The difference between sales tax and use tax
There’s more to sales tax compliance than sales tax. At one time or another, most businesses also deal with use tax, which comes in two types: consumer use tax and seller use tax. Though all three are often lumped together as “sales and use tax,” there are important distinctions between them.
To properly register a business with a state and correctly file and pay sales or use tax (or sales and use tax), you need to understand what each tax is, which situations call for each type of tax, and if/when you’re responsible for remitting sales tax, consumer use tax, and/or seller use tax. Read on to deepen your understanding of all three.
What is sales tax nexus?
Before diving into sales tax, consumer use tax, and seller use tax, we need to define the concept of nexus. Whether sales or use tax applies to a transaction depends primarily on sales tax nexus, the connection between a seller and a state that permits the state to impose a tax collection obligation on the seller.
When a business has sales tax nexus in a state, it’s required to collect and remit sales tax in that state. In certain situations, it may also have to remit consumer use tax.
When a business doesn’t have sales tax nexus in a state, it generally can’t be required to collect sales tax or pay consumer use tax. However, it may be required to collect seller use tax. More on that below.
How and when sales tax matters
Sales tax (or retail sales tax) is a transaction tax imposed by states and thousands of local jurisdictions on a sale — the transfer of a product or service from a seller to a consumer.
But someone needs to collect the tax, and it would be costly and awkward to station a tax collector in every shop to collect sales tax from each individual consumer. So, the task falls on the businesses that make sales. Approximately half of all states with a general sales tax are “vendor states,” meaning sales tax is legally imposed on the seller who may — but isn’t required to — pass it on the customer. (Most, if not all, businesses do pass it on to consumers because they’d have to pay it themselves if they didn’t.) The remaining states are “vendee states” in which the seller is legally obligated to collect sales tax from the buyer — they’re not allowed to pay the tax themselves (also called “absorbing the tax”).
Once a seller collects sales tax, it must hold it in trust until it can file a return and remit the collected tax to the proper tax authorities. If it doesn’t, it’ll be penalized for not collecting, filing, and/or remitting the sales tax. It’s a crime for a seller to keep collected sales tax revenue as one’s own: Sellers that fail to remit sales tax as required by law may face criminal charges in addition to financial penalties and interest charges.
Did you know? In some states, what feels like a sales tax to consumers may not actually be a true tax on the sale. For example, instead of a sales tax, Hawaii imposes a general excise tax (GET) on businesses, which aren’t required to pass it on to their customers (though most do); and New Mexico imposes a gross receipts tax on “persons engaged in business in New Mexico for the privilege of doing business in New Mexico.”
Understanding consumer use tax
Nexus is a key element in consumer use tax, too.
When a seller makes a sale in a state where it doesn’t have nexus, it typically can’t be required to collect “sales tax.” However, that doesn’t mean the transaction is somehow magically exempt. If a seller doesn’t collect sales tax on a taxable sale, the purchaser or consumer is required to remit corresponding use tax to state and/or local tax authorities.
Consumer use tax is also due when consumers make a taxable purchase in jurisdictions with a lower rate of tax than the one in their home town. For example, if you live in sunny Sequim, Washington, buy a motor home in tax-free Oregon, and store it in Sequim when you’re not on the road, you’ll likely owe Sequim’s 8.8 percent consumer use tax. If you buy it in Boise, Idaho, where the sales tax rate is 6 percent, you’ll likely owe the 2.8 percent difference. In both instances, the burden to report and remit consumer use tax falls on the buyer, not the seller.
The same is true when items are purchased abroad for use at home. While you may not get a tax notice for failure to pay consumer use tax on a £15 book purchased in London, don’t be surprised if the tax authorities go after consumer use tax on a rug purchased in Istanbul for 150,000 Turkish Lira.
Did you know? While sales and use tax rates are often the same, they can be different. Some jurisdictions don’t levy a use tax, while in others the rate is different than the sales tax rate.
Both businesses and individuals can owe consumer use tax. Individuals typically owe it when they purchase a taxable product or service from a seller who doesn’t have nexus and isn’t required to collect sales tax in that state. Since businesses also purchase items, they can owe consumer use tax in this way.
A business also owes consumer use tax when it uses an item purchased exempt from tax for resale. For example: If a café makes an exempt purchase of mugs to use at the café, and then gives some of those mugs to employees as gifts, it owes the state use tax on those mugs.
Failure to properly remit consumer use tax is a common cause of negative audit findings among businesses.
Understanding seller use tax
Consumer use tax isn’t the same as seller use tax (aka retailer use tax, vendor use tax, or merchant use tax).
Seller use tax applies when a vendor makes a sale to a customer in a state where it doesn’t have a physical presence but is registered to do business. Put more simply, if your business has a physical presence in a state, you’re generally required to collect sales tax; if you don’t have a physical presence in a state but do have an obligation to collect tax there, you’ll typically have to collect seller use tax.
There’s a lot more seller use tax being collected these days than there used to be. On June 21, 2018, the Supreme Court of the United States overruled a physical presence rule that long prevented states from taxing remote sales. In the South Dakota v. Wayfair, Inc. ruling, the court found a business’s “economic and virtual contacts” with a state to be a sufficient basis for nexus.
More than 30 states have adopted remote seller sales tax laws since the June ruling, and more will follow suit this year. That means more states are requiring businesses to collect and remit seller use tax.
It's all in the name
Confusingly, some states refer to both consumer use tax and seller use tax simply as “use tax.” And when talking about a remote seller’s obligation to collect tax some state tax authorities use the term “sales tax.” This is likely due to the fact that seller use tax is more of a court-created concept than a state-created concept.
For example, the Illinois Department of Revenue says certain remote sellers making sales to Illinois purchasers must collect “Illinois use tax.” Similarly, Washington uses the term “use tax” to describe the tax consumers owe when sales tax isn’t collected by the retailer, and the tax a remote seller collects (though it also uses the term “sales tax” or “sales/use tax” for this).
Still, nomenclature matters. It’s essential you know where you have an obligation to collect and remit sales tax, consumer use tax, and seller use tax, and that you’re properly registered to do so. Avalara Licensing can help you get registered in all states and local jurisdictions.
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
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