Use Tax (Pt. 1)
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat discuss and answer questions about use tax.
Here’s a glimpse of what you’ll learn:
The history of use tax
What is use tax?
What is a vendor’s use tax? Why is it relevant to use tax?
What is a consumer’s use tax?
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More, your go-to resource for all things state tax-related. Now, here is your host, Michael Fleming.
Michael Fleming: Hi, Mike Fleming here, founder of Sales Tax and More, and today's co-host of the Sales Tax and More Podcast, where we talk about everybody's favorite topic, which is, of course, sales tax. And today we're gonna talk about use tax. And we had so much material here, it was gonna be a really long podcast, so we've decided to break it into two podcasts.
Also wanna let you know, just came in from tending the horses out on the ranch I'm a little bit casual today, but that's that's life on the ranch. Before we get started let me [00:01:00] introduce you to my co-host, Ellie Moffat.
Ellie Moffat: Hey, everyone, great to be here. And I hope you're laughing like I am that Mike is saying that he's tending the horses on the ranch in a little bit of a New York accent coming through there with it.
He's in Texas, he's on a ranch, but he'll never fully drop that little bit of New York accent he's got. Before Mike even has a chance to reply to that, I'm gonna do a quick introduction for Sales Tax and More. Thank you for being here and listening to this podcast. Please like,
follow, subscribe. And we are a full service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, audit defense, exemption certificate management, and like our name states, more.
So if you have questions about our services or you'd like to work with us, please reach out. We would love to hear from you, and we'd love to work with you as well. So Mike, [00:02:00] with that being said let's talk about the history of use tax.
Michael Fleming: Okay. Yeah, you get a chuckle out of my accent.
You should see the people here in East Texas get a chuckle out of my accent. And-
Ellie Moffat: I bet they give you... They talk about it a lot.
Michael Fleming: Yeah they do, and it's not even that pronounced. Wait till I spend a week in New York and come back. Anyway let's talk about the history of use tax as you mentioned there.
And let's start with sales tax. Sales tax is generally a tax on the transaction itself. It's a direct tax. And when the first modern sales taxes were first introduced back in the 1930s, even the states didn't believe that you could tax interstate commerce directly. So when they introduced these sales taxes- I say I'm out here in Texas.
I'm right by Texarkana, [00:03:00] and Texarkana's a city where the state line runs right down through the middle of the city. Part of the city is in Texas, part of the city is in Arkansas. So say a state like Texas introduced a sales tax. Everybody on one side of the street would have to charge sales tax on their transactions.
The people on the other side of the street, if there was no tax in Arkansas, they didn't have to charge the tax. So someone could get something delivered, all they had to do is walk across the street and they got something tax-free from the delivery right outside the state. Or someone in the state of Texas could walk across the street, be in Arkansas, and purchase from that vendor there.
So there was an unfair advantage to out-of-state companies, 'cause they did not have to collect the tax. So the way the state sought to rectify [00:04:00] this situation is by introducing a use tax, and a use tax is for the storage, use, or consumption of an item or service in a state. So it's no longer a direct transaction.
It's not a tax on the transaction, it's a tax on the use. So some may say that is semantics. It's still a tax. A tax is a tax. But it's an important distinction. And over time there were different requirements for use tax than there were for sales tax. However, they didn't call it nexus back then, but if the seller had some sort of link or connection with the state, they still had to collect that use tax.
This is referred to as a vendor's use tax or a seller's use tax or a retailer's use tax. It's all one use tax but we're just talking about who's responsible for collecting it. [00:05:00] So it was instituted so that these out-of-state companies had to utilize the same tax that the in-state companies did.
So that stayed that way for quite a while. And in the 1950s- The states started saying, "You know what? Maybe we can tax interstate commerce." And they started, trying to tax more and more interstate commerce directly. And there were a couple of Supreme Court cases on it. And then in 1977, we have Complete Auto Transit.
And in Complete Auto Transit, they really didn't come up with anything new. They just cobbled together all of these different concepts they had since these cases started appearing in the 1950s. And what they basically said is, "Yes, a state can tax interstate commerce directly, so long as it meets this four-prong test."
And the prongs are pretty easy. So in 1977, we really saw a [00:06:00] blurring of the lines. Prior to 1977, you would either register for the sales tax or the use tax. After 1977, some states did away with that distinction, and you just registered for the sales or the use tax. A lot of states still kept it though, and that really began to change in 2018 when we had the Wayfair case.
