Use tax

A use tax is a type of excise tax levied in the United States by numerous state governments. Use tax is essentially the same as - and is assessed at the same rate as - sales tax, but is applied not where a product or service was sold, but rather where a merchant bought a product or service then converted it for its own use but without having paid tax when it was initially purchased. Since it was not "sold" the product is not imposed a sales tax (which is collected at the time of sale) but instead the transfer imposed a use tax (which is collected when the taxed item is converted from inventory into something that is "used" by the seller). In short, the seller is presumed to have bought the (untaxed) item from themselves and at that time must pay use tax in lieu of sales tax.

Introduction

Use tax is assessed upon tangible personal property purchased by a resident of the assessing state for use, storage, or consumption in that state (not for resale), regardless of where the purchase took place. If a resident of a state makes a purchase within his home state, full sales tax is paid at the time of the transaction. The use tax applies when a resident of the assessing state purchases an item that is subject to his home state's sales tax but, is purchased from another state. Usually, this is due to out-of-state purchases, as well as ordering items through the mail, by phone, or over the Internet from other states. The use tax is typically assessed at the same rate as the sales tax that would have been owed (if any) had the same goods been purchased in the state of residence.

While there are many reasons for payment of use tax, the most common are self-dealing (an office supply dealer takes a case of paper off the stock floor and uses it for its own printers), or untaxed interstate sales (company purchases a product via mail order from a seller in another state, it is supposed to then pay the use tax to its home state).

For example, a resident of Massachusetts, with a 6.25% "sales and use tax" on certain goods and services, purchases non-exempt goods or services in New Hampshire for use, storage or other consumption in Massachusetts. Under New Hampshire law, the New Hampshire vendor collects no sales taxes on the goods, but the Massachusetts purchaser/user must still pay 6.25% of the sales price directly to the Department of Revenue in Massachusetts as a use tax. If the same goods are purchased in a US state that does collect sales tax for such goods at time of purchase, whatever taxes were paid by the purchaser to that state can be deducted (as a tax credit) from the 6.25% owed for subsequent use, storage or consumption in Massachusetts. With few exceptions, no state's vendors will charge the native state's sales tax on goods shipped out of state, meaning all goods ordered from out-of-state are essentially free of sales tax. The purchaser is therefore required to declare and pay the use tax to his home state on these ordered goods.

The assessing jurisdiction may make the use tax payable annually, but some states require a monthly payment. For example, where a Vermont resident has not paid at least 6% sales tax on property brought in for use in the state, Vermont law requires filing a tax return (Form SU-452 and payment) by the 20th day of the month following non-exempt purchases to avoid a $50 late fee, a 5% penalty per month, to a maximum of 25%, plus statutory interest on the unpaid tax and penalties.

Typical exemptions include purchases by charitable non-profit organizations or governmental agencies, purchases for resale in commerce, and purchases via "casual sales" by individuals not in the ordinary course of business. Also note that there are thousands of tax jurisdictions in the U.S. and many have ever-changing lists of specific types of goods and services that are not taxable.

As an illustration of the complexities: a 2006 Massachusetts law requires payment of tax on "pre-written" (not custom) software purchased and downloaded over the Internet for installation and use in Massachusetts, regardless of where it originates. However, the actual use of the same software downloaded by a Massachusetts resident to a server in another state remains a non-taxed "service". In contrast, Arkansas generally does not tax anything delivered over the Internet (such as downloaded software or music), except VoIP which is specifically defined as taxable "telecommunications services". Software (pre-written or custom) "delivered thru a tangible medium" (i.e., on disk) in Arkansas is taxable even if ordered online, except "custom software for a particular customer" which is non-taxable "programming services" even if delivered on a disk.

In most cases, this complexity is part of the underlying sales tax laws; but while a brick-and-mortar store has to deal with only the sales tax laws of its own location, remote sellers have to deal with the use tax laws of many jurisdictions—up to every US state and locality that assesses them, if the company has a presence or "nexus" in every state (as large "brick-and-mortar" sellers like Wal-Mart and Best Buy do).

Self-assessment

Not all use tax derives from sales transactions. There are also internal transactions a company might initiate that will trigger use tax consequences. For example, ABC Furniture Company buys its inventory tax-free with a resale certificate, then charges sales tax to its customers. But if this company removes furniture from inventory for use in the retail store by its sales staff, it has triggered a tax incident: use tax is due on the converted inventory that is being used, not sold. The states differ in the tax basis of such a transaction: some tax [cost], others [cost + overhead], and still others [cost + overhead + markup].

For another example, suppose a carpet manufacturer sends swatches of carpet to its sales people to use as samples. That is a taxable use of carpeting to the manufacturer (or distributor as the case may be).

