in the past when you first start doing it, maybe a little bit of a shock to your customers, to your salespeople, but it's that important. Something like this is can be devastating to a business. When you think that you don't have any issues, all of a sudden you go into an audit and the auditor is disallowing the certificate you do have on file, if any.
So I think this is something we all need to take [00:14:00] extra time and attention to make sure that we're doing it correctly.
Ellie Moffat: Yeah, we say it for a reason. The reason it's on our website, it's in blogs, it's on this podcast, it's on our socials, it is for a reason. So thank you so much, Mike.
And for again, if you have any sales tax needs, we offer a lot of solutions, a lot of services, including ECM management. You can reach out to me directly. My email is E Moffat, E M O F F A T at salestaxandmore. com. You can also visit our website, salestaxandmore. com. And don't forget to like and subscribe.
Thank you so much for listening.
Michael Fleming: Thank you everyone. And we do hope to see you on the next episode of the Sales Tax and More Podcast. Bye bye.