Freyman CPA on Pitfalls of Sales Tax and Use Tax

Have you had any of these thoughts about your business’ sales tax or use tax obligations:

“I’m a service provider; I don’t need to collect and remit sales tax.”

“We were only in the state at a trade show for one week – we don’t have physical presence in the state, so we don’t have to collect sales tax.”

“I bought equipment for my company in another state, since they don’t have sales tax. I saved 6% by doing this!”

Sales and use taxes are a murky area with few clear-cut rules. As a result, you or your business may not be in compliance with states’ sales and use tax regulations.

Sales tax is a tax that is levied on the sale of goods or services. Unfortunately, states have differing definitions of what is included as a taxable good or service. A general rule of thumb is that the sale of tangible personal property (that is, physical assets that are movable) is taxable. The provision of services is generally not subject to sales tax unless a state has a regulation or law that specifically subjects the service to sales tax.

First Example

“I’m a service provider; I don’t need to collect and remit sales tax.”

Although this may be a safe assumption most of the time, you should assess whether you are providing services that are specifically subject to sales tax. For example, if you engage in business services like advertising or consulting, some states (e.g., Connecticut) have specific statutes that subject these services to sales tax.

In order to be subject to sales tax in a state, your business must have nexus in that state. Nexus is established through a number of different ways, but the current determination for most states is whether there is sufficient physical presence in the state. How much physical presence is required to establish nexus? Unfortunately, there is no straightforward answer to this question, as it depends on the activities that are performed in the state and the duration of these activities.

Second Example

“We were only in the state at a trade show for one week – we don’t have physical presence in the state, so we don’t have to collect sales tax.”

sales tax established by presence at trade showsPhysical presence in a state may be established if you participate in trade shows, but it depends on the state in which the trade show is held. Some states have safe harbors that allow you to be at trade shows for a certain number of days per year without establishing physical nexus.

There are numerous other activities that may constitute sufficient physical presence to establish nexus in a state. Making deliveries in your own vehicle, sending employees to make repair calls or in-person sales, storing inventory in a distribution or fulfillment center, or having computer servers in another state may result in your business having physical presence in other states. Once nexus is established, your company is subject to collecting and remitting sales tax in those states.

Third Example

“I bought equipment for my company in another state, since they don’t have sales tax. I saved 6% by doing this!”

Sales tax on equipmentUse tax is designed to complement sales tax. The two are mutually exclusive, so both sales and use tax are never paid on the same good. Use tax is an excise tax that is levied on and remitted by the consumer of a product (versus collection and remission by the seller, as in the case of sales tax). Use tax is levied on goods for which sales tax applies, but on which no sales tax was paid. In the statement above, the consumer purchased tangible personal property in a state that does not have sales tax. Given that the consumer’s home state does have sales tax on that property (at a sales tax rate of 6%), the consumer is subject to a 6% use tax on the property.

The purpose of the use tax is to deter consumers from avoiding sales tax by purchasing goods out of state (or from out of state retailers who do not collect sales tax). Many businesses and individuals are not in compliance with use tax regulations. If you purchase goods through an online retailer, such as Amazon, and you do not pay sales tax on the goods, you should file a use tax return and pay the applicable taxes. If you believe that you are not currently in compliance with use tax regulations, we can assist in assessing your liabilities and bringing you back into compliance.

Summary

This post gives a very high level look into the intricacies of sales and use tax requirements. Given how infrequently states have clear-cut rules surrounding the establishment of nexus, it can be difficult to determine whether you are subject to sales tax in a particular state. If you are considering engaging in new activities in a state, or are considering engaging in some type of business in a new state, please contact us so that we can help to assess your sales tax filing requirements.

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