What is Use Tax?

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Definition:

A use tax is one that applies to transactions on which the buyer didn’t pay sales tax, and that took place outside the buyer’s tax jurisdiction.

🤔 Understanding a use tax

In the case of most transactions, a buyer pays sales tax on an item at the time of purchase. The sales tax is usually a percentage of the total purchase price. But in the case of online purchases or those in states without sales tax, the seller doesn’t collect a sales tax. In that case, the government still expects the buyer to pay taxes. The buyer would pay a use tax at the same percentage as if they’d bought the item in their home tax jurisdiction. Use taxes help the government to collect consistent tax revenue from its citizens and help protect local businesses against competition from online retailers. 45 states and the District of Columbia have use taxes in place.

Example

When you head to your local retail store, you likely pay sales tax when you check out (unless you live in one of the few states with no sales taxes). But that’s not always the case for online purchases. Let’s say that you buy a new coffee maker on Amazon for $150. Depending on your location, Amazon may not charge you sales tax on that purchase. Because of that, your home state expects you to pay a use tax. Let’s say you live in a state where the sales tax rate is 6%. When you file your next state tax return, the law requires that you pay your state of residency that $9 tax.

Takeaway

A use tax is like driving through an automated toll booth without paying the fee…

Most out-of-state visitors drivers end up paying a small fee at highway toll booths. If you don’t pay as you’re passing through, you might get a bill in the mail to pay it later. This is the same concept as a use tax — Most transactions will require you to pay sales tax at the time of purchase. But on the off-chance you don’t pay it then, you’re supposed to pay the use tax later.

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What is a use tax?

A use tax is like a sales tax, but you don’t pay it at the time of the transaction. Both types of taxes may apply to the same transactions, but in different situations. Most states require that sellers charge sales taxes on retail purchases. But if for some reason you’re shopping in a place that doesn’t charge sales tax, you still have to pay taxes on that item. In that case, you’d pay a use tax at the same rate as the sales tax you’d normally pay in your home state.

Suppose you live in a state that charges a 6% sales tax. You’re on a family road trip, and happen to stop for some shopping in a state without sales taxes. Because your state has a sales and use tax, your state government will expect you to report that purchase and pay a use tax on it. Since the sales tax in your home state is 6%, your use tax will also be 6%.

What is subject to use tax?

What items are subject to use tax will depend entirely on where you live. If you live in one of the five states without a sales and use tax, then you won’t have to pay at all. Those five states are Alaska, Delaware, Montana, New Hampshire, and Oregon.

If you don’t live in one of the five states without sales and use taxes, you’ll have to pay them on taxable items. But remember that use taxes only apply if the seller didn’t collect sales tax at the time of the transaction. States generally require the collection of sales and use taxes on retail sales for goods, as well as many taxable services. Some states exempt certain items. Minnesota, for example, doesn’t charge sales and use taxes for clothing.

To make the tax system less regressive (so that it doesn’t hit low-income individuals as hard), most states don’t charge sales and use taxes on groceries and prescription drugs. There are also other items that are subject to taxes, but not at the same rate as retail items. Products such as gasoline, cigarettes, and alcohol are often subject to excise taxes instead, at a different rate.

Regardless of where you purchase an item, whether you have to pay a use tax on it depends on where you live. Suppose you live in Iowa and you drive up to Minnesota to buy clothing, since there’s no sales tax. Because you live in a state that does charge sales taxes on clothing, you’d have to pay a use tax.

What is the difference between sales tax and use tax?

Sales taxes and use taxes are similar, but the situations in which you’d use them are entirely different. A sales tax is one that consumers pay on taxable retail transactions. The definition of a taxable transaction differs from state to state, and some states don’t collect sales taxes at all.

Everyone has probably paid sales taxes at some point in their lives. Many state and local governments impose this type of tax. You generally pay it at the time of purchase, and then the seller of the item remits the tax collected to the government.

A use tax applies in a situation that would normally be subject to sales tax in your state, but the seller didn’t collect it, and you aren’t tax-exempt (some nonprofit organizations may be exempt from sales and use taxes). Common situations in which you’d pay a use tax instead of a sales tax include:

  • Online transactions
  • Catalog or mail order purchases
  • Purchases made in another state that doesn’t collect sales tax

How do you calculate a use tax?

The use tax rate for your state is the same as the sales tax rate for the same area. Suppose you live in Wisconsin, where the sales tax is 5.5%. You head to your local furniture store to buy a couch for $750. Because that purchase is subject to sales tax, you have to pay an extra $41.25. The seller will collect that sales tax and then send it along to the appropriate government agency.

But what if you had bought that couch online, and the seller didn’t charge sales tax? At the time of purchase, you’d have only had to pay $750 for the couch. But the state of Wisconsin still expects you to pay taxes on the purchase. You’d have to pay a use tax for the same 5.5% as the sales tax would have been. Except instead of giving that $41.25 in taxes to the seller, you just send it directly to the state.

The same principle applies no matter where you live. Keep in mind that while many locations have a statewide sales tax, plenty of local governments have one as well. In that case, you may want to speak to a tax professional in your state to make sure that you’re paying the right amount to the appropriate entity.

Which states impose sales and use taxes?

45 states and the District of Columbia impose sales and use taxes on certain transactions. In some states such as New York and Virginia, these taxes make up a fairly small part of the state’s total tax revenue. But for others such as Florida, Tennessee, and Washington, sales taxes make up the majority of income. This discrepancy is partially a result of the fact that Florida, Tennessee, and Washington are among the states with no state income tax.

It’s worth noting that use taxes for online purchases look very different in 2020 than they did just a few years ago. Previously, businesses only had to collect sales tax on purchases in states where they had a physical presence. So if you lived in a state with an Amazon location, Amazon would charge you sales tax. If Amazon didn’t have a presence in your state, the company wouldn’t charge you sales tax.

In 2018, the US Supreme Court ruled in the case of South Dakota v. Wayfair that states can require remote sellers to collect sales taxes for online purchases, regardless of a physical presence. Since that ruling, 43 states and the District of Columbia have passed laws requiring the collection of sales tax for online purchases. These laws make it a lot easier for consumers because it means you’re no longer responsible for paying use taxes on those purchases.

Do you have to pay use taxes?

If you live in one of the 45 states that require sales and use taxes, the law requires that you pay them. Paying your use taxes looks a bit different depending on the state in which you live, but here’s the general process:

  1. Throughout the year, track the purchases you make where sales tax would apply in your state, but the seller hasn’t collected it. These purchases might include those you make online, or in another state that doesn’t collect sales tax.
  2. Use your state and local sales tax rate to figure out how much you owe on those purchases. The percentage should be available via your state’s department of revenue. Multiply the percentage by your total purchase price for each transaction.
  3. Report and pay your use taxes on your annual state income tax return by the due date. The tax form likely has a line specifically intended for this purpose.
  4. Instead of reporting and paying annually, you can do it quarterly. Check with your state government to see if they offer a consumer use tax return for quarterly payments.
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