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Annette Nellen

The Practitioner’s Role in Use Tax Compliance

With more individuals purchasing goods online, practitioners may find that all of their clients have use tax liabilities.

August 9, 2007
by Annette Nellen, CPA/JD

States lose significant amounts of revenue annually because many individuals and businesses fail to pay their use tax. In response, states are increasing collection efforts that may catch some taxpayers and their preparers by surprise. California lawmakers found that many paid tax preparers ignore client-use tax obligations. Penalties and interest are potentially due when this tax is not paid. Practitioners who aren’t already helping clients to be use tax compliant should take steps now to address this matter.

The Use Tax: Aiming for Neutrality and Equity

All states with a sales tax have another tax that is its mirror — called the use tax. Generally, sales tax is imposed on the seller who may collect it from the buyer. In contrast, the use tax is imposed on the buyer when the seller is not legally obligated to collect the sales tax. In 1992, the U.S. Supreme Court ruled in Quill v. North Dakota (504 U.S. 298) that a seller without a physical presence in a state has no obligation to collect sales tax from customers in that state. However, when the seller is not required to collect sales tax, the buyer is required to self-assess use tax (at the same rate as the sales tax). The use tax helps the tax system achieve neutrality and equity. The use tax removes any preference for purchasing goods from a non-present vendor. It also ensures that all buyers in the state pay sales tax on taxable purchases regardless of where the purchases were made.

For decades, use tax liability was generated from catalog sales or items purchased out of state that were brought back to the buyer’s home state. E-commerce has broadened the number of transactions in which consumers are likely to buy from non-present sellers. E-commerce makes it very easy for sellers to have customers in many states, yet physical presence (offices, warehouses or workers) in very few states. Thus, use tax transactions are increasing, while sales tax ones are decreasing.

Use Tax Compliance

Many states have tried to simplify use tax compliance and make more taxpayers aware of the tax. At least 21 states have simplified reporting by adding a line for the use tax on the state income tax form, thereby eliminating the need for filing a use tax form (PDF). Some states provide use tax compliance instructions with the income tax form instructions and allow taxpayer-created forms for compliance.

A few states, such as New York and Maine, provide an optional table to determine use tax liability based on income. Often, the table may not be used for high-priced items. For example, in Michigan, use tax must be separately calculated on single items costing $1,000 or more and added to the table amount. With the table approach, recordkeeping obligations of taxpayers are greatly reduced.

In states that do not provide a table for estimating an individual’s use tax liability, individuals need to keep track of catalog, television and Internet purchases of taxable items for which the seller did not collect tax. They must also track the purchase of goods from other states that were brought into their state and the sales tax paid, if any, to the other state. A credit is often allowed for sales tax paid in the other state.

Example: The Smiths live in Michigan, which has a sales tax rate of six percent. While vacationing in Hawaii, they purchased and brought back $500 of goods and paid the four percent Hawaii sales tax. While on a business trip in California, Mrs. Smith purchased and brought back $100 of goods and paid 8.25 percent sales tax. In calculating use tax owed to Michigan, the Smiths owe an additional two percent on the $500, but nothing on the California purchases. Practitioners need to check if a client’s state allows a credit for sales tax paid in other states.

Where the table option is not available or not beneficial, practitioners should help clients establish recordkeeping systems to keep track of purchases for which use tax is owed. Invoices or monthly credit card bills are helpful. Some Web sites, such as Amazon, allow customers to access details of all past purchases. In addition, clients also need to keep records of purchases made while visiting other states if the goods are brought back, particularly where the sales tax rate in that state is lower than in the home state.

In states without a use tax line on the income tax form or taxpayer-created forms, a sales-and-use tax return likely needs to be filed and due dates must be determined. Individuals with business tax obligations may have alternative methods for reporting use tax.

Practitioner Role

Since 2003, California has given individuals the option of reporting use tax on the income tax form, a self-created form or sales-and-use tax forms. The first three years of the use tax line on individual and business income tax forms generated only $13 million of use tax, making a small dent in the $1 billion of annual uncollected use tax. For 2004, the tax agency found that self-prepared returns were eight times more likely to have use tax reported than were practitioner prepared returns. This caught the attention of the tax agency and legislative staff because they know that many individuals with blank use tax lines did not use alternative means to pay the use tax and question why tax advisers would not act to help clients avoid penalties and interest. View related information.

Some states have sent letters to taxpayers about potential use tax liabilities. Some states obtain vendor records for high-priced items, such as furniture and send use tax bills to residents. Receipt of a use tax letter will likely lead clients to call their tax preparers.

Some day, Congress may require non-present vendors to collect sales tax from all customers. However, small businesses are likely to be exempt and the law would not apply to non-U.S. vendors. Thus, the need to be use tax compliant will not go away. States are likely to work harder to collect the tax and non-compliant individuals risk penalties and interest (including estimated tax penalties in some states). Practitioners should familiarize themselves with use tax rules, exemptions, special rules and filing options in the states where their clients reside and help clients create appropriate recordkeeping systems. Practitioners may also want to encourage lawmakers to provide the tax table option to ease recordkeeping burdens for clients. Don’t delay — states are paying closer attention and clients expect their tax advisers to keep them informed of all of their tax obligations and to help them comply.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University, where she teaches MST courses in tax research, accounting methods, property transactions, and high technology tax issues. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA, ABA, and Santa Clara County Bar Association. She is a frequent speaker to industry, professional and governmental organizations on the topic of taxation of e-commerce. She has several reports on federal and state tax reform and a blog at http://www.cob.sjsu.edu/nellen_a/TaxReform/21st_century_taxation.htm.