A lot of states, like Illinois, they had kept their use tax separately from their sales tax. And with the use tax, generally you didn't have to collect the local rates. You would only collect the state rates. And when the Wayfair case passed you had states like Colorado say, "You know what?
An economic nexus is a significant nexus, and it's pretty much the same as a physical presence. So if you have a significant nexus in our state you gotta collect the sales tax. Everybody's gotta collect the sales tax at this point if you [00:07:00] have nexus in our state." And once they said that, you now had to start collecting the use tax, and other states followed.
Illinois and a lot of states that, previously you didn't have to worry about collecting local taxes when you collected the use taxes, now you do. Some states still make a distinction between a sales tax and a use tax like Oklahoma. In Oklahoma, if you're a remote seller, you wanna sign up for the Oklahoma vendors use tax.
There's a lot less requirements for that than the Oklahoma sales tax, so that's a benefit there. But in most states, the only time you can sign up for a use tax nowadays is if you don't have nexus in the state. So if you don't have nexus in the state, you can generally sign up for the use tax.
If you do have nexus in the state, you've gotta sign up for their sales tax generally, with a couple of exceptions.
Ellie Moffat: Okay. Mike, can you give us a quick summary if someone were to [00:08:00] ask, what is use tax?
So if someone were just to come to you, and they have absolutely no idea, let's really boil this down for people.
Michael Fleming: It's again, it's a tax on the storage, use, or consumption of an item, and it's complementary to the sales tax. In other words only one tax needs to be charged.
You either pay a sales tax or a use tax in general. Again, there's always exceptions to every rule, but in general, you pay one or the other. Why is this important nowadays? Let's say that your vendor doesn't have nexus in your state, and is not required to collect the tax. If it's a taxable transaction, it's not tax-free just because the vendor doesn't collect the tax.
If the vendor doesn't collect the tax, you're supposed to self-assess it, and remit it directly to the [00:09:00] state. And not only do businesses need to do this, but individuals are supposed to do it also. Problem is businesses are audited, and use tax in audits is either the leading cause or the second leading cause of large assessments, but individuals don't get audited.
And very few of them hardly anyone I know, ever paid the use tax on their online purchases, and that was a major source of revenue that the states believed they were missing out on. Which is why we ended up with the Wayfair case. Because the states wanted to capture all those individuals the tax on the transactions that they were purchasing.
So they implemented Wayfair, and now if they have an economic nexus, which makes them have to collect a tax. If you're a business and you're buying something and you're not charged the tax, you gotta self-assess and remit it to the state directly as a use tax.
So [00:10:00] today if someone asks what is use tax, we're generally talking about the consumer use tax. It's all one use tax, but who's responsible for remitting it? Is the vendor responsible for collecting it, like in Oklahoma, or is the purchaser responsible for collecting it? So that's what is use tax.
It's a tax that needs to be paid generally by the consumer nowadays when tax is not charged on a transaction and it's a taxable sale.
Ellie Moffat: Mike already has answered some of these next couple questions here. So as a review Mike really touched on what is vendor's use tax, why is it relevant in the conversation about use tax, what about consumer's use tax?
But we are gonna go back, and I am gonna make you kinda double down and review on some of this stuff, Mike. We already really touched base on it again, but would you mind summarizing, or if there's anything else additional that you would like to add, what is vendor's use tax? Why is it relevant to the conversation [00:11:00] about use tax at all?
Okay. It was a lot more relevant prior to Wayfair. Prior to 2018 it was a lot more relevant, but it's still relevant today. As I mentioned Oklahoma, so if you register for the sales tax in Oklahoma, you gotta pay the Department of Revenue $25, you gotta get registered with the Secretary of State, which is a $350 fee.
You then have to get a registered agent, which will cost you 99 to $350, depending on who you're using. You gotta file an annual report every year. It's gonna subject you, in most cases, to the income tax. So there's a lot of baggage with the sales tax in Oklahoma. Whereas if you're a true remote seller, then you wanna register for the vendor's use tax, and the vendor's use tax is real easy.
It doesn't come with any of that baggage. You don't even have to pay the state $25 for the privilege [00:12:00] of collecting their tax. You just get registered, you collect and remit their vendor's use tax. So- that's what the vendor's use tax is nowadays. There are some states that still make a distinction between a sales tax and a use tax, but it's becoming less and less.
