All about exemptions

What is an exemption?

In some cases, buyers don't have to pay sales tax on goods or services that would otherwise be taxable, such as a contractor buying lumber to build a house. When applied to a transaction, an exemption reduces or removes the sales tax requirement.

What is an exemption certificate?

An exemption certificate is a document that proves the buyer's exempt status.

What are exemptions based on?

  • Use-based exemptions generally refer to the intended use of the item by the buyer. In other words, the item sold will be "used" in an exempt activity, such as being resold by a wholesaler.
  • Product-based exemptions refer to products that have been deemed non-taxable by the state. For example, in certain states, groceries or clothing are tax-exempt.
  • Organizational and individual-based exemptions include categories of organizations and individuals that may not be required to pay tax based on their activities or for public policy reasons.

In Sovos products, these are usually referred to as reasons for exemption.

Which organizations and individuals are tax-exempt?

  • The federal government is exempt from paying state sales tax because of federal sovereignty. Federal sovereignty means that the federal government's authority takes priority over the state's power to tax.
  • Some states and local governments may also be tax-exempt, but it depends on each individual state.
  • Schools, churches, charities, and non-profit organizations can be tax-exempt as well, again, depending on the state.
  • Wholesalers can also be tax-exempt, since they'll collect sales tax when they resell the product they purchased. Wholesalers must present a resale exemption certificate to the original seller to prove their tax-exempt status.

Often these organizations are only tax-exempt if the purchase is related to their main purpose. If they engage in an activity that is not related to their core purpose, the purchases they make for those activities may not be tax-exempt.

What are the seller’s responsibilities regarding exemption certificates?

  • Getting exemption certificates from customers before a sale takes place.
  • Storing exemption certificates of existing customers.
  • Making sure that exemption certificates obtained from customers are valid and up-to-date.
    • Check with the appropriate taxing authorities how to validate certificates in the states where you collect tax.
    • Exemption certificates may or may not have expiration dates, depending on the state. Expired certificates must be replaced with new ones or sales tax may be charged on future transactions.
  • Making exemption certificates available in case of an audit.

What are some things I can do to effectively manage exemption certificates?

  • Research what exemptions are valid under each state’s law.
  • Research the appropriate forms necessary to claim an exemption.
  • Obtain valid exemption certificates from all your exempt customers before a sale is made.
  • Have procedures in place for replacing expired certificates.
  • File the correct exemption certificate and in the correct format for the taxing jurisdiction.
  • Define a process that allows you to safely store and readily access certificates if audited.