Sales tax exemption certificates play a crucial role in your tax compliance as an online business.
Imagine: A new customer approaches you and claims that they don’t have to pay your US sales tax. Are they lying to you? Trying to scam you out of paying taxes you’ll have to cover?
New retailers aren’t always aware of sales tax exemption certificates, but as your business grows, it’s something you’re likely to encounter. Depending on the type of business you run, you may even want to file for one yourself so that you can purchase goods intended for resale without paying taxes.
Not sure what your tax exemption certificate obligations are? Read on for our advice:
What is a sales tax exemption certificate?
A sales tax exemption certificate is an official document that declares a business’ purchases are not subject to the usual taxation system, be that sales tax, VAT, or GST. This certificate serves as proof of your organization's tax-exempt status and is typically required when making tax-exempt purchases.
There are several reasons why a business’ purchases might be exempt from sales tax, and those reasons can each have their own type of certificate. Let’s take a look.
4 types of tax exemption certificates
Because nothing associated with the US sales tax system is easy, there are actually several different types of sales tax exemption certificates your business may qualify for or receive from your customers, including:
- Entity exemption certificates
- Usage-based certificates
- Resale certificates
- Direct pay certificates
1. Entity exemption certificates
Certain types of entities – such as governmental bodies and some nonprofits – qualify to purchase items tax-free for their own use. These organizations qualify for “entity exemption certificates.”
2. Usage-based exemption certificates
Others qualify based on the way they’ll be using their purchases. Retailers that are purchasing items to resell, for example, are typically issued usage-based resale certificates. Contractors who will be working on governmental projects may qualify for usage-based exemption certificates as agents of a government entity.
3. Resale certificates
A resale certificate is used by US businesses who are buying products for the purpose of reselling them to end consumers. Sales tax isn’t applied until the product reaches the end consumer. Therefore, these businesses’ wholesale purchases are usually tax-exempt, and they need a “resale certificate” to prove that.
4. Direct pay certificates
Yet another type is the direct pay certificate, which is most often used by companies that purchase both tax-exempt and taxable goods at the same time. Companies using these certificates promise that they’ll handle their tax calculations and remittals on their own.
Do sales tax exemption certificates expire?
Some tax exemption certificates do expire, although the expiration date depends on your state and entity type. In certain states, such as Texas, your resale certificate will not expire as long as none of the essential business information has changed.
How long are tax exemption certificates good for?
Tax exemption certificates last for one year in Alabama and Indiana. Certificates last for five years in at least 9 states: Florida, Illinois, Kansas, Kentucky, Maryland, Nevada, Pennsylvania, South Dakota, and Virginia.
If you hold a tax exemption certificate in one of these states, make sure you renew as required to avoid possible penalties.
And if you sell to certificate-holding customers in one of these states, you’ll need to flag when their certificates expire so that you can request new ones with enough time to receive the updated information before purchases go out.
How to get a tax exemption certificate
Getting a tax exemption certificate involves several steps that probably vary depending on your location and your type of business or organization. In general, the process involves the following steps:
- Determine your eligibility
- Register your business or organization
- Apply for federal recognition (in the US)
- Pay application fee
- Apply for state-level exemption
- Look into local-level exemptions
- Stay tax-compliant!
1. Determine your eligibility
First things first, you have to understand the specific criteria for tax exemption and whether your organization fits the bill. Common categories include:
- Religious organizations
- Educational groups and institutions
- Nonprofit organizations
The criteria could also include something about the legal structure of your organization. Typically, tax-exempt status is granted to organizations registered as nonprofits or entities with a specific charitable purpose. More on that in the next points!
2. Register your business or organization
Your business must be registered with the state or local authorities where you are located. This may involve filing articles of incorporation or other official documents. It could also mean simply registering for sales tax, even though you will eventually have a tax-exempt status. Here are some tax registration guides by state and country!
3. Apply for federal recognition
If seeking federal tax-exempt status in the United States, apply for tax exemption from the IRS by filing Form 1023 (for most organizations) or Form 1024 (for certain other types). These forms are available on the IRS website.
4. Pay application fee
Just so you know, there’s usually a fee that comes along with applying for federal tax-exempt status. The fee amount can vary depending on the type and size of the organization.
5. Wait for approval
After submitting your application, be patient! The IRS will review your request, and the process could take several months.
6. Apply for state-level exemption
In addition to federal recognition, some states may require a separate application for state-level tax exemption. We’ll list some of those states below, with links to their sales tax exemption forms!
7. Look for local exemptions
Some local jurisdictions, like cities or counties, may have additional requirements for tax exemption. Check with your city or county tax office for any local exemptions that may apply.
8. Stay tax compliant!
Once granted tax-exempt status, it's crucial to comply with ongoing filing and reporting requirements. You also need to make sure your certificate is always up-to-date. Failure to do so could jeopardize your organization's tax-exempt status, plus cause other legal trouble for your business. For example, if you’re audited and can’t provide a valid tax-exempt certificate, you will be on the hook for paying the missing taxes.
Remember, the process and requirements can vary, so check with a tax professional or legal advisor to make sure you’re following the specific regulations for your business!
Guide to exemption forms by state
Below you’ll find direct links to the sales tax exemption forms by state, focused on the most popular US states. In some cases, you’ll need to select the form that matches your business from a list of various exemption certificates.
Tax Exempt Form California, all CDTFA forms
Connecticut Tax Exempt Form, all CERT forms
Tax Exempt Form Florida, Form-DR5
Idaho Tax Exempt Form, ST-101
Indiana Tax Exempt Form, ST-105
Iowa Tax Exempt Form, 31-014
Maryland Tax Exempt Form, SUTEC
Michigan Tax Exempt Form, 3372
Missouri Form 149 for Tax Exemption
New York Sales Tax Exemption Form, all ST forms
NC Tax Exempt Form, E-595E
PA Tax Exempt Form, REV-1220
Tennessee Tax Exempt Form, SLS-450
Texas Tax Exempt Form, all AP forms
Utah Tax Exempt Form, TC-721
Virginia Sales Tax Exemption, all ST-forms
Wisconsin Tax Exempt Form, S-211
Does tax exemption and other sales tax compliance sound like a pretty big hassle? We agree. That’s why businesses trust Quaderno. Our automated sales tax management platform takes care of tax compliance for you, so you can focus on what you do best. Give us a try with a free trial.
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.