US Taxation: Sales tax vs Use tax

This article will briefly describe the differences between Sales Tax and Use Tax.

What is a Sales Tax?

Sales tax is the tax charged to the consumers as required by the states and thousands of local jurisdictions.

Seller will have to collect sales tax from consumers if there is a transfer of goods and services from the sellers to the consumers.

So, the business owner has the responsibility to collect the sales tax on behalf of the tax authority. Once the seller receives the sales taxes, they will need to file the tax and remit it back to the tax authority correctly.

Business owners need to take note that it will be an offense if they do not file the sales tax accordingly. If they failed to collect, file, and remit the sales taxes, fines and penalties will be imposed onto them. It is a serious crime to commit if the business owner keeps the collected sales tax revenue for their benefits.

According to statistics, almost half of all states with general sales tax are "vendor states," which means sales tax is legally imposed on the sellers who can decide to absorb the sales tax or to pass it to the customers. Most of the businesses will include sales tax into the price of goods sold to the consumers; otherwise, they will need to bear the costs on their own.

The remaining states are the "vendee states," in which sellers are legally required to collect sales tax from their consumers. They are not allowed to pay the taxes on behalf of their consumers.

What is Use Tax?

There are two types of use tax - consumer use tax and seller use tax.

Consumer use tax is a tax imposed on consumers who do not pay sales tax at the point of purchase. It is used to capture "lost tax revenue" from consumers who purchase high-value goods within a state where the product is not taxable, but use the items in another state where the product bought is taxable. In such an instance, there is no sales tax charged to the consumer. Instead, the consumers remit the use tax to their state.

However, if the product is exempt from tax in both the state where the product was purchased and the state where the consumer will use the product mainly, there is no consumer use tax collected.

Consumer use tax is also imposed in instances where the sales tax paid at the point of purchase in one state is lower than the sales tax that would have been paid if it was purchased in another state where that the product will be used. The consumer will have to remit the use tax to the state where the product is used.

In general, the consumer use tax is at the same rate as sales tax for that particular product category, but some states might differ. It is best to check each respective state's tax resources to ensure that the right rate of consumer use tax is used.

Example 1 (Consumer Use Tax)

You own physical outlets of a sports shop selling sports equipment. You have nexus in Ohio, New York, Texas, and Arizona. A customer based in Florida has requested to purchase some equipment. You do not have nexus in Florida; therefore, you do not have to collect sales tax from the consumer. However, the customer has to pay the consumer use tax to Florida tax authorities.

Meanwhile, when you sell your products to a customer in Texas, you will need to collect sales tax as you have nexus in Texas. Your Texas-based customers do not have to remit use tax to their state.

Example 2 (Consumer Use Tax)

You are a buyer who purchased a vacuum cleaner in State A. State A has a sales tax of 5% on vacuum cleaners. The vacuum cleaner is for use in your residences at State B. State B has a sales tax of 8% on vacuum cleaners.
You will have to pay a 5% sales tax to State A (usually captured within the net price of the vacuum cleaner at point of purchase), and an additional 3% consumer use tax (8% - 5%) to State B.

Seller use tax is tax paid by remote sellers who sell to a state where they have economic nexus.

Economic nexus is triggered when you have exceeded a certain threshold in terms of the value of your sales within that state, or if you have achieved x amount of transactions within that state in a year. Not all states practice economic nexus laws. Read more about nexus here.

In general, it is for sellers who do not have a physical presence or brick-and-mortar store, such as online retailers.

Do note that the seller use tax also applies to international sellers (not based in the US) who have triggered economic nexus in states that practice economic nexus laws.

Example 3 (Seller Use Tax for US sellers - out of state transactions)

You are an online retailer based in State C. You do not have any physical presence in State D, where most of your customers are based. However, State D practices economic nexus laws, and you have fulfilled the criteria for economic nexus. Therefore, you have to remit the seller use tax to State D.

Example 4 (Seller Use Tax for International Sellers)

You are an online retailer based in China, with no physical store in the US. Your bulk of customers are based in State E, where you have economic nexus. You are required to remit the seller use tax to State C's tax authorities.