What Is Use Tax and How Does it Differ From Sales Tax?
Most people are familiar with sales tax. It's the tax added to the price of goods and services at the point of sale, a straightforward transaction where the consumer pays an extra percentage based on the purchase price. However, use tax is less commonly understood but equally important, particularly for businesses and individuals who purchase items from out-of-state sellers. So, what is use tax? Let's delve into the details.
What is use tax?
Use tax is a tax on the use, storage, or consumption of goods within a state when sales tax has not been collected at the point of sale. Essentially, it is a complementary tax to the sales tax, designed to capture tax revenue on transactions that fall outside the traditional sales tax system.
For example, if you purchase an item online from a seller in another state and no sales tax is charged, you are responsible for reporting and paying use tax to your state. Use taxes ensure that states receive tax revenue on purchases made out-of-state and help to level the playing field between in-state and out-of-state sellers.
The purpose of use taxes
The primary purpose of use taxes is to prevent tax evasion and to ensure that states can collect revenue on goods and services used within their borders. Without use taxes, consumers might avoid paying taxes by purchasing items from states with lower or no sales taxes. This would unfairly disadvantage local businesses and reduce state revenues.
Use taxes also support state budgets by funding public services such as education, infrastructure, and public safety. By ensuring that all goods and services used within a state are taxed, use taxes contribute to the overall financial health of the state.
Use tax vs. sales tax
Understanding the distinction between use tax and sales tax is crucial. Sales tax is collected by the seller at the point of sale and is remitted to the state by the seller. Use tax, on the other hand, is the responsibility of the buyer. It is self-assessed and paid directly to the state by the consumer when sales tax was not collected at the time of purchase.
Sales tax
- Point of collection: Collected by the seller at the point of sale.
- Responsibility: Seller's responsibility to collect and remit.
- Example: Purchasing a book at a local bookstore, where the store adds sales tax to your bill.
Use tax
- Point of collection: Paid by the buyer directly to the state.
- Responsibility: Buyer's responsibility to report and pay.
- Example: Buying a book online from an out-of-state retailer that does not charge sales tax.
Sales and use tax: a complementary relationship
Sales and use taxes are designed to work together. When sales tax is not collected, use tax steps in to ensure that the transaction is still taxed. This system helps states maintain a consistent tax revenue stream and ensures fairness among in-state and out-of-state sellers.
For example, a business in California might purchase office supplies from a vendor in Oregon, where there is no sales tax. If the vendor does not charge California sales tax, the business is required to pay California use tax on those supplies. This ensures that the transaction is taxed appropriately according to California's tax laws.
When does use tax apply?
Understanding when use tax applies is essential for both individuals and businesses to ensure compliance with state tax laws. Here are the key scenarios where use tax typically applies:
Out-of-state purchases
When you buy goods from an out-of-state seller who does not charge your state's sales tax, you are responsible for paying use tax. This situation often arises with online purchases, catalog orders, and purchases made while traveling.
- Example: You order a piece of furniture from an online retailer based in a state with no sales tax. Since the retailer does not collect your state's sales tax, you must report and pay use tax on the purchase.
Untaxed services
Some states impose use tax on certain services if those services are consumed within the state and were not taxed at the time of purchase.
- Example: You hire a consultant from another state to provide services for your business. If the service is taxable and no sales tax was collected, you must pay use tax on the service.
Equipment and supplies for business use
Businesses frequently purchase equipment and supplies from out-of-state vendors. If these vendors do not collect sales tax, the business must self-assess and pay use tax.
- Example: A construction company in Texas buys machinery from a manufacturer in another state that does not collect Texas sales tax. The company is responsible for paying Texas use tax on the machinery.
How much is use tax?
The rate for use tax is typically the same as the sales tax rate in the state where the goods or services are used. This rate can vary significantly from state to state and even within regions of a state, depending on local tax rates.
Who is responsible for paying use tax?
