Sales tax, income tax, and use tax: What are the main differences?
Small business taxes come in several forms — including sales tax, use tax, even income tax, depending on your business structure, what you sell, and where you sell it.
How do those different taxes apply to your business? When do you have to collect sales tax? Who pays use tax? And how does income tax factor in?
Here’s a quick primer you might find helpful whether you’re just getting your business started, you’re making changes, or you simply want a refresher.
You’re no doubt well aware of individual income tax, but does your business need to pay income tax as well? Are there specific taxes for business owners? In this instance, your business structure can make all the difference. For example, if you operate as sole proprietor or LLC, your profits and losses are reported on your personal tax return (after you deduct expenses) — the business itself pays no income tax. It’s similar for S corporations, but C corporations, which are larger, pay corporate income taxes (and you’ll still need to pay individual income tax on your salary).
There are advantages and disadvantages to each kind of business structure, and you’ll want to consider the tax consequences when setting up (or considering a change to) your business.
Businesses that sell certain products or services must collect sales tax, depending on where they have nexus — a connection to a particular state or jurisdiction that can be triggered by where your business is located, where customers are located, or even where inventory or a warehouse is located. As a result of the recent Supreme Court ruling in the case of South Dakota v. Wayfair, Inc., there are a lot of new sales tax rules to remain aware of (check them out here). It’s also important to remember that while your business is responsible for collecting and remitting sales tax, your customers are the ones actually paying the tax when purchasing items or services from you.
If you don’t collect sales tax from customers when you should, your business could be the one on the hook. For example, if a state learns you haven’t been charging sales tax on taxable items, it might pursue payment of those taxes from you — even long after you made the sales.
This is a tax that confuses many small businesses, as well as customers. It applies when something is purchased that should be subject to sales tax, but the tax wasn’t paid for some reason. Say a buyer lives in Washington state, which has sales tax, but purchases a computer in Oregon, which doesn’t charge sales tax. The buyer is supposed to report that purchase to Washington and pay the appropriate tax (which in Washington is the same amount as the sales tax would have been). Many people don’t realize they’re supposed to do this, and even many who do know simply decide not to report and pay.
Use tax applies to business purchases, too, unless your purchase is in an exempt category. States can pursue payment of this tax either from buyers or sellers — so there can be risk involved in not collecting sales tax for out-of-state buyers, or not reporting purchases you make in a state with no sales tax or a lower tax than your state charges.
There’s not enough room here to get into all the details for these taxes, because so many different factors can apply. A tax professional can help you determine your specific responsibilities and obligations when it comes to income tax; Avalara solutions can help you make sure you comply with your sales and use tax obligations.
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
Stay up to date
Sign up for our free newsletter and stay up to date with the latest tax news.