Tuesday, July 15, 2008

The Use Tax

Tax Girl has a post on something I have wondered about for about a year (since I learned about it): the USE TAX.

In every state with a sales tax, (all but 5 states, DC, and the US territories) ,there is also a use tax. This tax applies generally to businesses as well as individuals. The tax regards goods (and some services) which are bought in another state and then brought into the state for use in that state. (ex: a box of napkins bought in DC for use in MD). Such purchases have either not been taxed on sales elsewhere-or have been taxed either at a lesser rate, a greater rate, or the same rate in the other jurisdiction where the goods were bought.

When purchases are taxable under the use tax, the user of the purchases must fill out a use tax return and remit the tax that would have been paid to the state had the goods been purchased in state. Generally, the person may take a dollar for dollar credit (not a deduction) against the tax for the amount of sales tax that was paid in the other jurisdiction.

Ex. I buy a couch in DC for use in MD. I pay 5.75% tax on the couch when I buy it in DC-per the DC sales tax. (The rate in MD is 6%). When I go and bring it to MD, I am technically required to bring it to the attention of MD on a "use tax" re turn, and pay .25% (6-5.75) to the state. (not a deduction-but a credit).

In some states, you must add up all the use tax you owe and return it annually and pay. In MD, you must do the same quarterly (4 times a year). In some states, such as Pennsylvania, you must do this every month. (Technically, this means that all Pennsylvanians must file a total of 14 tax returns (at least) per year-12 sales, 1 state income, and 1 federal income).

This use tax is unaffected (generally) by the way the goods were purchased. It doesn't matter, for example, that you bought the goods online. It doesn't matter if you bought them by mail order or by telephone. You still have to pay the use tax. Note this is not a tax on the internet, (which would possibly be a violation of the current federal moratorium on such things), it is instead a tax on the purchases you are importing to the state that may not have been taxed for sale.

Also generally, only purchases which are liable for the sales tax are liable fore the use tax. So, for example, in DC, where the sales tax does not apply to certain food and drink sales, if one bought and brought in from, say, NH, (which has no sales tax), a can of soda, that person would not need to pay use tax, since it would have been exempted from sales tax in DC.

The use tax return form for MD is here. The MD Comptroller's website substantially repeats the above as it applies to MD. (In MD the tax collection agency is the Comptroller-the state equivalent of the IRS) . The form has you list purchases from out of state and the tax paid on them there and then add up the use tax you owe. The rules are basically the same in other states-except the filing rules are diffrent (annually, quarterly, monthly).

In my opinion, the Use tax, if actually enforced against individuals, would create a nightmare.

First, taxpayers have enough trouble filing 2 tax returns a year for their personal income tax (and perhaps their dependents or elderly parents etc..) Imagine if you had to file 14 returns! (see above PA rules).

Second, the rule that use tax only applies where sales tax would have when in state creates another problem. There are literally dozens of exemptions to the sales tax, and not all of them are clear. Some of the meanings of the exceptions sales tax have been the subject of complex tax litigation with companies in state. Most consumers (and even tax lawyers) cannot understand their meanings completely. An example of this problem: one foggy exemption (at least in Md) from sales tax are sales by vendors which don't usually sell and sell less than a certain amount per year ( a kid's lemonade stand, or a garage sale, for example-would usually not have to pay sales tax). So how do you know if the vender you buying from out of state meets this exemption? must you ask the vender before you buy on Ebay how big he is and how muc h slaes he does every year so that you know if he would be liable in your state for sales tax-so that you then know your liable in your state for the use tax if you buy form him and use it in your state?

To make matters even worse, many counties and municipalities also have sales/use taxes. This means you could be liable for the tax (and the requirement to fill out and file a return) simply by shopping in a neighboring county that has a diffrent sales tax rate. MN's use tax return form, for example, has a place to calulate extra use tax you owe becuaase you bought the items out of county and brought them in for personal use.

Of course, exceptions and timing for filing various municipality use taxes will inevitably be slightly different from those of the state.

Finally, there is the issue of back taxes. Suppose Md suddenly got serious and prosecuted everyone who hadn't paid their use tax in a while. Not only would you owe the taxes, you would also owe interest and penalties for each tax you didn't pay based on when that particular tax was due. Furthermore, many state tax laws have statues of limitations far longer than the federal 5 year statute. For example, the Md statute of limitations on tax issues is 7 years. We could all be hit with 7 years of use taxes on our ebay, amazon, and itunes purchases at any minute the Comptroller decided to clamp down. Some state have no time limitations on the gov suing for tax.

