I’m sure that everyone is familiar with sales tax: the tax that businesses charge when you buy their products. A sales tax is a tax paid to a governing body for the sales of certain goods and services. The tax is generally collected by the seller from the consumer at the time or point of purchase. But are you familiar with use tax and the requirements for small businesses?
How Does Sales Tax Work?
Sales tax is levied on the sale of a good to its end user. So a sale of goods from one business to another business who later resells the goods is not subject to sales tax because that business is not the end user. The second business will charge sales tax to the buyer when they sell the goods.
Sales tax is always imposed at the state level and sometimes also at the county and even city level. For example, sales tax in Chicago (Cook county, IL) on general merchandise is currently 9.25% consisting of 6.25% state tax, .75% county tax, 1.25% city tax and a 1% regional transportation authority tax. The city of Chicago also has an additional tax on qualifying food, so buying certain foods or eating out could cost you an additional 2.25%!
But what if you live in Chicago and purchase something on-line from a business in Indiana? Because the item will not be used or consumed in Indiana, the seller is not obligated to charge you Indiana sales tax. And because the seller in Indiana is not subject to the jurisdiction of the State of Illinois, Cook County or the city of Chicago, he is also not obligated to charge you those sales taxes either. So you think, “Great. No sales tax when I purchase something from out of state. I think I’ll buy all of my materials and supplies from vendors out of state and never pay any sales tax again.” Well, if you’re not familiar with the existence of use tax, that strategy could be very costly for you.
Use Tax: A Tax on Remote Sales
Buying something from an out-of-state vendor via phone, mail order, or an e-commerce site (i.e. a website) is known as a “remote sale.” And because states with a sales tax law know that you won’t be paying sales tax on those purchases, they created a use tax component in their sales tax law that applies to these remote sales.
A use tax is a tax assessed on items purchased by a resident of the assessing state for use, storage or consumption in that state regardless of where the purchase took place. The use tax applies when the items purchased were not subject to the purchaser’s home state’s sales tax. The use tax is generally assessed at the same rate as the sales tax that would have been paid had the goods been purchased in the state of residence.
It is the purchaser’s responsibility to calculate, report and pay use tax to his home state in accordance with that state’s rules and regulations. This means knowing under what circumstances use tax is owed, at what rate it is owed and when it needs to be paid to the state.
Your Obligation as a Small Business Owner
Most state use tax laws are governed by the Department of Revenue. In California, it happens to be the State Board of Equalization. If you can’t find the proper department by doing an internet search, contact the Secretary of State’s office and ask what the state’s taxing authority is.
In general, use tax applies to all tangible personal property (TPP) that would otherwise be subject to sales tax if you had purchased it in your state of residence. Tangible property is something that can be physically seen or touched like computers, tools, books and office supplies. However, most states have some type of provision for exemptions based on the nature or use of an item. These categories can include medical goods, some food items and some services like education and professional services. In most states, the cost of an item does include the amount charged for shipping and handling. It’s your responsibility to know what is and is not subject to use tax.
The first thing you should do is contact the state taxing authority and register for use tax. Depending on the amount of out-of-state purchases you make, your use tax returns will probably be due monthly or quarterly. Next, create a spreadsheet or some other means of keeping track of the purchases you make that will be subject to use tax. It can be something as simple as this:
| Date | Vendor | Description of Purchase | Amount | Use Tax % | Use Tax Due |
| 7/01/14 | Deluxe | Business checks | 130.00 | 6.00% | 7.80 |
| 7/13/14 | Amazon.com | Books | 45.30 | 6.00% | 2.72 |
| 8/06/14 | Star Inc. | New laptop | 550.00 | 6.00% | 33.00 |
| 8/20/14 | Amazon.com | Office supplies | 23.25 | 6.00% | 1.40 |
| 8/31/14 | Staples | Office supplies | 14.60 | 6.00% | 0.88 |
| 9/15/14 | 4Imprint | Business cards | 130.50 | 6.00% | 7.83 |
| Total Due for Q3 2014 | 53.62 |
Lastly, be sure to file your form and pay the tax due by the due date. Late penalties and interest are typically assessed by all states.
A Word of Warning
If your business is not currently assessing all out of state purchases for use tax liability, I suggest you begin doing so or risk a large tax bill if you should ever be audited. As internet sales have increased over past years, states have begun feeling the effects of lower sales tax revenue coming in. Many have begun stepping up the number of sales and use tax audits they perform as a means of identifying and collecting this lost revenue. A use tax audit could cost you thousands of dollars in unpaid taxes, interest and fines.