Sales tax and use tax are both imposed on the sales of taxable goods and services, but they each have very different applications. Let’s understand their differences by learning more about each.
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In this article:
- The Sales Tax Nexus
- What Is Sales Tax?
- What Is Sellers Use Tax?
- What Is Consumer Use Tax?
- Knowing the Proper Nomenclature
Use Tax Vs. Sales Tax | What’s The Difference?
The Sales Tax Nexus
The sales tax nexus is the legal connection between a seller and a state, permitting the state’s imposition of a sales tax collection obligation on the seller. This nexus determines which tax, sales or use, applies to a specific transaction.
A business with a physical presence in a state is obliged to register with the tax authorities and collect and remit sales tax as per the nexus. Individuals and in-state businesses are also responsible for remitting consumer sales tax.
Tax legislation is a complex, ever-evolving landscape. Traditionally, establishing nexus in a state means having a form of legal presence in or connection to a particular state, like having a warehouse or a salesperson there.
Today, businesses without a physical presence in a state are also obliged to collect and remit sales taxes under the economic nexus rule. The definition of nexus is expanded by many states.
For example in Massachusetts, completing beyond 100 transactions to residents establishes nexus. In Ohio, nexus is established upon the sale of over $100,000 worth of taxable goods or services in that state.
What Is Sales Tax?
Sales tax, or retail tax, is a state-imposed transaction tax on the sale of a product or service, seller to consumer. Taxable sales vary from state to state but they generally include the following:
- Transfer of possession or title of a taxable, tangible personal property for consideration
- Barter, exchange, rental, or lease of a taxable, tangible property
- Performance of a taxable service for consideration
By transferring the responsibility to collect taxes to the sellers, state governments don’t have to assign tax collectors in every business in their jurisdiction, which is costly and inefficient.
This tax is the responsibility of the seller and is usually calculated based on the sale’s gross receipt. However, this rate varies from state to state.
We have what we call the “vendor states,” which legally impose the sales tax on the seller. These states permit sellers to pass it on to the customers and most choose to.
There are also what we call the “vendee states” who legally oblige the seller to collect sales tax from the customer. These states do not allow sellers to pay the tax themselves.
If a business fails to collect sales tax as required by law, it can be held liable for uncollected taxes (which can and often do accumulate) by the state and local tax authorities.
Sellers will hold the collected sales tax until they can file a return and remit it to the proper tax authorities. A seller cannot keep any collected sales tax as part of his or her own profit; it’s against the law.
If a seller fails to remit the collected sales tax as the law requires, he or she may face criminal charges plus financial penalties and interest charges.
What Is Sellers Use Tax?
Sellers use tax, aka retailers use tax or vendors use tax, is similar to sales tax. It’s also a state-imposed transaction tax calculated as a percentage of the sale’s price of goods and services.
The difference is sellers use tax applies for vendors located outside of a state, but are registered to collect and remit tax in this state. Businesses with a physical presence in a state are imposed with sales tax; out-of-state vendors with economic nexus in a state are required to collect seller use tax in that state.
As a result of the June 2018 US Supreme Court ruling that physical presence is no longer the only requirement for sales tax collection, there had been an increase in the collection of sellers use tax as of late. This allows states to impose remote sellers with sales tax collection obligation.
Currently, there are more than 37 states that plan to adopt economic nexus laws after the said court decision. More are bound to follow suit.
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What Is Consumer Use Tax?
Businesses with no nexus with a state are not required to collect and remit sales tax on taxable purchase from customers. Consumer use tax or compensating use tax is imposed on businesses, organizations, or individuals who purchase goods or services without paying sales tax.
If a seller does not collect tax from the purchases and the transaction is taxable, the buyer is responsible for paying the tax to the state.
States and local governments impose consumer use tax for two reasons:
- To prevent entities from evading sales tax by purchasing taxable goods or service from a non-taxing state and shipping them into a sales tax imposing state.
- It protects retailers in the state by removing the consumers’ incentive of shopping outside the state to avoid paying sales tax.
The rate for sales tax and consumer use tax is the same—state taxes and the potential inclusion of local state taxes.
If a taxpayer fails to pay consumer use tax, he has to pay penalties and interest.
Example of transactions that may be subjected to this tax are:
- Transactions with mail-order companies with no nexus with the state of delivery
- Deliveries from remote companies with no nexus with the state of delivery
- Benefit received from a remote performance of a service
- Buying from remote or in-state companies required to collect sales tax but do not
Tax authorities can also chase after in-state businesses over consumer use tax when they consume items they bought, tax-free, for reselling. This can be be done by:
- Giving charitable donations
- Inventory transfers or withdrawals
- Offering promotional giveaways
For instances, if an appliance store pulls a coffee maker out of inventory for use in its office, it owes the state consumer use tax on that coffee maker.
Consumer tax is also imposed when:
- Non-exempt consumers buy taxable goods in states with a lower tax rate than their home state’s
- Purchasing items abroad for home use
Knowing the Proper Nomenclature
Some states refer to both consumer and seller use tax simply as “use tax.” Some states authorities also use the term “sales tax” when pertaining to an out-of-state seller’s responsibility to collect the tax because the term “seller use tax” is not a state-created concept, but more of a court-created one.
This flexibility in the usage of terms may cause confusion. It’s important to know your own state or municipality’s terminologies to be safe.
Having a clear grasp of these different types of taxes is important to stay compliant with our tax responsibilities. We hope this quick guide has cleared up any confusion you might have had over these types of taxes.
Do you have any other questions about sales tax, sellers use tax, and consumer use tax? Let us know in the comments section below!
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.
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