Your Guide to Sales and Use Tax Types: Understanding the Differences
Sales and use taxes are a crucial source of revenue for state governments in the United States. Currently, 45 states, the District of Columbia, and Puerto Rico impose sales and use taxes, while Alaska, Delaware, Montana, New Hampshire, and Oregon do not have a state sales and use tax.
This article will explore various types of sales and use taxes and their implications for businesses and consumers.
What are sales taxes?
No two state tax codes are identical, with states having the freedom to create definitions and determine taxability differently. When we talk about sales taxes in a general sense, it usually refers to a transaction-level tax on the exchange, sale, or transfer of goods or services.
However, this categorization of sales tax papers over significant theoretical differences between the states related to what exactly is being taxed. For example, is the tax from a foundational standpoint levied on the seller, the transaction itself, the revenue from the transaction, etc. Practitioners often talk about four different categories of sales taxes in order to analyze this distinction: seller’s privilege tax, consumer levy, transaction tax, and gross receipts tax. These represent subsets of sales tax that can all be put under the sales tax umbrella.
These categories are not set in stone, as states may use different elements from each one. And despite the different subsets, states will often refer to their transaction-level tax only as a sales tax even when it is technically a seller's privilege tax, a consumer levy tax, etc. While categorizing these subjects may seem like a theoretical distinction, they reflect real differences that can have significant practical implications.
Seller’s Privilege Tax
- Retailers are charged for the privilege of selling in the state with the seller privilege tax. A seller’s privilege tax is typically levied on the seller of goods or services when they make a retail sale.
- Sellers often have the option to pass the tax on to the purchasers or absorb it themselves (i.e., not collecting it from the purchaser but paying it out of their pockets). Therefore, separating the tax amount on the invoices is usually not mandated, as the liability of paying the tax rests with the seller anyways.
- In an audit situation, the seller is responsible for the tax, not the purchaser, and the audit will focus on whether the seller remitted tax measured by its gross sales.
Consumer Levy Tax
- Another type of sales tax is the consumer levy tax, the most common type in the US. It is imposed on the purchaser on the act of consuming or purchasing products or services, and the seller acts as an agent who collects the tax on behalf of the state. In many consumer levy states, sellers are compensated by the state for collecting and remitting the tax.
- Sellers can’t absorb the tax, which must be reflected separately on the invoices provided to the purchasers.
- In consumer levy states, the seller typically remits the collected tax to the relevant tax authority, but the liability for payment falls on the purchaser. As such, sellers must ensure they levy the tax on all sales and remit the collected tax to the relevant authorities. During an audit, the state may impose the applicable tax on either the seller or the purchaser
- This type of sales tax combines seller privilege and consumer levy taxes. Transaction tax is imposed on the retail sale (“transaction”) of products or services.
- Sellers can’t absorb transaction tax and must be reflected separately on receipts and invoices provided to the purchasers.
- The tax liability falls on both the seller and the purchaser. While the buyer is obligated to pay taxes to the seller, the seller is responsible for collecting and remitting these taxes. During an audit, the state may impose the applicable tax on either the seller or the purchaser.
Gross Receipts Tax
- Finally, there is the gross receipts tax, also referred to as gross excise tax, which is imposed on the seller for the privilege of conducting business within a jurisdiction. Hawaii and New Mexico are notable examples of states with gross receipts tax. Unlike a seller's privilege tax, which is levied on the retail sale of goods or services by the seller, a gross receipts tax is imposed on the total gross receipts generated by a business within the taxing jurisdiction.
- The seller is responsible for paying the tax to the state government, which is calculated as a percentage of their gross revenue. However, the tax is expressed as a percentage of the price on the customer’s invoice. One key feature of gross receipts taxes is that almost all services sold by businesses are taxable by default, unlike in other states where only enumerated services are taxable. This is because all types of services contribute to the total gross receipts generated by businesses operating within a jurisdiction. This also means there just a few exemptions or exclusions from gross receipt taxes.
- Gross receipt tax doesn’t need to be separately stated, and the seller can absorb it if desired.
What are use taxes?
Consumer Use Tax
Consumer use tax is a complementary tax to sales tax, and it is imposed on the storage, use, or consumption of taxable goods and services within a state. It comes into play when a sale, which would otherwise be subject to sales tax, does not include sales tax, such as when the seller does not have nexus in the purchaser’s state.
Nexus refers to a connection between the seller and the purchaser’s state based on sales revenue, number of transactions, or physical presence. In interstate transactions where the seller does not have nexus in the purchaser’s state, sales tax cannot be imposed by the state where delivery is made. This is because the delivery state has no right to impose sales tax on retail sales consummated in other states, as states can only impose tax on transactions within their boundaries. This creates a loophole from the state Department of Revenue’s perspective, as the state’s residents could avoid paying a state’s sales tax via internet purchases or by crossing the state border and making their purchases outside the state. This can create an unfair business advantage for out-of-state sellers as the purchase price for otherwise taxable goods or services would not include sales tax.
To close this loophole and level the playing field for in-state and out-of-state sellers, each state with a sales tax also has a complementary consumer use tax, usually simply referred to as “use tax.” Sales tax rates and use tax rates are usually identical. The responsibility for reporting and paying use tax falls on the purchaser, meaning the end-consumer must calculate and remit the tax to their state government. This is a similar concept to value-added tax’s reverse charge mechanism, except that the use tax applies to both businesses and individuals.
Sellers’ Use Tax
The naming may be misleading, as sellers' use tax (also referred to as vendors' use tax) is equivalent to sales tax. It applies to vendors who are located outside the purchaser's state but are registered to collect tax within that state. The requirement for sellers' use tax stems from the concept of economic nexus, which means that out-of-state vendors who have sales that exceed a certain nexus threshold in the purchaser's state should register and collect tax in that state.
While some states use the term "sales tax" for both in-state and out-of-state vendors, others differentiate by referring to out-of-state vendor tax payments as sellers' use tax. In some states, sellers' use tax is filed separately from sales tax, with the latter generally specific to in-state vendors. Additionally, seller's use tax rates may differ from sales tax rates.
How can Fonoa help with sales and use tax?
With the complex and constantly changing sales tax landscape across jurisdictions, staying compliant with sales and use tax rates and laws can be daunting for many businesses. Fonoa offers a global tax engine that can be a valuable tool for companies operating in the US, providing a simple and efficient solution for managing sales and use tax obligations.
Get in touch to discover how we can help you meet the challenges and take the complexity out of tax.