If you’ve ever purchased anything for your business tax free, then consumed what you purchased in some way, you could be on the hook for use tax.
A complement to sales tax, use tax typically applies when a seller doesn’t collect sales tax on a taxable transaction — either because the seller isn’t registered for sales tax, or because the buyer qualifies for an exemption. It’s a simple enough concept but use tax errors are routinely among the top audit risks, and most sales and use tax assessments stem from use tax errors or omissions.
Businesses that make a lot of tax-exempt purchases may be more likely to incur use tax liability than businesses that make few such purchases. However, just about any business could develop use tax liability in one of the following ways:
- Buying taxable goods from an unregistered out-of-state vendor
- Pulling inventory for charitable donations, promotional giveaways, or other business or personal use
- Purchasing equipment for business use
- Transferring inventory or assets
- Using a service in multiple locations but paying for use in only one location
Please note that tax laws vary from state to state, and what follows is a general overview. For state-specific policies regarding use tax, please check with the department of revenue or a trusted tax advisor.
1. Buying taxable goods from an unregistered out-of-state vendor
If you buy taxable goods from an out-of-state vendor that doesn’t charge you sales tax, you’re responsible for remitting the equivalent use tax to the state.
States were once limited to taxing sales by businesses with a physical presence in the state, so they couldn’t require out-of-state businesses to register for sales tax. That changed with the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc., which allowed states to tax remote sales. Nonetheless, some businesses still aren’t required to register for sales tax in some states because all states that tax remote sales provide an exception for businesses selling beneath a certain threshold (e.g., $100,000 in sales or 200 transactions in the current or previous calendar year).
So, if your business purchases taxable goods from an unregistered seller, it’s your job to pay and report any use tax due.
2. Pulling inventory for business or personal use
Charitable donations and promotional giveaways are a great way to advertise your business and perhaps do a good deed. But there’s often a hidden cost to giving away items you have sitting on your shelf: use tax.
One example of this is a department store giving out free samples of chocolate or perfume. In Georgia, “When a dealer purchases samples under terms of resale and subsequently withdraws them from its untaxed resale inventory and provides them to a customer without charge, the dealer is liable for use tax on the cost price of the sample upon its withdrawal from inventory.”
Another example is a shoe store giving shoes to a local running club. If the store originally purchased the shoes, tax exempt, for resale to customers, and sales tax would have applied to the sale of the shoes, the corresponding use tax would apply when the shoes were given free of charge to the runners.
Use tax liability can also be created by using inventory purchased that was purchased tax free. Several examples come to mind:
- An office supply store pulls a ream of paper off the shelf to print invoices
- Employees at a coffee shop drink from paper cups purchased for customer use
- A bookstore gives books to employees
- The owner of a clothing store takes items from inventory for personal use
Here’s another example from Georgia: “A dealer who provides property to its sales representatives at no cost is liable for use tax on the cost price of the property. Because the property has been permanently given to the sales representative, the dealer is no longer holding the property in its inventory for sale in the regular course of business. It is immaterial whether the property is used by the sales representative only for demonstration and display purposes or for other purposes in addition to demonstration and display.”
3. Purchasing equipment for business use
As explained by the California Department of Tax and Fee Administration, “If you operate a business here in California and are required to hold a seller’s permit, … your purchases of items for use in your business in California, for example equipment, consumable supplies or other tangible assets, are subject to use tax.”
Diane Yetter, founder of the Sales Tax Institute, offers the following example: A business purchases forklifts to unload raw materials from a delivery truck and place them in inventory, bring inventory to their production plant, and to move product between different stages of the manufacturing process. The business may believe all of these uses qualify for an exemption, but some states that provide an exemption for manufacturing equipment may only allow the exemption for forklifts that move products between production stages. Forklifts purchased for the other two uses would be subject to use tax if purchased tax free.
4. Transferring inventory or assets
If you move inventory or assets — or your entire business — to a new city or state, you may incur use tax based on the tax rate in the new location. The Tennessee Department of Revenue explains: “A business relocating to Tennessee brings property purchased in a state with no sales or use tax. The dealer would be liable for use tax on this property.”
Similarly, a business moving from a location with a low rate of tax to a location with a higher rate would likely owe the difference in use tax.
5. Using a service in multiple locations but paying for use in only one location
Use tax liability can also be incurred when a business purchases an item for use in one location but ends up using it in multiple locations. Software comes to mind. If you buy software to use at an office in Kansas, then expand and use it in new offices in Missouri and Texas, you could end up owing use tax.
The construction, hospitality, and manufacturing industries tend to have high incidences of use tax liability because of the nature of the industries themselves. But retailers can often run afoul of use tax, as can very small businesses that offer services. If you’ve ever made a tax-free purchase of a laptop or software for your business, then used it for personal reasons, you could be at risk of owing use tax.
Like a stop sign covered by shrubbery, use tax liability is low-hanging fruit for people tasked with enforcement (aka, auditors). Don’t be caught unawares. Learn how Avalara Consumer Use can help you manage use tax.
Cover photo by Canva
