A business tax exempt certificate, also referred to as a sales tax exemption certificate, is documentation that allows for purchases to be made tax-free. Typically, a purchaser will present a tax exempt certificate to the seller, who in turn will sell goods or services without charging sales tax.

Sales Tax Exemptions

Business owners who maintain a physical presence in any state must register to collect sales tax if they are generating sales on taxable goods. To clarify, a business owner must collect sales tax on any sale in the state where the entity is registered, unless a valid exemption is applied. There may be certain sales tax exemptions based on the nature of the item being sold or the purchasing entity.

Common Types of Exemptions

There are many forms of tax exemptions, but one thing they all have in common is that they entirely eliminate or reduce the obligation to pay tax. Common types of tax exemptions include:

  • Type of good: There are items that may be legally exempt from tax, including specific services, intangibles like digital goods, and real property. Some goods often are exempt from sales tax or are taxed at a lower rate. These types of tax exemptions don‘t require any formal documentation. For example, goods of necessity are services and products that consumers must buy regardless of income level. Necessity goods may include such items as:
    • Food
    • Medicine
    • Clothing
    • Water
  • Type of use for goods sold: Resale exemptions occur when products are resold in the same condition in which they are purchased. Additionally, tax exemptions may be allowed when goods are either processed or made into other goods prior to resale. Certain industries have special tax exemptions including manufacturing, agricultural, and industrial processing.
  • Type of purchaser: Any goods that are sold to the federal government cannot be taxed. Similarly, tax exemptions may also be available to the following agencies:
    • State and local governments
    • Nonprofit organizations
    • Religious, education, or charitable groups

Exemptions for Resellers

Resale exemption is the most common type of exemption. Resale exemption occurs when goods are purchased and then resold in the same form in which they were originally bought. Later, when a reseller sells the goods at the full-selling price, they are required to collect sales tax.

Once a seller receives a sales tax registration number, they can begin collecting sales tax. A sales tax registration number is needed to complete a resale certificate which will be presented to suppliers. States that allow for resale exemptions require proof of a state-issued resale certificate. Additionally, some states accept a multi-state resale certificate that can be issued by the Multistate Tax Commission (MTC).

It is important for resellers to be aware of the rules and limitations surrounding resale exemptions. Remember, in order to properly use a resale certificate, purchased merchandise must be resold by the business. To clarify, if a company purchases items tax free and later consumes or uses those items, that company will now owe tax on those purchases as the end consumer.

In this scenario, the tax is referred to as “use tax.” At the time of sale, a purchaser should never sign a resale certificate if they do not know whether the goods will be resold or used for another purpose.

Exemptions for Drop Shipments

Drop shipping occurs when retailers do not keep items in stock, but rather transfer customer orders and shipment information to a wholesaler, manufacturer, or another retailer. The goods are then shipped directly to the customer. This method is often referred to as supply chain management.

Drop ship taxation can be very complicated. Often a retailer is not registered in the state where the goods are being shipped to, but the shipper or supplier is. If a seller has a presence in a state and is registered to charge sales tax, they must collect sales tax on every taxable sale that is delivered into the state.

Exemptions For Manufacturers (or Purchasers of Raw Materials)

To qualify for a tax exemption, it is the responsibility of the purchaser to prove that they properly meet exemption requirements. Typically, this means having the appropriate documentation to meet each state's requirements. In most cases, an exemption certificate is necessary to prove meeting tax exemption requirements. Retailers must request and retain a copy of a purchaser's exemption certificate. If documentation is not presented, then the sale must be deemed taxable.

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