Both individuals and businesses can be responsible for paying use tax. While businesses are more frequently audited for use tax compliance, individuals are also required to pay use tax on out-of-state purchases that did not include sales tax.
For Individuals
- Personal purchases: If you buy a computer from an online retailer based in a state without sales tax and the retailer does not collect your state’s sales tax, you must report and pay use tax to your state.
- Remote sales: Increasingly, online retailers are collecting sales tax on behalf of the buyer’s state, but when they do not, the onus falls on the buyer.
For Businesses
- Business purchases: Businesses must track and report use tax on all purchases where sales tax was not collected. This includes office supplies, equipment, and even certain services.
- Audit risk: Businesses are often subject to tax audits to ensure use tax compliance, making it essential to maintain accurate records and ensure all use tax liabilities are met.
How to report and pay use tax
The process for reporting and paying use tax varies by state, but it generally involves the following steps:
- Determine the taxable amount: Calculate the total amount of taxable purchases where sales tax was not collected.
- Apply the use tax rate: Use your state’s use tax rate, which is usually the same as the sales tax rate, to determine the amount of use tax owed.
- File a return: Complete a use tax return form, which can often be done online through your state’s department of revenue or taxation website.
- Pay the tax: Submit the payment for the use tax owed along with your return.
Compliance and record-keeping
Maintaining compliance with use tax regulations requires diligent record-keeping. Businesses should keep detailed records of all purchases, including invoices and receipts, to document whether sales tax was collected. For individuals, saving receipts from out-of-state purchases can help track potential use tax liabilities.
Many states offer guidance and resources to help taxpayers understand and comply with use tax requirements. Utilizing these resources can help ensure that you meet your obligations and avoid potential penalties and interest for underpayment or non-payment of use tax.
Sales tax and use tax in the digital age
The rise of e-commerce has significantly impacted the collection of sales and use taxes. The 2018 Supreme Court decision in South Dakota v. Wayfair, Inc. has allowed states to require remote sellers to collect and remit sales tax, even if they do not have a physical presence in the state. This new requirement is commonly known as economic nexus. This ruling has increased sales tax compliance among online retailers, reducing the burden on consumers to self-assess use tax.
However, use tax still plays a crucial role in capturing tax revenue from transactions where sales tax is not collected. As online shopping continues to grow, both consumers and businesses must remain aware of their use tax obligations to ensure compliance with state tax laws.
Conclusion
Understanding use tax and how it differs from sales tax is essential for both individuals and businesses. Use taxes help ensure that states can collect revenue on all taxable transactions, promoting fairness and supporting vital public services. By staying informed about use tax requirements and maintaining accurate records, businesses and individual taxpayers can meet their obligations and avoid potential penalties.
As the landscape of commerce continues to evolve, staying up-to-date with sales and use tax regulations will be increasingly important. Whether you are a consumer making occasional online purchases or a business managing a large volume of transactions, understanding and complying with use tax laws is crucial for financial and legal peace of mind.
Do you need help with your sales tax compliance? Book a free call with one of our sales tax experts to find bespoke solutions for your business, optimize your tax costs, and reach millions of new potential customers.
Frequently Asked Questions
What is use tax?
Use tax is a tax imposed on the use, storage, or consumption of goods within a state when sales tax has not been collected at the point of sale. This ensures that states can collect revenue on purchases made from out-of-state sellers.
How does use tax differ from sales tax?
Sales tax is collected by the seller at the point of sale and remitted to the state. Use tax, on the other hand, is the responsibility of the buyer and is self-assessed and paid directly to the state when sales tax has not been collected.
When does use tax apply?
Use tax applies when you purchase goods or services from out-of-state sellers who do not charge your state's sales tax. It also applies to certain untaxed services and equipment or supplies bought for business use.
Who is responsible for paying use tax?
Both individuals and businesses are responsible for paying use tax. While businesses are more frequently audited for use tax compliance, individuals must also pay use tax on out-of-state purchases that did not include sales tax.
