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Finance 101: Understanding Use Tax

If you think you can stock up goods from a different state that has zero sales tax and use it in your native state. You’re sadly mistaken! There is no way you can skip sales tax. But, knowing better about it can save you a lot of hassle. Even though you make a purchase from a zero sales tax, you are required to pay sales tax to your state government. This self-assessed sales tax is called Use Tax.

In this article, we will discuss:

  1. What is Use Tax?
  2. What is the Difference Between Use Tax and Sales Tax?
  3. How to Calculate Use Tax
  4. How is Use Tax Related to Nexus
  5. Useful Resources

What is Use Tax?

Use tax is a sales tax applied on purchases made outside the physical boundary of one’s native state or jurisdiction. It is valid on the purchase of taxable items that are to be consumed, or used, or stored, in one’s state of residence but on which no tax was collected in the state of purchase. Say, you buy 100 packets of soap from state A where you don’t have any sales tax on soap and you are a resident of state B where soaps are taxed at 5%. In that case, 5% use tax will be due on you. It will be under your responsibility to collect and remit that sales tax to your state government.

Use tax is the government's way of ensuring protection to in-state retailers against unfair competition from outside the state sellers that aren’t required to collect sales tax. It applies in most states. Use tax is different in different states, just like sales tax. Another major benefit is, the Use Tax laws ensure all the residents of a state, regardless of where they shop, help fund the state and local programs. This helps the state prosper by keeping unfair trade competition at bay. Not paying Use tax is a punishable offence and is subject to interest and penalties.

Fact: All the 45 out of 50 U.S. states plus the federal District of Columbia have a use tax law, as of 2020.

What is the Difference Between Use Tax and Sales Tax?

Like state tax, Use tax is also charged upon the end consumer of the tangible good or service. But there’s a stark difference between the two, in who is required to calculate the tax and remit it to the government. The sales tax is collected by the seller. The seller of a particular state acts as its agent, who collects sales tax from its consumers on the purchase of goods or services and remits the tax to the state on the behalf of the consumer. Looks easy, right? The challenge is in the collection of the Use tax. Typically, the Use tax is self-assessed and remitted by the end consumer himself. This is why Use tax is so difficult to enforce. In general, Use tax is only applied to sizable purchases of tangible goods.

Example for Understanding Use Tax

The Use tax rate is basically the same as the sales tax rate of the state of the residence. It includes state and local sales taxes. It ranges from 0% to 16%; and varies in state-to-state. Here’s an example –

Let’s suppose, you are a resident of California and you are required to pay 5% sales tax on alcohol, home decor, gifts, books, CDs, appliances, toys, automobiles, clothing.

  • Case 1:

Now, if you buy clothing from a nearby California retailer, the retailer will collect 5% sales tax from you and remit the tax to the state. In this case, no use tax is due on your part.

  • Case 2:

Say, you’ve bought home decor online from a retailer in Michigan. Under Michigan State law, the retailer does not collect sales tax on the goods he sells. In this case, you’re liable to pay 5% use tax on the home decor purchase to the California tax authority called the Board of Equalization. However, if you had bought cereals from the same retailer, you would not be required to pay any use tax, because cereals are not taxed by the state of California.

How to Calculate Use Tax

Say, your state sales tax is 10% on alcohol. And your county sales tax rate is 5%. But, you choose to buy alcohol from another state which has 0% sales tax and no local taxes. How much Use tax do you owe to your state?

You will owe a fat 15% (10% + 5%) use tax on the purchase of the alcohol to your state. So, if you made a purchase of $300. Your Use tax liability will be 15% of $300, which is $45.

How is Use Tax related to Nexus?

Before branching into consumer use tax and seller use tax, you must know the concept of nexus. Whether sales tax or use tax applies on a purchase depends completely on sales tax nexus. The sales tax nexus is the connection between a seller and a state that allows the state to impose a tax collection mandate on the seller.

Commonly, retailers aren’t allowed to collect sales tax on the purchase of goods and services by consumers in states where the retailer does not have a physical presence (or nexus), like a shop, sales office, warehouse. In those situations, consumers have to calculate the sales tax and remit the tax to the state government. Whether or not your business owes sales taxes to a particular government depends primarily on the way that government defines nexus.

Useful Resources

Remember you can report Use tax while filing your tax returns. Sometimes tax returns can get really complex and seeking professional help can be the only way out. Here’s a list of resources that can come to your rescue at those hours-

Tax Group Center, LibertyTax and Visor offer services that keep you updated with the latest changes in tax systems and help file your taxes without having to do your own research.

You file your taxes for free via TaxAct.

For help with tax extensions, in particular, consult TaxExtension.com. It is an IRS-certified portal that can guide you through the process of filing for extensions on your taxes.

TaxSlayer and EZTaxReturn help you get the tax refunds you are owed without a hassle. It guarantees 100% accuracy.