It's really important you're aware of the use tax vs sales tax differences: how they're applied, when they're applied, and in what instances they might apply to you
As with anything tax-related, it's not always straightforward.
So, join us as we answer questions such as "what is the difference between sales tax and use tax" and "is use tax the same as sales tax".
Use tax and sales tax aren’t the same. The modes of collecting and remitting these taxes differ depending on the parties involved and their place of business. However, both are an additional percentage tax collected by a merchant or consumer and remitted to the government.
The main difference between use tax and sales tax is who is collecting the tax. Inevitably, both taxes will go to the government, but the means by which they end up there depend on which type we’re talking about.
A frequent question that arises is why the difference between taxes is important, especially given that typically the rates of both taxes are fairly similar, if not the same. For example, in California, the sales tax rate and use tax rate are equal at 7.25%.
California sales tax is a tax that passes through the business and onto the customer at the time of purchase. The business adds this tax onto the transaction at the time of sale, which it collects and then remits to the proper government agency.
California use tax is not collected by the seller. Instead, the customer must pay the government directly, specifically in situations where no sales tax was collected on the transaction.
Let’s dig into the comparison a bit more to help you understand their differences, specifically:
The difference between sales and use tax comes to the fore in the case of tax audits, and is an area you should take time to be clear on.
While both forms of audits heavily consider the good faith of the parties involved, there are a few notable differences between the two:
Let’s look at these in more light in terms of sales tax vs use tax:
Compared to sales tax and other forms of audits, use tax audits often reveal much larger sums of unpaid taxes.
This is typically because, unlike sales taxes, which are charged by the seller at the time of purchase, use taxes in California are owed by the customer after the purchase by April 15th the year after the purchase was made.
Further, use taxes are almost always asserted against the lessor due to the complexity of determining whether the lease was a “sale” by virtue of the Sales and Use Tax Law.
Sales tax audits may face higher scrutiny and pushback from sellers who appeal, depending on the volume of sales audited.
In instances where a significant number of sales are evaluated on a sample test basis, the possibility of error or an over-estimation of tax liability may be more likely to occur in a sales tax audit than a use tax audit.
In the state of California, use tax audits generally apply in the context of leases. The use tax will be utilized and applied against a lessor because of the complexity of determining whether the lessee’s records show that the lease was a sale under the Sales and Use Tax Law.
In instances in which a tax audit reveals that a tax has not been collected by the lessor and the auditor cannot determine whether or not a tax was properly due, the Form CDTFA-1164, also known as the “Audit Memorandum of Possible Tax Liability,” will be filled out.
The information collected on the form is utilized in audit selection and aids in the disclosure of taxes that would otherwise remain unreported.
The auditor will carefully scrutinize the taxpayers’ transactions, taking into account various elements, including:
Unlike use tax audits, which typically involve leases, as mentioned above, sales tax audits in California typically target sales for resale.
In California, taxpayers often claim deductions for resale of their property, which is a frequent target for the California Department of Tax and Fee Administration (CDTFA).
Two key ways that the CDTFA auditor will verify sales for resale are:
The audit will consist of an evaluation of documentary evidence, including the validity of the seller’s resale certificates, correspondence with the customer and vendors, contracts, and other receipts related to the transaction.
The nature and type of items at issue in the transaction will also be scrutinized.
Once the audit is complete, the auditor will issue a decision on whether the resales are supported and done in good faith. If the resales do not pass the audit, those sales will be nullified.
In the state of California, sales taxes are added by retailers to the price charged to customers.
Sales tax is collected at the time of purchase by the seller, who then remits it to the state.
The following are just a few examples of transactions in which a sales tax would apply:
In these situations, the DVD store, book store, or pharmacy will add the sales tax as a separate item on the customer’s receipt.
In retail, use taxes are owed by the buyer directly to the state.
In certain scenarios, California consumers will buy tangible goods from retailers or sellers that do not collect California sales tax (i.e. out-of-state sellers and vendors). In such cases, the consumer use tax will apply.
For example, if you’re a California resident and buy a car from a dealership that solely conducts business in Utah and ships it home, you would not pay the dealership a sales tax since there is not a sufficient economic nexus between the dealership and California.
Still, a use tax will apply, because you plan to use, consume, or store the merchandise, in this case a car, in-state. Therefore, in lieu of the sales tax, you would owe a use tax to the state of California.
The use tax does not consider the location in which the product was purchased, but rather the residence of the seller and buyer.
If the seller’s business is not from the buyer’s home state and lacks a sufficient nexus to the state, they are not required to add that state’s sales tax.
The following are just a few more examples of transactions in which the use tax would apply:
Summarizing the situations above:
Use tax applies to out-of-state purchases where no sales tax is incurred. This is because the seller is not from the state and lacks a sufficient connection with the state. Should the buyer take their purchase and use it in their home state, they would owe a use tax.
In California, one particular scenario can become quite tricky if not managed properly: resale certificates.
