We’ve all heard of sales tax, but have you ever heard of use tax? If you haven’t, you’re not alone. In fact, many of my clients think the government is imposing a new kind of tax when they find out that this tax applies to them! In today’s post, I’ll help explain how use tax works and how to know if you owe it.
What is use tax?
Use tax is a tax that applies when sales tax wasn’t collected at the time you purchased a taxable item or service. In other words, if you live in a state that collects sales tax and you purchase something from out-of-state but aren’t charged sales tax on it, then you owe use tax to your state.
What is the purpose of use tax?
Please pardon this quick pause for a brief tax history lesson: States started implementing sales tax laws in the early 1930s. A few years later, they figured out that they should also collect use tax to keep things fair.
How does use tax keep things fair? Well, it keeps residents of a state from being able to avoid paying local sales tax by making purchases in states without sales tax. In current times, this also means that online vendors don’t have an unfair price advantage over local businesses who must collect sales tax at the point of sale.
Additionally, use tax is a guarantee that all items “consumed” within a state contribute to the local tax funds that are typically used to pay for things like public infrastructure, schools, social services, and safety.
Which states have use tax?
Every state that has a general sales tax also has a matching use tax. The only states without a statewide sales tax and use tax are Alaska, Delaware, Montana, New Hampshire, and Oregon.
How much is use tax?
In most states, the use tax rate is the same as the sales tax rate. There are a few exceptions like in Hawaii and in certain taxing jurisdictions in states like Alabama, Colorado, and Louisiana.
What types of purchases require buyers to pay sales or use tax?
This bit is confusing because each state has its own sales and use tax laws, so not only can states have different tax rates, but they also have different rules about:
- Which products are taxable
- Which services are taxable
- Filing requirements
- Exemptions
- Reporting methods
On top of that, if your business operates in multiple states, the rules can be even more complex.
If you’re a small business owner and have questions about use tax, you should work with a CPA to ensure that you’re complying with your state’s requirements and keeping your books clean and organized.
Who has to pay use tax?
Both individuals and businesses can owe use tax. Remember that use tax can apply to your purchase if you bought a taxable item from a seller that didn’t collect your state’s sales tax at the point of sale.
Many individuals and business owners unknowingly owe use tax because vendors fail to charge sales tax or don’t charge the correct amount for sales tax.
You may owe use tax if all 3 of these things are true:
- The item you purchased is taxable in your state.
- Sales tax wasn’t collected or not enough was collected by the seller.
- The item you purchased is used, stored, or consumed in your home state.
How do I pay use tax?
Many states allow individuals to report the amount you owe for use tax on your state income tax return or through a separate use tax form that can be filed at the same time you file your state income tax return.
For businesses, many states require businesses to report use tax on their regular sales tax returns.
Does buying something online mean you owe use tax?
No, most online retailers collect sales tax automatically because state laws mandate that remote sellers collect sales tax once they meet certain sales thresholds.
However, you may run into cases where smaller online sellers don’t collect your state’s sales tax. If they don’t, you may be responsible for paying use tax yourself.
Because of this, you should always review your receipts for online purchases, especially larger purchases, and definitely for any larger purchases your business makes.
How do small businesses keep track of use tax that they owe?
If you want to avoid surprise use tax bills, you can take these steps:
- Review your vendor invoices each month.
- If there are any purchases where no sales tax was charged, determine whether those purchases are taxable.
- Record any use tax due before filing your sales tax returns.
Many accounting software programs can help flag purchases that may require use tax, but they aren’t always perfect, so I recommend that you still review your receipts regularly, especially for large purchases of business assets.
What happens if you don’t pay use tax?
Since use tax can be difficult to enforce and collect, many people assume that states never do. While it’s true that smaller amounts may go unnoticed, businesses are often audited for sales and use tax compliance.
During an audit, states typically examine:
- Credit card statements
- Equipment purchases
- Expense accounts
- Fixed asset purchases
- Vendor invoices
If it’s discovered that you owe unpaid use tax, then you may owe back taxes along with interest and penalties. Because of this, it makes more sense to just keep track of use tax as you go so you don’t have to deal with an audit that may result in a higher tax bill.
When should you consult an accountant about use tax?
There are some situations where it’s smart to contact a CPA for help with use tax:
- You purchase equipment from out-of-state vendors.
- Your business regularly buys products online.
- You’re not sure if sales tax was collected correctly for something you purchased.
- You received a state sales tax audit notice.
- Your business operates in multiple states.
Abridged by Amy
Use tax isn’t a separate, extra, or new tax. It’s just the counterpart to sales tax when tax wasn’t collected at the time of purchase. For individuals and small business owners, use tax can come up after making large online or out-of-state purchases.
You just need to keep in mind that if sales tax wasn’t collected, your responsibility to pay tax for the good or service may not be over. Taking the time to review your purchase receipts throughout the year and to speak to a CPA when you have questions can save you time and money down the road.
