Perhaps one of the most misunderstood areas in the state and local tax field is that of “use tax.” Most people comprehend the concept of sales tax— that when taxable property or a taxable service is purchased, forty-five of the fifty states impose a tax upon the retail sale of the item or service. Moreover, many of the states have passed legislation that permits localities to impose their own sales taxes, with the local taxes being added to those of the states for reporting and collection purposes. However, in many cases a clear understanding of exactly what “use tax” is and when it applies often proves to be elusive in nature.
Characterizing “Use Tax”
The simplest way to define use tax is as a companion tax to the sales tax. While sales tax generally applies to in-state purchases by both residents and non-residents alike, use tax is applicable to purchases by residents that are often made out-of-state or on-line without sales tax being charged on the purchase.
For example, if Ms. Jones goes into a store in New York City to purchase a computer, she will be charged a sales tax of 8-7/8% on her purchase. That rate represents the combined total of the New York State rate (4%), the New York City local rate (4-½%), and the additional sales tax rate (0.375%) that applies to taxable sales made within the Metropolitan Commuter Transportation District.
However, if Ms. Jones, sitting at the desk in her New York City apartment, goes on-line to purchase a new computer, and the company she orders it from does not have tax nexus with New York, it is likely that she will not be charged any sales tax. Assuming the computer is shipped to Ms. Jones from an out-of-state location for use in New York City, upon her receipt of the computer she will have an 8-7/8% use tax obligation to New York State.
Some Interesting Scenarios
Let’s alter the facts of the above example a bit such that the seller of the merchandise is located in Florida. Upon the purchase of the computer by Ms. Jones while on vacation in Florida, the seller charges her Florida sales tax (6%) on the purchase. When Ms. Jones brings the computer home to New York City, she will owe an additional 2-7/8% use tax to New York State. The additional tax represents the difference between the amount of sales tax she paid in Florida, and the amount of tax she would have paid if the purchase had been made in New York City.
By stretching the facts some more, we come up with yet another interesting use tax scenario. What if upon a fall antiquing trip in upstate Saratoga, NY, Ms. Jones spots a lovely vase for sale and decides it would look wonderful in her dining room breakfront cabinet? Upon the purchase of the vase, she is charged the applicable combined state and local sales tax rate for Saratoga, that being 7%. However, when she brings the item into New York City for use in her apartment, she owes a use tax of 1-7/8% to New York State.
Again, the use tax owed represents the difference between the sales tax paid upon the purchase in Saratoga and that which would have been paid had the purchase occurred in New York City. The fact that the original sale occurred within New York State does not affect the ultimate use tax liability, since the rate of use tax is tied to the ultimate location within the state where the item is used.
How Does the State Know?
Whenever I raise the issue of use tax with taxpayers, one of the first questions I usually hear is “How will the state find out about my out-of-state, or out-of- locality purchases?” First, I note that, for a number of years, New York State has included a question on all residents’ personal income tax returns with respect to whether they owe any use tax to the state. Also, concerning “big ticket” items, such as paintings and other forms of art work, as well as jewelry, the New York State Department of Taxation and Finance (the “Department”) has personnel assigned to tracking the purchase of those items and their importation into New York. There are many documented instances where individuals have been contacted by the Department shortly after importing art work into the state. The Department is made aware through newspaper articles, social media posts, and U.S. Customs’ records.
Finally, state taxing authorities may become aware of use tax obligations while conducting audits of businesses. For example, if the Department is successful in asserting nexus over an out-of-state jewelry retailer who has a history of shipping untaxed items into New York State, the Department can often, during the course of an audit, identify state residents who have purchased jewelry without remitting any use tax to the state in connection with their purchases.
State taxing authorities are well aware that many in-state residents ignore their use tax reporting obligations and are committed to eliminating as much tax avoidance as possible. To that end, many taxing authorities are targeting the use tax area in their continuing quest for more tax dollars. Taxpayers who ignore the problem do so at their own risk since by not reporting their use tax liabilities, the statute of limitations never runs with respect to the tax.
If you have any questions regarding the use tax area, please contact the author at (212) 842-7019, or if you prefer, via e-mail at firstname.lastname@example.org.