The following principle should be locked into every taxpayer’s mind: a transaction is not tax-exempt unless it’s supported by documentation that’s acceptable to the taxing authority. If you lose the documentation or fail to obtain it within the required time frame, you’ll probably lose the deduction, no matter how legitimate it might otherwise be.
In most jurisdictions, exemption certificates are the primary documents needed to support deductions for transactions that would otherwise be taxable. Transactions or activities that are excluded from the tax base, such as installation labor in most states, can generally be supported by ordinary records such as sales invoices, work orders, contracts, and similar original documents. Sales of non-installed property shipped to customers in other states (i.e., sales in interstate commerce) may be supported by shipping documents such as bills of lading and carrier receipts.
The resale certificate is the most common type of exemption certificate. A resale certificate is an affidavit provided by a purchaser to a seller, stating that the purchaser is buying the subject property for resale. The buyer fills out the certificate, signs it, and gives it to the seller so the seller can document the deduction when she claims it on her sales tax return for the period of sale. Generally the certificate must include the buyer’s sales tax permit number, address, business name and nature, a description of the property being purchased, and, of course, a statement that the property is being bought for resale. (Note that the words “for resale” should be specifically stated. Most jurisdictions will not accept overly general descriptions such as “nontaxable” or “exempt.”)
Alabama, Mississippi, and Oklahoma don’t employ resale certificates, so in these states, the seller should write the buyer’s sales tax permit number (and indicate “for resale”) directly on the relevant sales invoice. The invoice should also include the buyer’s name and address and should clearly state the nature of the property sold.
Florida, Maine, New Mexico, and Washington issue preprinted reseller forms to businesses that resell property. The businesses, in turn, must provide copies of these forms to their vendors to avoid being taxed on merchandise they buy for resale.
In addition to resales, most states require sellers to obtain exemption certificates for other types of nontaxable sales of items within their tax bases. Such sales might include property that’s nontaxable because of its intended use (e.g., in manufacturing) or because the buyer is a tax-exempt entity. California, D.C., Hawaii, Illinois, and Ohio require contractors to issue specialized exemption certificates (and not resale certificates) when buying materials that will be incorporated into realty in a different state.
Both the Streamlined Sales Tax Governing Board and the Multistate Tax Commission have developed general purpose exemption certificates that may be used for a variety of purposes in participating states. The certificates can be accessed at www.streamlinedsalestax.org and www.mtc.gov, respectively. Each form lists the states where it may be used and, where applicable, each state’s individual limitations.
Most states that are not part of the Streamlined Sales Tax project or the Multistate Tax Commission require exemption certificates (including resale certificates) in their own specified formats. Many states have one all-purpose exemption certificate, and others have individual certificates for each type of exemption. (Connecticut has more than 40 such forms.) These certificates can be found at each state taxing agency’s website.
Auditors often will disregard an exemption certificate if they suspect it was not taken in good faith. For example, a resale certificate issued by a contractor for the purchase of a backhoe would at least be questioned unless the contractor was also in the business of selling such equipment. Exemption certificates that are only partially filled out are also likely to be disregarded.
In most states, exemption certificates are good until affirmatively revoked by the issuer. In some states, however, the certificates are only good for a specified number of years. In any case, it’s advisable to request updated certificates periodically (every three years or so), if only to keep up with customer name and/or address changes. The older certificates should be retained along with the updated versions, since some states will not treat the new ones as valid for periods before their issue dates.
Any questions and comments about exemptions documentation? Feel free to submit below...
Construction contracts with exempt entities will be the subject of next month’s article. (BTW - Let us know if there are any particular issues you'd like us to address in that post.)
Other recent “Construction / Contractor Tax” posts by Dan Davis:
- Arizona's New Contractor Tax Rules: Watch for Misleading Terminology!
- Contractors: Watch Out for Arizona Tax Changes
- Construction Contracts with Exempt Entities (State Breakdown)
- Supporting Your Exemptions: Acceptable Documentation
- Common Construction Exclusions and Exemptions