Sales tax isn’t on the receipt—that doesn’t mean you won’t owe tax! Use tax is a sneaky transaction tax that many business owners don’t see coming. This is your guide to understanding use tax vs sales tax.
In this article:
- What is use tax?
- Use tax vs sales tax
- How to calculate and pay use tax
- Use tax notice and reporting
What Is Use Tax?
Use tax is a transaction tax passed through to the customer. It sometimes is referred to as consumer use tax or compensating use tax. It applies to any purchases made from an out-of-state business, not subject to a state sales tax. Where sales tax would have been collected and remitted by the in-state seller, use tax is paid by the buyer.
Use tax is designed to level the playing field between in-state retailers who are required to collect tax, and some out-of-state retailers who are not — California Department Of Tax And Fees
Technically everybody should be paying use tax, individuals and businesses alike. Since large purchases are generally made by businesses they bear the brunt of the law. States are very concerned with use tax revenue because just like sales tax, it goes to fund state programs. So companies are responsible for calculating and paying use tax on any purchases not charged sales tax, or risk an audit.
What Is The Difference Between Sales Tax And Use Tax?
They are referred to as “companion taxes” and virtually the same thing. The only difference is by who and how use tax is paid. Usually, businesses that have physical or economic presence in a state collect and remit sales tax for the customer. Use tax is the purchaser’s responsibility, and if tax liability is low it is included on the annual tax return.
What Is A Taxable Purchase For Use Tax?
Usage is the keyword and determining factor for which items are taxed. How you “consume,” “use” or “store” items for your business. Purchases made by phone, web, mail, in person, and internationally are all subject to use tax. Plus the item can be reviewed long after the transaction has taken place.
These are common taxable purchases for businesses:
- Property: title, rental or lease transfers
- Fixed assets
- Promotional giveaways
- Charitable donations
- Services (applicable in some states)
Since each state regulates use tax, they vary on what items are taxable or exempt. If items are intended for resale and you didn’t pay sales tax, you must pay use tax. A good rule of thumb—if your state doesn’t charge sales tax on the item, it is likely you do NOT owe use tax.
For Example: You purchased computer equipment for your SaaS company from Oregon, and you were not charged sales tax. The items are for use in your resident state of Colorado. Since Colorado charges sales tax on computer equipment items, you owe use tax.
When Do Individuals Need To Pay Use Tax?
It is hard to force individuals to pay use tax. Individual reporting runs on the honor system and usually transactions under $1000 don’t get attention if they go unreported. However, if an individual makes a large purchase it is wise to report it on an annual tax return.
Top items that individuals pay use tax on:
- Luxury items: jewelry, clothing, shoes, etc
- Tech gadgets
What Is Sellers Use Tax?
Sellers use tax is the same as sales tax. It is also known as retailers use tax or vendors use tax, and applies to remote sellers with economic nexus in a certain state. Tax is collected and remitted by the out-of-state seller, just like a sales tax would be. It is called use tax and not sales tax because in some states it is remitted on a use tax return, NOT a sales tax return.
Use Tax Penalties And Fines
Auditors spend a lot of time with use tax compliance. They are looking for businesses who have made purchases across state lines and did not properly pay tax. The most common items that are flagged: expenses, fixed assets, and inventory transfers.
Mismanaging use tax can be a costly error for the company checkbook. States will charge 1-30% negligence penalties for paying the wrong amount or paying late. If you are intentionally avoiding taxes you will be slapped with criminal charges and hefty fines.
How To Calculate, Pay, And Report Use Tax
To calculate use tax, you multiply the same rate as the local sales tax rate. Very few states have differing use tax vs sales tax rates. In destination-based states, taxes are regulated by each municipality, so use tax rates slightly differ. Some states require taxes, fees, shipping and handling charges be included in the taxable balance.
If sales tax isn’t collected, neither is use tax. There are 5 states that currently collect NO sales tax, nicknamed NOMAD for: New Hampshire, Oregon, Montana, Alaska, and Delaware. Don’t throw caution to the wind, even though they don’t mandate statewide sales and use tax, some of their municipalities do.
For Example: You purchased computer equipment for your SaaS company from Oregon, were not charged sales tax. The items were shipped to your residence in Greenwood Village, CO which has a sales tax rate of 7.25%. However, you will be using the equipment at your business in Broomfield, CO which has a sales tax rate of 8.15%. You owe 8.15% use tax to the state of Colorado.
How To Pay Use Tax
There are a couple ways to pay use tax. The approach you take will depend on your tax liability, and whether you have a sales tax license.
- Report use tax liability on annual tax return. Some states provide a simple use tax table to pay a specified amount based on your adjusted gross income.
- If you have a state sales tax permit, file use tax on an use tax return or state sales tax return. For businesses it is important to know if your payment schedule is monthly, quarterly, and annual. Otherwise you could be charged late fees
eCommerce Use Tax Notice And Reporting Laws
A few states have use tax notice and reporting laws for out-of-state online retailers. These are laws for non-collecting retailers that don’t have sales tax nexus in a state and therefore don’t charge sales tax. These laws are a nuisance to retailers because states want to generate more revenue via use tax payments or sales tax permit registration and collection.
When company sales reach a certain threshold in a state, out-of-state businesses are required to report all transactions subject to use tax. Furthermore, they must send out notices to buyers, at the end of the year, about their use tax liability. Some states do have pricey fines for non-compliance, upwards of $20,000. Remember: this is NOT collection and payment, it is notice and reporting.
11 states have use tax notice and report laws:
- Rhode Island
- South Dakota
Sales And Use Tax Automation - Did You Know?
Sales and use tax laws can be burdensome. Since it is up to the state to regulate, tax rates are always changing. If you’re making more than $100,000 in annual revenue, you should consider automating your sales and use tax with software like TaxJar and Avalara. Always consult with a tax professional to understand your use tax vs sales tax liability.