Most ecommerce businesses know they need to do something about sales tax. But as many find out, it’s a complex challenge to solve. Knowing where to collect, how much to collect, and the process of remitting to the states is no easy task. For help with sales tax,download our 10-step process for sales tax compliance. Eventually most ecommerce businesses will also come across use tax. Many people refer to sales tax and use tax as the same thing. Although they are both essentially sales tax, charged by state and local jurisdictions, it’s important to understand the differences. Not understanding use tax vs. sales tax could lead to businesses not being fully compliant with sales tax and facing potential penalties and back-taxes.
Sales Tax vs. Use Tax
Let’s start by looking at sales tax and use tax separately. A basic understanding of sales tax and nexus is required in fully understanding use tax.
What is Sales Tax and Nexus?
Sales tax is imposed by state and local jurisdictions at the time of sale. The responsibility to pay sales tax to states and local jurisdictions falls on the backs of the seller of a product or service. Most sellers pass the cost of sales tax to its customers. They collect sales tax when the customer purchases their product or service and then remit that sales tax to the necessary tax authorities. Failing to properly register, collect, file, and remit sales tax can lead to big penalties. Furthermore, businesses that collect sales tax and never remit that sales tax to the states can be criminally charged.
Understanding where a business needs to collect and remit sales tax is the biggest challenge that ecommerce businesses face with sales tax. When a business has a strong enough connection with a state that requires them to collect sales tax, the business is said to have “nexus” in that state. States have differing nexus laws, so it’s complicated. But sometimes a business can sell to customers in a state where it doesn’t have nexus. Therefore, the business doesn’t need to collect and remit sales tax for those sales.
What is Use Tax?
As with sales tax, use tax is also imposed by state and local jurisdictions, but generally falls on the backs of the customer. As mentioned, businesses don’t need to collect and remit sales tax for sales in states where they don’t have nexus. But this doesn’t mean those sales are exempt from taxes. The states still want their money! In these scenarios, the states impose the tax on the buyer instead of the seller, as use tax. For ecommerce businesses, they become the buyer when purchasing from vendors.
Use Tax for Ecommerce Businesses
The first way ecommerce businesses are affected is when they need to remit sales tax on purchases from vendors. For example, let’s say an ecommerce company buys supplies or assets from a vendor and sales tax wasn’t charged for that sale because the vendor didn’t have nexus in the ecommerce businesses’ state. The ecommerce company (the buyer in this case) will need to remit the proper amount of use tax according to state and local jurisdiction laws.
The process we suggest for this scenario is for your accounts payable department to sift through all its paid invoices and notice which ones did not include sales tax. Then sales tax experts can advise on whether you need to remit use tax to the state. Or you can attempt to figure it out on your own. (Best of luck!)
The other common scenario for ecommerce businesses is when they “use” inventory that wasn’t sold to a customer. This includes the following:
- Employees getting free product
- R&D using inventory
- Inventory used in giveaways
- Influencers receiving free product
- Inventory withdrawn for any normal course of business. For example, Starbucks would need to remit use tax for coffee consumed by its employees.
In these situations, the ecommerce business needs to remit use tax to the state according to its laws. This is because these are technically $0 transactions. So, these businesses can’t pass the tax burden onto the customer but must remit it themselves. Businesses only need to remit use tax on products that are taxable. To determine how much to remit, base the tax on the cost of the products, and use normal sales tax rates unless other use tax rates apply. Usually a business will only need to remit use tax to their home state.
Use Tax Compliance
Use tax is reported and remitted with sales tax returns. We suggest doing the following before completing the use tax portion of your return:
- Have your AP team check all paid invoices for any purchases that you didn’t pay sales tax, but should have
- Track product used for promotional giveaways and remit use tax on the cost of that product
- Track product withdrawn for R&D purposes and remit use tax on the cost of that product
- Check for buy-one-get-one-free promotions. Did you collect sales tax for both the product that was purchased and the free product? If not, you will need to remit use tax on the difference that you should have collected.
- Did you withdraw inventory for any other purposes?
Checking for use tax is a common part of audits. If you are audited and not following these guidelines, your business could face big back-taxes and penalties. Following the guidelines in this article will be a great starting point for properly managing use tax.
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