Complying with your sales tax obligations involves a lot of variables – your nexus, taxability of your products, type of customer you are selling to, etc. Another key factor that affects your sales tax obligations is related to exempt transactions and exemption certificates.
Exemptions are statutory exceptions eliminating the need for the retailer to collect sales tax on a particular transaction or on all transactions with a customer. The most common exemption is a “sale for resale,” which allows businesses to purchase products free of tax with the expectation that the business will subsequently sell the product and collect the applicable sales tax at that time. Other exemptions can apply to transactions with special entities like government organizations and nonprofits.
Businesses who believe their purchases are exempt must obtain and provide an applicable exemption certificate to their vendor. The vendor then has an obligation to apply a level of due diligence in accepting the exemption certificate.
Sellers create sales tax exposure when they don’t charge sales tax and don’t request and review an applicable exemption certificate. In the case where an exemption applies (for example a resale transaction) then the seller has the opportunity to request a resale exemption certificate from their client even after the transaction has occurred.
However, what options does a seller have when there is no applicable exemption and they fail to collect sales tax? This is where the XYZ sales tax compliance letter comes into play. XYZ letters are commonly used when sales tax is due and the vendor failed to collect the sales tax and there is no applicable exemption opportunity.
ABCs of the XYZ Letter
As the seller, you are responsible for collecting and reporting the applicable sales tax (assuming you have sales tax nexus in the jurisdiction in question). As noted above, exceptions include when your customer made the purchase for resale, when your customer paid the tax directly to the state, or when your customer is exempt from sales tax.
An XYZ sales tax letter to customers serves as an affidavit that the sales tax obligation has been satisfied by the consumer. This is generally through a use tax accrual and payment by the customer to the state, or the customer is assessed under audit and pays the applicable sales tax due. The tax compliance letter will typically include the seller’s name and permit number; invoice numbers and dates (sometimes invoices are attached); a description of the property sold; and the amount of the purchase. The customer must then identify whether or not the use tax was paid, how much, and on which returns.
XYZ letters are a great tool to help minimize sales tax exposure. One of the downsides, is that if you are selling to small businesses, small businesses are less likely to have accrued and paid use tax or to have been audited. If your customers are larger, they will be more likely to have already satisfied the sales tax/use tax obligation. You may be able to rank your customers in order of their size and/or the amount of sales tax exposure to your business, and reach out to these customers first.
If you need help understanding your sales tax obligations and whether you should be collecting sales tax, get in touch. TaxConnex has experts to help answer these XYZ letter questions and to help you establish an ongoing process to ensure you remain compliant – even with the frequently changing rules of sales and use tax.
No matter how many states you're in or how often regulations change. It’s only possible because of our proprietary platform and network of sales tax experts. Sales tax is more complicated than ever, especially in a post-Wayfair world. Yet the providers who claim to simplify sales tax often still leave the hardest parts – and the liability – up to you. When you work with TaxConnex®, it’s all on us. This means you get all the know-how, all the backup, and none of the risk. That’s why everyone from big corporations and accounting firms to the latest online boutique all turn to TaxConnex. Now it’s all on us.®
