Strengthening use tax compliance through automation and internal controls

Consumer use tax, also known simply as use tax, is the yin to sales tax’s yang. Both are an important element of your company’s tax compliance. With added complexity required to monitor use tax compliance compared to sales tax, use tax can lead to increased compliance risk. This can result in use tax exposure, called underpayments, for your business if not properly managed. Use tax compliance errors can also lead to significant overpayments which can impact your company’s cash position.

Baker Tilly and Avalara recently held a joint webinar to explore common use tax pitfalls and best practice initiatives across a variety of industries. They shared how combining use tax compliance automation with a documented business process can reduce risk and the likelihood of accumulating compliance errors identified in audits.

Key takeaways

• Use tax is often overlooked, causing significant tax compliance and audit risk. Even when vendors charge sales tax, your business is still responsible for ensuring it was applied correctly. If no tax was charged, you (as the buyer/consumer) are responsible for self-reporting and remitting the use tax.
• Use tax compliance can be complex for certain industries. Many businesses buy both taxable and exempt goods and services. In many cases, the same item may be taxable in one situation and exempt in another, making manual review difficult to sustain at scale.
• A hybrid approach to use tax strengthens compliance. Combining intelligent use tax automation with streamlined and documented internal procedures can help reduce risk which gives the tax and finance teams additional time and resources to focus on other priorities.

What is use tax?

Use tax is complementary to sales tax. It is typically owed when sales tax has not been collected at the time of purchase. Every state that imposes sales tax also has a use tax.

There are significant differences between sales and use tax, particularly who is responsible for paying and reporting the tax. Sellers collect sales tax from buyers and remit it to state tax authorities. However, in the absence of a properly billed and paid sales tax (to a vendor), your business must determine and self-assess the consumer use tax and report it on your sales and use tax returns.

Figuring out how much use tax you owe can be tricky, and relying on manual processes alone can be both inefficient, inconsistent, and error-prone.

When does my business owe use tax?

Key reasons you can trigger a use tax obligation for your business include what you purchase, how you use it, and where you use it.

According to Michael Cantrell, a Director in the Baker Tilly State and Local Tax (SALT) practice, “For a business with significant and varied purchases, there is inherent risk in relying solely on vendors to properly determine sales tax.”

For instance, a vendor might undercharge sales tax or calculate the wrong sales tax rate on goods or services sold to your company. A supplier might apply an incorrect exemption. Vendors sometimes overcharge sales tax as well, in which case your business must correct the mistake with the vendor, seek appropriate and allowable credits/offsets, or file a refund claim with the state. Alternatively, a vendor may not be required to charge sales tax in the state where they shipped products or provided a remote service. In these situations, your business may have to self-assess use tax.

Other times, how you do business makes the difference. You could owe use tax if your company consumes taxable goods or services that your business bought tax-free. Another common scenario is if/when your company is shifting tax situs, such as when goods are purchased in a state without a sales tax or a low sales tax rate and are then transferred and used in a taxing state or a jurisdiction with a higher tax rate.

What industries typically have formal use tax management and compliance needs?

While any industry or business can have use tax compliance and reporting needs, the manufacturing, retail, health care, technology, and energy sectors often need documented and scalable use tax processes and tools to handle use tax reporting and compliance. Businesses in these industries commonly purchase and use both tax-exempt and taxable goods and services, often in large volumes, which can make compliance particularly complex. In some cases, an item’s use may be taxable in one case and exempt in another. If you work in any of these industries, use tax compliance may be a significant area of need.

Direct pay permits can be a useful part of your use tax compliance strategy when used judiciously because you don’t have to rely on a vendor to calculate sales tax correctly. They can help you budget use tax more accurately and may also potentially result in significant local tax savings. As a trade-off, you may be more likely to be audited if your company is issued a direct pay permit, so make sure you understand both the benefits and obligations.

What are best practices for managing use tax compliance?

An effective way to manage use tax compliance is to take a 2-pronged approach: 1) seek to replace manual processes, particularly with respect to large volume purchases, by leveraging automation and 2) ensure your accounts payable team maintains clear and useful documented procedures to oversee use tax compliance and reporting.

Even with automation, you need to ensure you have a proper use tax accrual process in place and understand your goods ordered (GO) system. Identify who in your company handles initiating and reviewing purchase orders. And know how and where your business purchases are used.

Taking a hybrid approach to use tax compliance means predictable, high-volume purchases, like those from recurring vendors, can be handled automatically. Tax professionals then provide expertise where it matters most, such as complex or high-risk scenarios like technology purchases, capital expenditures, and buying from new vendors.

Mo Huda, Principal at Baker Tilly, recommends targeting highest reasonable attainable accuracy on your use tax accruals, based on materiality threshold of purchases.

According to Huda, it’s important to maintain a continuous review process after establishing defined protocols and implementing automation. Pull a few sample invoices each month to make sure that vendors are collecting the right amount of tax. After manually validating the invoices are accurate, use automated validation to check them again.

How does automation strengthen use tax compliance?

An automated use tax compliance solution like Avalara AvaTax for Accounts Payable improves accuracy, saves time, and simplifies tax management. The solution consolidates use tax compliance for procure-to-pay processes in one centralized portal and connects to the ERP and procurement systems you’re already using through prebuilt integrations, API, or the AvaTax MCP server.

AvaTax for Accounts Payable uses AI and automation to identify underpaid and overpaid sales tax on your purchases and apply use tax owed on your returns. AI-powered rules adapt to purchase risk profiles and thresholds that let your business accept the amount a vendor charged, flag it for review, or auto-accrue. The solution automatically calculates the correct tax based on jurisdiction, taxability, and special rules, helping your business avoid penalties and interest for underpayments and resolve overpayments.

Scale confidently with greater visibility

With tax rules constantly changing and purchasing patterns evolving, tax and finance teams need clear visibility into their use tax obligations. Professional expertise supported by automation helps provide that clarity so you can confidently stay ahead of compliance challenges as your business grows.

FAQs about use tax compliance

What is a direct pay permit?

A direct pay permit is a special type of exemption that allows a buyer to purchase items tax-free from a vendor in exchange for self-reporting use tax on all their taxable purchases. A business that makes the direct pay permit election often has to meet statutory or regulatory requirements such as demonstrating the ability to self-report and remit use tax. AvaTax for Accounts Payable supports direct pay permits by automatically calculating and accruing the appropriate use tax within the Avalara platform.

How do I know if my business has use tax exposure?

Common indicators that your business may have use tax liabilities include purchases made across state lines, tax-free purchases that are later consumed internally, significant complicated spend categories (e.g., technology) and capital expenditures, and frequent vendor sales tax discrepancies. Reviewing these areas can help identify use tax compliance risk and related areas for improvement.

How is use tax different from sales tax?

Sales tax is collected by the seller at the time of purchase and remitted to the state. Use tax is self-assessed and reported by the buyer when sales tax was not charged or was charged incorrectly. While the tax rate is typically the same, responsibility for reporting differs. AvaTax for Accounts Payable works with Avalara AvaTax to help businesses apply consistent tax determination across both sales and purchase transactions. Users of Avalara Vendor Exemption Management can provide vendors with their exemption certificates.