Large manufacturers purchase many items that are used in both exempt and nonexempt manners. To facilitate determination of the correct tax due, they use a Direct Pay Permit that authorizes them to omit sales tax to their vendors, while requiring them to self-assess their purchases and remit the correct amount of use tax to the proper taxing authority.

It is also possible that equipment purchased under a manufacturing or mining exemption in one state is later relocated across a state line—into a jurisdiction where the exemption no longer applies. In this case, the company must recognize the book value of the capital item when it was relocated as the basis of the use tax due to the nonexempt state. Another form of use tax related to this example is referred to as reciprocity. Reciprocity is triggered when items taxed at a lower rate are transferred or put to use (subsequent to first use) in a taxing jurisdiction with a higher rate. The use tax due, where StateA is the sending state and StateB is the receiving state, is typically (((StateB rate - StateA rate) + local rateB) x tax basis). Most states do not offer reciprocity for their local rates, and they may have specific states they will reciprocate with or they may reciprocate on a quid pro quo basis with the other state.

Tax practitioners in large corporations must always be vigilant of transactions such as the above examples that trigger tax consequences for two reasons: to make sure they are in compliance with state laws, and to take advantage of all possible planning opportunities to minimize or avoid tax. Where the tax consequence is substantive and/or the law is vague, assistance will often be sought from outside professionals such as consultants, CPAs, or attorneys who specialize in sales and use tax and who keep up to date with the changing laws and case law history of the various states.

Enforcement

In 2007, 22 states [1] including New York, California, Ohio and Virginia have included an entry on their state individual income tax return for taxpayers to voluntarily calculate an amount for use tax liability. Taxpayers however have been reluctant to pay these taxes to the state. A few of these states have tried another approach by pre-determining the tax liability owed by every taxpayer via a tax table based on the individual’s adjusted gross income. For example, a Michigan taxpayer with $45,000 of income can use the state’s use tax table[2] to estimate his use tax liability as $36. Use of this table is limited, however, to purchases of less than $1,000 and may be challenged during an audit. For purchases over $1,000, the taxpayer must calculate the tax for each item and add this amount to the use tax from the table. States using this method have seen an increase in voluntary compliance over those states that have the taxpayers calculate the use tax themselves.

As the amount of e-commerce sales continues to rise ($34 billion for just the second quarter of 2008)[3] states recognize that the key to collecting these taxes rests not only in educating the individual taxpayer but with coordinating their efforts with other states. Currently, there are 19 full member states and 3 associate member states that belong to the Streamlined Sales Tax Project[4] (SSTP). The SSTP assists states in collection of sales and use tax by registering merchants who charge out-of-state consumers the appropriate state sales tax and remit the tax to the appropriate state through a certified service provider. SSTP has also been in the forefront of an effort to push Congress to amend the laws to make collection of sales tax less burdensome. In fact, in May 2013, the United States Senate passed a bill that would give the states authority to require sellers to collect sales tax on out-of-state sales. The House of Representatives must still pass the bill and send it to the President of the United States before it becomes law.[5]

States may also work with adjacent states via interstate use tax agreements.[6] These agreements allow states to exchange tax audit records from businesses that have shipped goods to out of state consumers. Reciprocal states will then use those records and send a tax bill including penalties and interest to the individual taxpayer.

States have also pursued their collection efforts through the court system. In 2007, a California appeals court[7] ruled that Borders Online owed California sales tax for online purchases that the store failed to collect from 1998 to 1999 since customers were able to return merchandise bought on-line to Border's retail stores in California.

See also

References

  1. ↑ Manzi, Nina (November 2007), Use Tax Collection On Income Tax Returns In Other States (PDF), St. Paul, Minnesota: Policy Brief, Research Department, Minnesota House of Representatives, retrieved 2008-09-26
  2. ↑ 2010 Michigan MI-1040 Individual Income Tax (PDF), Lansing, MI: Michigan Department of Treasury, December 2010, p. 9
  3. ↑ Winters, T.; King, C.; Davie, W. (August 15, 2008), "Quarterly Retail E-Commerce Sales 2nd Quarter 2008", U.S. Census Bureau, Washington, D.C.: Department of Commerce
  4. ↑ Peterson, Scott (July 1, 2008), "Governing Board States", Streamlined Sales Tax Governing Board, Inc., Nashville, TN
  5. ↑ "Senate Passes Bill to Widen Tax Collection on the Web". The New York Times. 7 May 2013 – via New York Times.
  6. ↑ "Connecticut/New York Cooperative Interstate Sales and Use Tax Administration" (PDF), Publication 904.1, Albany, NY: New York State Department or Taxation and Finance, February 2006
  7. ↑ Borders Online, LLC v. State Board of Equalization, 29 Cal.Rptr.3d 176 (California Appellate 2005).

External links

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