In this first installment of our series aimed toward helping you navigate the impact of sales and use tax on your business, we start with a fundamental element: understanding the difference between and implications of sales and use tax.
Sales and use taxes are transactional based and impact everyone and every business. While closely related, it’s important to know the difference between the two:
Sales tax is imposed on sales, leases and rentals of tangible personal property and certain services. Sellers collect sales tax from the consumer and remit the tax to the taxing authority — your city and state.
Use tax is complementary to the sales tax and often misunderstood. Use tax is imposed on the use, storage or consumption of tangible personal property and taxable services. When a seller does not charge sales tax, the consumer is required to proactively pay the associated use tax directly to the taxing authority.
The use tax issue is often less than clear from an obligation standpoint, leading to real consequences for sellers.
While most taxing authorities hold the consumer ultimately responsible for paying the tax, sellers still have collection responsibilities. Consumers may be required to pay either the seller or the taxing authority directly, but sellers that meet the taxing authority’s nexus standard are required to collect and remit sales tax. Nexus standards, having dramatically evolved since the Wayfair decision in 2018, are no longer limited to physical presence (permanent or transitory). Now nexus standards can also be met if a seller exceeds a dollar or transaction threshold (typically $100,000 or 200 transactions).
States have essentially outsourced the collection of sales tax to sellers rather than rely on consumers to self-assess and remit use tax. Sellers act as agents for the taxing authority in the tax collection efforts. This agency concept is critical to remember for two reasons:
Most states will hold both sellers and consumers jointly liable for unpaid taxes. Taxing authorities may audit the seller, consumer or both. In a sales tax audit, a seller may be assessed tax on uncollected sales tax if the seller cannot prove the transaction was not subject to tax or that the consumer paid use tax. If the consumer is also audited, use tax may also be assessed on the same transaction.
The distinction between exclusions from tax and exemptions from tax is important. As a result, sellers need to categorize or somehow classify their products and services for sales tax purposes to determine whether the transaction is taxable, nontaxable (excluded) or exempt.
An exclusion is a transaction that is outside the scope of the taxing authority and does not require documentation to support the non-taxability of the transaction. Exclusions commonly arise in transactions involving services. Because states generally only tax enumerated services, services not specifically listed as taxable in a state are excluded from the tax base. Documentation is not needed to support why the transaction is not subject to tax.
In contrast, exemptions are transactions that are within the scope of the taxing authority’s power; however, the authority provides an exemption based on the nature of the customer or use of the product or service. Exemptions require sellers to obtain certificates or other documentation to support the exemption. We will take a deeper dive into this classification process and best practices in future posts.
Understanding the difference between sales and use tax, and how it can affect your business, is a great first step toward a stronger sales and use tax strategy. Sellers without strong practices and procedures in place may face audit assessments, financial statement impacts and issues during due diligence on the sale of the business.
Contact Hannah Prengler at hprengler@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.