Sales and use tax are both taxes on the sale of goods and services, but they have very different applications. Knowing the difference can be confusing for many small business owners, especially if you’re selling or purchasing out of state. But it’s important to have a firm grasp on the difference between sales and use tax in order to stay in compliance for sales made both on your premises and online.
This quick guide will clear up the difference between the two and help you stay compliant. We’ll also look at changes on the horizon with an upcoming Supreme Court case that may affect the way your sales are taxed in the near future.
One point to clarify upfront is that sales and use taxes are mutually exclusive, meaning that at no time would both taxes be charged on the same sale. Let’s take a look at each one and explore the difference.
What is it?
Sales tax is the responsibility of the seller. This means every time you sell an item, a percentage of the sale price is charged to the customer, reported, and paid to the state and locality in which your business has an established sales-tax presence. The tax is usually calculated based on the gross receipt from the sale. The rate varies by state. In an ideal world, that would all be relatively simple. But in the often-complex world of commerce, it’s not always so simple.
If you sell online to a customer in another state, you may need to register with that state to collect sales tax.
If you sell from a brick-and-mortar location, and you’re located in one of the 45 states that collect sales tax, you report and pay sales tax to your home state where the sale was made. The same holds true if you sell online to a customer in your state. If you sell online to a customer in another state, you pay sales tax to that state only if you have nexus (a sales-tax presence) there.
When you don’t have nexus, you may still be required to report the sale to that state in some cases. Remember that in order to legally collect sales tax for any state, you must be registered with that state to do so.
In an attempt to increase revenues and make up for budget shortfalls, and in a response to the explosion of online sales in recent years, many states are now expanding the rules related to nexus and going after businesses that are out of compliance. Sales tax law, especially in this area, changes often, so it’s important to stay up to date on this issue and know when a change affects the sales you make in a particular state.
How does it affect you?
Your duty as a small business is to collect sales tax at the correct rate for any state where you have established nexus, and then to report and pay those taxes before the deadline. Do not collect sales tax for sales in states where you haven’t registered.
Be certain, if you make sales online, that you know exactly which states will consider your transactions taxable. Traditionally, establishing nexus in a state meant having some sort of legal presence in or connection to that state, such as having a warehouse or salesperson working there.
You most likely have established a sales tax presence in a state if you store goods there.
Today, however, many states have expanded the definition of nexus. In Massachusetts, for instance, if your business completes over 100 transactions to customers who live there, that establishes nexus. And in Ohio selling over $100,000 worth of taxable goods or services in that state establishes nexus. This more expansive definition of nexus is known as “economic nexus” and is a very recent development.
Considering the increasingly complex landscape of tax legislation, a knowledgeable up-to-date tax advisor is becoming a necessity. Additionally, a service such as LumaTax can help you automate and simplify the entire process and provide the peace of mind that comes from knowing you’re in compliance.
What is it?
Use tax is the responsibility of the buyer. According to the tax code, a state cannot require out-of-state companies that don’t have nexus with the state to collect and remit use tax. However, this seems likely to change.
At this time, use tax for the most part should be reported and paid by individuals or organizations who purchase over a certain dollar amount in goods without paying sales tax on those goods. In Virginia, for instance, use tax kicks in after $100 worth of purchases of taxable items that haven’t been taxed. In Missouri, the threshold is $2000.
What type of transaction would not have already been subject to sales tax?
- A purchase from an online seller located in another state
- A purchase from a seller online not established as a business
- A purchase from a seller in person not established as a business
- A purchase made by phone or mail from a seller in another state who ships the product to you
According to one research firm, online retail sales in the US are expected to reach $500 billion by 2020. With figures like that, and because the state laws governing use tax are notoriously difficult to enforce and mostly seem to go unnoticed by consumers, states are responding.
One way states get around the current law is by requiring businesses to file annual purchase reports.
Colorado, for example, managed to bring a law into being in July of 2017 that allows the state to require online or other retailers, who make sales to Colorado residents but aren’t required to collect sales tax, to file “annual purchase reports.” These reports show the purchase history of individual Colorado residents for the year and represent an enormous administrative burden for businesses.
How does it affect you?
For now, your duty when it comes to use tax is to pay the tax on your business’s purchases of taxable property where sales tax was not charged. Additionally, if you don’t have nexus in a state with new reporting requirements, like Colorado, you must send annual purchase reports (either to the customer or the state, depending on the state). In Colorado, this applies if you sell over $500 in goods to any one customer or over $100,000 in combined sales to customers there.
Large online retailers without nexus in Colorado, like Amazon, are opting to register to collect sales tax for customers in the state instead. This saves the expense and hassle of complying with the new law.
Other states with brand new reporting requirements to be aware of so far are:
Why so many changes?
From the states’ perspective, revenue from online out-of-state sales represents revenue that was once received by businesses in state where sales tax would have been charged. While this is arguable, states will continue to view online revenue mostly as lost tax revenue. And, as you can see they’ve resorted to other roundabout means of capturing that revenue, such as economic nexus and affiliate nexus, while further complicating life for the small business.
States view online out-of-state sales as lost tax revenue.
Why don’t states just require out-of-state retailers to collect and remit the consumer use tax for them and avoid all the complicated maneuvering?
The answer to that question rests on a supreme court ruling from 1992, Quill vs. South Dakota , which prevents them from doing that. And now, since South Dakota passed legislation that challenges that ruling, the decision is being revisited in the Supreme Court.
What does the SCOTUS case mean for you?
If the Quill ruling is overturned by a new case, South Dakota vs. Wayfair Inc., retail businesses that sell online may be required to collect and pay use tax for all the states in which they make sales. With roughly 9,600 different local jurisdictions in the US (new tax districts are created often), this sounds like an overwhelming and near-impossible task. Most proposed sales-tax legislation in the recent past, however, has included provisions to simplify reporting and rate calculation. It’s hard to tell exactly what new requirements would look like.
What is almost certain is that if the laws change, small businesses will be reporting and collecting more taxes than they do now. Some states have already taken steps to simplify and standardize their sales tax rules by joining the Streamlined Sales and Use Tax Agreement.
While some believe the challenge to Quill is in the best interest of brick-and-mortar retailers who often must charge more for the same products sold online tax-free, others believe the change will complicate and burden all retailers. Another valid perspective is that a new ruling could put an end to the recent efforts by the states to find ways around the law, which has broadened their powers and created new complications for small businesses already.
Like everything related to tax law, there’s no simple answer.
Sales Tax legislation at the state level changes constantly as states try to make up for budget shortfalls.
For now, sales tax is the responsibility of the seller, while use tax is the responsibility of the buyer. But this is changing quickly. What has already become more complicated without a change in federal law?
- Determining nexus if you sell in more than one state
- Determining your reporting requirements
That a projected $500 billion in online revenue would affect the law seems inevitable. Exactly what that will look like for your business’s reporting and collecting is yet to be seen, so stay tuned. The constant state budget shortfalls over the past years mean that sales and use tax will likely continue to be a contentious issue.
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