Okay, great. Okay, so what about consumer's tax?
Michael Fleming: Consumer's use tax, as we mentioned, that's what most people think about today when they hear the term use tax. Very rarely, unless we're talking within the industry, do we hear of a vendor's use tax. If a tax needs to be collected, most of our clients just say, "Hey, a tax is a tax. I don't care if it's a vendor's tax or a sales tax." And most of their customers say, "You're collecting tax from me. I don't care. Call it a sales tax. We'll keep it simple." So when they think of use tax, they think of the consumer's use tax. That's what they gotta pay out of their own pocket and get it to the state themselves.
It's not just individuals out [00:13:00] there. People think of individuals as consumers. Businesses are consumers. And businesses get audited. So this is one area where you know, when an auditor comes out, they're not just looking at your sales to make sure that you're charging the right amount of tax and that all of that tax is getting remitted and you got all the right exemption certificates.
They're also looking at your purchases, and they wanna make sure that you have paid tax on all the purchases where you needed to. So that is not realized by a lot of companies, and that's why this is the number one or number two issue for large audit assessments. Now, while that auditor's out there, this is also where a lot of businesses get found when you're doing business on a business to business basis.
It's how the state finds you for an audit. And any time they run across an invoice that doesn't have tax charged on it it's usually set up in a list, and [00:14:00] it's turned over to the discovery unit in a state. Most states have discovery units. That's where the people in the discovery unit, their entire job is to find people who they believe should be registered in their state and collecting sales or use tax.
So you may not get called today, tomorrow but you're on a list, and they're gonna get around to you eventually. And is the way that it generally happens. Maybe six months from now, maybe two years from now. But you're on that list, and it's a, Not that bad to be on a list. Maybe you didn't have a responsibility to collect the tax.
Maybe you didn't have nexus, so that's okay. But if you do have nexus you wanna be registered prior to the state finding you, and you wanna take care of any of that past liability. There are mitigation programs out there to deal with some of this past liability but most of the time it's off the table once the state comes and finds you.
But again, that's a, that's another [00:15:00] podcast. Consumers use tax, let's just say that's a huge issue. And for some industries it's a bigger issue than others. We said that businesses can be considered consumers. Contractors, this is where some of the the big problems come in, 'cause contractors if they're making improvements to real property, are consumers of the goods themselves.
They can't turn around and charge tax to their customer. Whereas if you're a contractor and it's not considered an improvement to real property. You're just installing it, maybe a dishwasher or something like that, generally not gonna be an improvement to the real property you are considered the retailer if you're selling them that dishwasher, and you need to collect tax on that.
But if you're installing a door a door does become a part of the real property, and you do not charge your customer for that door. You're the [00:16:00] consumer of any of the supplies and materials that go to incorporating that into the property. So use tax it's a lot bigger issue than most people realize.
Ellie Moffat: So okay, Mike, we already told everyone we're splitting this into two podcasts. Do you mind giving everyone kind of a brief overview of what we're gonna talk about in the next podcast, or give them any parting words of wisdoms for this part one, anything else you'd like to say?
Michael Fleming: Part one, just to make you aware- of use tax and how big of a problem it can be.
In part two, we're gonna go into a little bit more about the audit process. In part two, we're gonna talk about use tax accrual systems, what some of the common problems when it comes to use tax are. Again we've done webinars about this. We've got white papers about this.
There are a lot deeper information. In a podcast, we just wanna [00:17:00] introduce you to these subjects. So in part two of the podcast, we're gonna introduce you to some of the commom problems, some of the solutions that you need to be looking at, and how you can go about doing it.
Ellie Moffat: All right. Thank you so much, Mike, and thank you to all of our listeners.
If you have sales tax needs, we have many solutions and services, and you can reach out about them to me directly at E-M-O-F-F-A-T@salestaxandmore.com. That's emoffat@salestaxandmore.com. You can also visit our website, salestaxandmore.com. And in addition to our services, we offer an entire series of free webinars.
We have a ton of information on our website, a lot of resources to help you out. So thank you so much for joining us today, and hopefully you're tuning in for part two.
Michael Fleming: Thank you, everyone, and we hope to see you on the next episode of the Sales Tax and More Podcast. Bye-bye.
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