During a tax audit, an auditor will carefully scrutinize resale certificates to determine whether there has been a lack of good faith by the taxpayer, typically via the misuse of resale certificates:
By providing their supplier with adequate documentation in the form of a resale certificate, registered sellers can avoid sales tax when purchasing from vendors.
The resale certificate indicates that the item was purchased with the understanding that the purchaser would resell it and report the sales tax to the government.
Here is an example of how this would work in an everyday scenario:
In this scenario, by presenting to the vendor the certificate and indicating his purpose of reselling the hat as a hat salesman, Abe does not need to pay the vendor the usual sales tax on the hats.
That said, however, once Abe does ultimately sell the hats to a customer, the transaction would, in fact, include the sales tax, which Abe would then submit to the state for collection.
The point of the resale certificate is not to get rid of the sales tax completely, but rather to avoid double taxation on the same item.
As mentioned above, when a sales tax is circumvented, a use tax is still owed by the customer to the state if it is used or consumed in any manner. The use tax must be reported and paid to the customer’s appropriate jurisdiction.
In other words, say, for example, an individual purchases a chair with the intent to resell and possesses a valid resale certificate.
After a few weeks of attempting to sell the purchased chair to no avail, the individual decides instead to use it for their personal at-home office. Is this ok?
Yes, but because the individual is using the chair, as opposed to reselling it as they indicated when they purchased the item with the resale certificate to avoid the sales tax, they now owe a use tax because the used chair has now become a taxable item.
In cases of the misuse of a resale certificate, in which a purchaser knowingly issues a resale certificate when purchasing items that they will not resell, the consequences will include:
Other penalties may include the following:
To avoid these situations, taxpayers should do their due diligence by reviewing any resale certificates obtained from third party vendors.
According to the California Department of Tax and Fee Administration (CDTFA), there are two primary ways to verify that a customer holds a valid resale certificate:
This happens when a reseller purchases an item either without the intent to resell or later decides to use or store it for their own personal keeping.
In such an instance, the individual is on the hook for paying a use tax on the item that they had originally purchased for resale. If the use tax is not paid, this can lead to a host of legal problems, including a tax audit or other penalty fees.
Ultimately, understanding the difference between whether a sales tax or a use tax is owed in situations involving resale certificates is key to avoiding legal penalties.
Now that we have discussed the ramifications of tax audits on resale certificates generally, we can now delve into a more specific topic: the treatment of property storage intended for resale.
As discussed above, in situations where a purchaser gives a resale certificate with the intent to resell and, subsequently, makes any use of the property aside from reselling, the California use tax will apply.
The same rule applies in cases even when the purchaser does not explicitly use the purchased property, but instead stores it for a period of time.
According to Sections 6094 and 6244 of the California tax code, property used as an accommodation while awaiting the delivery of property purchased, or leased, from the lender will be taxed at the fair rental value of the property for the period of such use.
The tax codes’ terms are as follows:
In short, the first provision stipulates the measure of the use tax to be levied on the property, and the second provision expands on the timetable of when the taxes will start to accumulate.
Therefore, when looking at the storage of property for resale in the state of California, be wary of two key points, which will determine whether and how much use tax will be owed:
While the storage of property (for resale or not) typically triggers the use tax, there are instances in which the sales tax will apply instead.
These situations primarily involve in-state purchases, which are then stored or used solely out-of-state.
For example, say a sales tax is collected from you when you purchase a pair of skies from a California retailer. After you receive the skies in California, you transport it outside of the state for solely outside, out-of-state use.
In this case, since the use and/or storage of the equipment is out-of-state and the items were purchased in-state, a use tax does not apply and is not owed to the state of California.
Instead, the sales tax applies.
The key difference between sales tax and use tax returns is that a sales tax return is a form that is filed by the seller or the business, whereas a use tax return is a form that is filed by the buyer or the consumer.
Let’s look at the key areas:
In California, the due date for filing a use tax return and paying the use tax owed is typically the same as the due date for the state income tax return.
But, it will differ for individuals and businesses:
It's worth noting that California does have a mandatory e-filing for businesses with annual sales tax liability of $100,000 or more, and for those that are required to file returns on a monthly basis.
It's always recommended to check with the California State Board of Equalization (BOE) or consult with a tax professional to confirm the due date and any other details regarding the use tax and sales tax filings and payments in California.
In California, the difference between sales and use tax exemptions are quite slim, but both exemptions intend to provide relief from paying tax on certain types of transactions or items.
Sales of the following are currently exempt from sales tax in California:
Purchases of the following are currently exempt from sales tax in California:
Note that the above is a high-level summary, and there are nuances to every sales tax exemption in California and use tax exemptions in California. No matter your situation, you’d still need to obtain an exemption certificate.
Ultimately, the difference between use tax and sales tax is quite nuanced.
However, the importance of distinguishing between the two cannot be emphasized enough, as mislabelling them can lead to tax audits and serious consequences.
If you’re unsure of the differences and how they might apply to you, especially in the sense of an audit, then get in touch with us.