The flip side of this argument is that there are good reasons for use taxes. For example, if one state has a higher rate than another, business in that state would suffer if one could get a lower rate by traveling to the neighboring state. Furthermore, the state would suffer a loss of revenue on the missed sale.

Some states try to strike a balance by just having consumers estimate the use tax on their yearly state income tax return. KY is one example of this.

Many other states are trying to organize a streamlined sales tax that would give each state 1 rate ( no special tax districts) and then allow states to require businesses out of state to collect the tax and remit the portion of the tax above the out of state rate to the state of the purchasers' origin. There is difficulty getting legislatures to sign on, and more difficulty in implementing it without a lot of states getting involved.

I'm not sure what the solution is. But its a serious problem.

Update: The point of this post is not to compare the tax burdens of diffrent states, neither by looking at a single tax, nor the total tax wedge. There are long complicated analyses written about such issues-comparing all the state and local taxes of one jurisdiction, to anther. Some studies do this per capita tax charged to residents-others do it by a percentage of the average personal income which ends up taxed. Some only include state taxes. Some include both state and loical taxes. Some of these include the offset of the intersection with federal taxes. BTW one good site for this is the tax foundation's site. For example I do not mean, by one of the examples in this post, to state that sales and use tax rate of DC (5.75%) is lower than the MD rate of 6% and that therefore DC residents pay higher taxes overall. Nor do I intend to say that a sales tax may not be increased in some circumstances based on the good you bought. (ex: dc has a hinger sales tax on restaurant food than their normal rate). Indeed the point of this post is not even to talk about the monetary burden of a use tax. The point of this post is to talk about the administration of the use tax (and how its basically impossible), not to talk about which states are the best tax havens. I had thought this was clear-but apparently not.


Martin Weiss said...

1. I realize there is a tax table that says the DC sales tax is only 5.75%; however, they also have a 12% parking tax, a 14% hotel tax and a 10% restaurant tax.

2. Suppose you bought a meal in DC, ate some of it at the restaurant then took home part of it for consumption at home in Maryland. In that case, I guess you would have to allocate based on your estimate of how much you consumed in DC at the restaurant (where you paid 10%) and how much at home.

3. Another interesting case is where you live in MD near the DC line and you order take out from a business in DC. After the food is delivered to your house in MD from the business in DC, you take the food to a picnic at a park in DC.

4. In the Portland, OR/Vancover, WA metro area, Washington State has lower income taxes and Oregon has lower sales taxes. This actually creates, several times a year, Sunday traffic jams on the I-5 bridge that connects the two cities. They've been trying to figure out a way to resolve this for the past two decades or so without success.

George Weiss said...



1. yes. they also have an income tax and an estate tax and property taxes etc. so does Md. so does every other state. and all that is very nice. we are talking about sales and use tax.
true, parking and restaurant taxes are examples of rates where the sales tax if higher than the general rate. Md also has such cases.

Now by definition,I don't see hwow parking could be subject to a use tax...since you pay for the privlige to park in the place where it is. (how would you buy parking in MD that you "used" in DC?

I think your problem is that you think i mean to say that becuase dc has a lower sales tax then md-that things are taxed lower there-that is not what i mean to say-nor is it suggested by what i did say.

In any case-the point of this blog post is not to compare sales tax rates in various jurisdictions. Its to talk about use tax liability

2. not in the case of buying in DC restaurant and taking to Md. The way it works is that if you buy an item outside your state and use it in your home state you take a dollar for dollar credit on the SALES TAX YOU PAID. (the credit is not the sales tax you paid on what you used-the sales tax you paid on what you bought). if the sales tax on restaurant food in dc is way over 6% than even if you brought the entire thing home to MD you ate home with you your use tax liability would be 0.

3. the use tax in DC (i think) does not apply to special sales tax rates. So if you took out in MD and brought home to DC-you probably wouldn't need to fill out a form becuase theres probably a special use tax exception for such things
since they are not really sales taxes so much as special restaurant taxes.

4. see number 1.