What you need to know about use tax.
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Hi Reader,
Today, we are going to talk about one of the least understood tax concepts:
Use tax.
Exciting, right?
Okay, maybe not. But it is one of those sneaky little topics that many business owners either don’t know about or don’t fully understand.
What is use tax?
Most people understand sales tax.
If I walk into a local office supply store here in Pennsylvania and buy a cute desk organizer set for my business, the store will charge me Pennsylvania sales tax of 6% at checkout. If my desk organizer costs $100, I would pay $6 in sales tax.
Simple enough.
But what happens if I buy that same desk organizer online from a small Shopify store located in New York?
There is a good chance that the store may not charge me Pennsylvania sales tax, especially if they do not have sales tax nexus in Pennsylvania.
But here is the key thing to understand:
Just because the seller did not charge me sales tax does not necessarily mean the purchase is tax-free.
Pennsylvania still wants its $6.
That is where use tax comes in.
Use tax is basically the tax you owe when you buy a taxable product or service and the seller did not charge you the sales tax that would have applied in your state.
So in this example, if I bought a $100 desk organizer for my business and no Pennsylvania sales tax was charged, I would report and pay $6 of Pennsylvania use tax.
Most states have use tax
Lest you think this doesn’t apply to you, almost every state that has sales tax also has use tax.
That means most business owners technically should be watching for purchases where sales tax was not charged and deciding whether use tax is due.
In practice?
A lot of small business owners do not do this.
Some do not know use tax exists. Some assume that if the online seller did not charge tax, no tax is due. Some know about it but have no system for tracking it. And some are just overwhelmed because sales tax rules are already complicated enough.
And I understand why.
Use tax can get messy because you have to answer a few questions:
- Was the item or service taxable in my state?
- Did the seller already charge my state’s sales tax?
- Does my state require me to report use tax on my sales tax return, income tax return, or somewhere else?
And of course, every state has its own rules.
More companies are charging sales tax now
The good news (I guess?) is that because of economic nexus laws, more online sellers and service providers are now required to collect sales tax in more states.
I have personally watched this change happen gradually over the years. Companies and software providers that never used to charge sales tax are now charging it.
And if you buy from a marketplace facilitator like Amazon, Etsy, or eBay, the marketplace is usually already collecting and remitting sales tax for applicable states.
That means if you buy a business item from Amazon and Amazon charges you the correct sales tax, you do not also need to pay use tax on that same purchase.
Use tax is for the situations where sales tax was not charged, but should have been.
Speaking of Amazon...
Since we are already talking about online business purchases, Amazon Prime Day is coming up June 23–26.
If you are planning to grab any business supplies, equipment, office tools, or other helpful finds, this is a good time to look for deals on items you were already planning to purchase.
Below I’m sharing some of my favorite Amazon Prime Day finds for business owners, so read on!
So what should you actually do?
When you review your business purchases, keep an eye out for taxable items or services where no sales tax was charged. This requires a good understanding of what is taxable in your state.
If sales tax was already charged, great. Move on.
If sales tax was not charged, then you may need to report use tax.
In Pennsylvania, this is asked about on the Sales, Use, and Hotel Occupancy Tax return. So if you file Pennsylvania sales tax returns, you may already be seeing the use tax question when you file.
What is the risk of ignoring use tax?
I do not want to be dramatic about this, but I also do not want to pretend it doesn't matter.
Use tax is not optional.
If your business is audited for sales and use tax, the state may review purchases where no sales tax was charged. If they determine use tax should have been paid, they can assess the unpaid tax, plus penalties and interest.
The risk is usually higher when:
- The purchases are large
- The purchases happen regularly
- The business is already registered for sales tax
- The missing tax is easy to spot from invoices or expense accounts
- The business buys a lot of equipment, supplies, software, or furniture from out-of-state sellers
Is the state likely to chase down every tiny $12 purchase? Probably not.
But if you are buying larger items or have online subscriptions for your business and no sales tax is being charged, it is worth paying attention.
My practical advice is this:
Do not panic. But do not ignore it either.
As always, sales tax rules vary by state, so check your state’s rules or ask your tax professional if you are unsure.