Wednesday, August 05, 2009

The Four Loopholes (Loophole Number 3)

There are four loopholes which created the need for use tax. Over a short period of time after inventing sales tax, the states started discovering that there were some situations where they weren't able to get the sales tax revenue they were expecting. We'll use this series of posts to discuss each one.

Withdrawal from Inventory (or Conversion to Use)

What's the fundamental and almost universal exemption?

OK, I'll tell you. Resale! Because sales and use taxes are generally intended to be imposed on the final consumer, the retailer shouldn't have to pay taxes on his or her purchases that will be resold to others. Read more in this incredibly well written article. And we have a lot of articles connected with this topic - including this one.

The loophole arises when a retailer buys stuff to resell, then turns around, changes their mind, and uses it. A lumber yard uses some building materials to build a new shed. A store takes picnic supplies out of inventory for a company outing. A computer store takes a price tag off of a laptop and gives it to the new guy. And the car dealer gives sales reps demos to drive.

These are all examples of withdrawal from inventory or conversion to use. I prefer the second term, but you'll see the first term more often in your research.

This was a loophole. If the state only has a sales tax, they don't have an obvious way of recovering the tax that the retailer should have paid at the time of purchase - on the building materials, picnic supplies, laptop or car. So the states invented use tax. When the retailer uses his goods by withdrawing untaxed stuff from inventory, the states can now get their money.

And if you read the instructions for your sales and use tax return, you'll usually see this particular item mentioned as one of the types of things that belong in the "use tax on your purchases" line.

More on this topic, with more illustrations, here.

Sales Tax Guy

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