Sales and Use Tax - Explained
Taxes on the Sale of Goods
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Table of ContentsWhat are sales and use taxes?What is Sales Tax?What is Use Tax?Discussion QuestionPractice QuestionAcademic Research
What are sales and use taxes?
Sales taxes are assessed to purchasers of products from commercial sellers. Use taxes are assessed when purchasing goods from a separate jurisdiction that charges less than the applicable use tax rate.
Each is discussed below.
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What is Sales Tax?
Businesses that sell any sort of good are subject to sales and use tax. Sales tax is the amount that the merchant must charge to customers who purchase goods for use (rather than resale). Sales tax is generally a fixed percentage of the value of the good. Other taxes that accompany sales tax may also apply for specialty occupations, such as merchants selling luxury goods, hotels, and restaurants. The merchant must collect the tax from the customer and not simply pay the taxes from the proceeds of the sale. The taxes withheld must be deposited with the states department of revenue on a regular basis. The taxing state is the location where the good was sold. It does not matter the location where the seller is located.
- Example: I buy widgets from a wholesaler and then resale those goods to the public. Each time a customer purchase a widget for $10, I also charge the customer 6% sales tax. This means that the final amount is $10.60. At the end of month, I transmit all sales taxes collected to the state department of revenue in which I collected the taxes. This requires that I keep track of my location when I sold the goods and the location of the customer.
- Note: Note: The sales tax rules become tricky when a retailer sells over the internet in a state where she does not have a physical business or significant presence. Generally, if the customer is located outside of the state where the retailer is located or has business operations, and the retailer ships the item to the customer, the retailer does not have to collect and deposit sales taxes in the state where it does business. They question becomes, does the company have to collect sales taxes in the state where the customer is located. Prior to June 2018, the rule was that a company must have a physical presence in a state to be subject to state sales tax collection rules. So, online retailers did not have to collect tax in the state where the item was sold. This was a big advantage for online retailers over in-state retailers. In South Dakota vs Wayfair, Inc (2018), the Supreme Court determined that states can tax internet sales in a state if the company has an economic interest in the state. With this ruling, most online retailers selling in a state (regardless of physical presence) would be subject to sales tax collection.
What is Use Tax?
Use tax is a separate tax that is similar to sales tax and applies to the purchase of goods by individuals or businesses. Use tax is assessed when goods are purchased for use or consumption and sales tax is not paid on the item. This scenario may arise when a merchant purchases goods for resale, which is done free of sales tax, and then converts the item to personal use. Another common use-tax scenario is when an individual or business purchases a good in a state other than the state in which the goods will be primarily used, consumed, or located. If the sales tax assessed in the state of purchase is lower than the sales tax in the state where the goods will be used, consumed, or stored, the purchaser must pay the tax rate difference to the state where the good is used, consumed, or located.
- Example: Tommy decides to purchase a new truck. He lives in Wyoming, but travels to Montana to purchase the truck. Montana has no sales tax; while Wyoming assesses a 4% sales tax. If he pays $30,000 for the new truck, he will owe use taxes of $1,200 to Wyoming, as that is the state where he will use the truck.
Can you think of a large corporation that actively negotiates exemption for state sales tax obligations for goods sold via its Internet service? Why would a state grant this business relief from collecting sales tax on items sold within the state? How do you feel about the assessment of use tax? What do you think is the reasoning behind this tax?
Aragon is a large online retailer. It is headquartered in Kentucky, but sells and ships consumer goods all across the country. In order to allow for rapid shipping, Aragon builds distribution centers in many states. Aragon ships to customers in State A, which assesses a sales tax, but has no physical presence in the state. Aragon also ships to customers in State B, which assesses a sales tax, but it has a major distribution centers in State Bs capital city. Lastly, Aragon ships to customers who have PO boxes in State C, which does not assess sales taxes. These State C customers then take the goods with them for use or consumption in State D. What are the potential sales and use tax assessments in this situation?
- Most states have a use tax, which requires individuals who purchase goods in states without a sales tax or with a lower sales tax than in the state where the good will be used or consumed. In this scenario, Aragon will be forced to collect sales taxes in State A on sales only if it has an economic interest in the state. This generally means that the business targets individuals in the state as customers. Aragon will also be forced to collect sales taxes on State B. Aragon is not required to collect sales taxes in State C. If, however, the goods being sold in State C are transported across state lines to States A, B, or another state with a sales tax - the purchasers will be subject to a use tax assessment.