What it means
Sales tax is normally collected by the seller at the till and passed to the government. When a seller does not collect it, for example because the seller has no presence in the buyer's state, the tax does not simply vanish.
The buyer owes the equivalent amount as use tax. Businesses meet use tax most often with equipment, supplies and software bought from suppliers who did not charge sales tax.
It also arises when a company takes items out of its own inventory for its own use, for instance a retailer using shop stock as office furniture, because the company never charged itself sales tax. The rate is normally the same as the sales tax rate at the place of use, which is set by state and local governments rather than by the buyer.
Taxes already paid to another state on the same purchase are often credited, so the buyer is not taxed twice. Compliance is where companies slip up.
Because no one collects the tax at the point of sale, it falls to the accounts payable team to spot untaxed invoices and to accrue (record in advance) the liability. Many states audit for it, and unreported use tax can lead to back taxes, interest and penalties.
Exemptions mirror those for sales tax. Goods bought for resale, certain manufacturing machinery and purchases by qualifying nonprofits are often exempt, but the company must hold the right certificates to prove it.
A practical habit is to review the largest untaxed invoices each month before the books are closed. Doing so costs little and prevents the build-up of an unrecorded liability that grows with every purchase and is only found years later during an audit.
In practice
Real-world examples
Example 1
A law firm orders $8,000 of office chairs from an online seller that does not charge sales tax. The accounts team spots the missing tax and accrues $480 of use tax at a 6% rate. The firm reports and pays it with its next return.
Example 2
A restaurant owner takes $1,500 of kitchen equipment from stock held at her catering supply business for her own use. Because she never paid sales tax on the items, she accounts for use tax on their cost. The tax is added to the cost of the asset.
Example 3
A software start-up subscribes to a service from a foreign vendor that does not collect tax. The finance lead checks whether the subscription is taxable where the company operates and, finding that it is, accrues the use tax each month.
Think of it
Imagine ordering a meal for home delivery from a restaurant outside your delivery zone, and they forget to charge you the local clean-up fee. You are still responsible for sending that small contribution to your local council yourself so your neighbourhood stays clean.
Formula
Calculation
Use tax = Purchase price of taxable item x Local tax rate - Sales tax already paid to another jurisdiction
A design studio buys a $20,000 piece of printing equipment from a supplier in another state, and the supplier charges no sales tax. The studio's local rate is 6%. Use tax = 20,000 x 6% = $1,200. If the supplier had charged $500 of tax that the studio's state recognises as a credit, the use tax owed would be 1,200 - 500 = $700. In the first case the studio books an extra $1,200 to the cost of the equipment and a matching liability until it files its return.Case study
Seen in the real world
Maple Ridge Fabrication is an illustrative, fictional metalworking firm that regularly buys tooling and supplies from suppliers in other states. For years the buyers assumed that if an invoice showed no tax, none was due.
A state auditor reviewed three years of purchases and found $400,000 of taxable items with no tax charged. At a 6.5% rate, the use tax owed was 400,000 x 6.5% = $26,000, plus interest and a penalty of $4,500.
In the illustrative response, the company added a check to its invoice approval process so that any taxable purchase without tax is flagged and accrued each month. Within a year, the accounts payable team had cut missed use tax almost to zero and avoided further penalties.
Watch out
Common mistakes
- Assuming that no tax on the invoice means no tax is owed, when the buyer may owe use tax directly to the government.
- Forgetting to accrue use tax on items taken from inventory for internal use.
- Paying tax twice by ignoring the credit available for tax already paid to another jurisdiction on the same purchase.
Questions
People also ask
Is use tax different from sales tax?
The rate is usually the same, but sales tax is collected by the seller at the point of sale while use tax is reported and paid by the buyer when the seller did not collect.
Do individuals owe use tax too?
In principle yes, for taxable items bought without tax, although businesses are the more common target of audits.
How should the use tax be recorded in the accounts?
As an addition to the cost of the item bought, with a liability to the tax authority until it is paid.