The Four Loopholes (Loophole Number 4)

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.

The state can't "reach" the seller - they have no jurisdiction over the seller

In other words, the state can't get the seller to collect the sales tax from the buyer, so they invented use tax to get it from the buyer instead.

The most common example of this is our good friend Amazon.com or, for that matter, any other mail order or online retailer.

If you're in most states, when you buy from Amazon.com, they don't have to charge you tax. The short answer is that they aren't in your state. There are no stores, warehouses, offices, facilities, delivery trucks, representatives, etc. In order for a state to impose their laws on a potential taxpayer, that taxpayer must have nexus in the state - a physical presence.

Amazon.com doesn't have a physical presence or nexus in most states. According to this page on Amazon.com's web site, they do have nexus in these states (WA, ND, KS, and KY) and charge tax. They also charge tax in NY, but that's a weird situation. Someday, I'll write an article about it, but don't hold your breath.

So Amazon.com doesn't have to obey most state laws and doesn't have to charge their buyers tax. So what is, say, Alabama supposed to do? They want that tax revenue. Mail order and online sales are a big part of the economy, and they can't simply write off that segment.

Alabama and all of the other states therefore close the loophole by imposing a use tax on the buyer. That use tax doesn't get paid very often, particularly by individuals. But for businesses, this is the primary objective of the audit that will hit you at some point. They will want to see if you've been paying your use taxes. Hopefully, regular readers of this blog are.

Another related way this loophole works are sales by the Federal government. States generally can't make the Feds collect sales tax on their sales. But many states will say that, if the buyer gets something from the Federal government, and it wasn't taxed, the buyer owes use tax. This is about the only other example of a situation where the state can't "reach" the seller.

The fourth loophole for why states have a use tax is to plug situations where they can't make the seller collect the tax.

Sales Tax Guy

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Picture note: I wanted to illustrated interstate sales and I don't have any pictures of semi-trucks. But this is one of my most popular train pictures. Enjoy it on Flickr here if you want to see it larger.

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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Picture note: I thought you'd enjoy the Christmasy shot - only a few days left till Christmas! The picture above is hosted on Flickr. If you'd like to see a larger version, click here, then click on the "all sizes" button above the picture.

The Four Loopholes (Loophole Number 2)

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.

The Vendor Makes a Mistake

The vendor (Steve) sells Mike a machine and, for whatever reason, fails to charge Mike sales tax. What will happen to Mike when he gets audited and the eagle-eyed auditor notices that there is no tax on the invoice? Hmm?

[I'm trying to recreate a seminar experience here, folks. So I need someone to blurt out the answer. ]

[Waiting....]

Yes, absolutely correct. Gold star for Mary! The auditor will make Mike (the buyer) pay the use tax. In most states (but not all) the buyer, for all intents and purposes, has the burden of the sales tax imposed on him. If it is not, the buyer will have to pay the use tax. But the buyer's burden is usually relieved by simply having a receipt from the seller showing that sales tax was charged.

Since Steve (the seller) didn't charge Mike tax and therefore Mike has no tax receipt, Mike will get burned at audit time. Or, if Mike has a good AP specialist, he (or she) may have spotted Steve's mistake and accrued the tax in the meantime. Either way, the state gets their money. They either get it from Steve (the vendor) when he does his job correctly. Or they get it from Mike (the buyer) later.

The loophole was that if the seller didn't charge tax, the state couldn't get the money from anyone but the seller. But when they invented use tax, they had a mechanism to get the tax from the buyer as well. Nifty.

Here's a question though. Did Steve screw up? What if he absorbed the tax? Or what if he knows the item isn't taxable? If the AP specialist, or the auditor, simply reacts to the invoice not having tax, then Mike might over pay his use tax. Heavens!

That's another article.

Sales Tax Guy

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Picture note: I wanted a picture the shows a mistake clearly being made by someone.

The Four Loopholes (Loophole Number 1)

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.

Purchases in another state
Say the rate where you are, in Vancouver, Washington is about 9%. But if you cross the bridge and go to a mall in Portland, Oregon (a 15 minute drive), you'll pay zero % sales tax. Where are you going to buy your big screen TV? Something tells me that, per capita, there are a lot fewer appliance stores in Vancouver than there are in Portland. Just a guess.

There's not a whole lot Washington can do about your buying that TV in Oregon. It's not like they can post border guards. You might leave a trail however. A woman in Washington bought a TV with a store account in Oregon, took the set home, and three months later, got a letter from Washington demanding the use tax.

She left a trail. The store filed a lien on the TV in Washington, where those records are computerized. So all the Washington revenuers have to do is scan the liens looking for one filed by an Oregon seller. Bingo. Revenue!

Pay cash though, and all that exists is the paperwork in the seller's offices. Unless they get audited..... Not that I'm suggesting this method of avoiding your proper Washington taxes, though. I'm just sayin'.

And I know of no state that routinely audits individuals for use tax. First of all, individuals don't keep sufficient records of all their purchases and receipts (except for the more anal among you). So there isn't anything to audit. Plus it's politically unwise to audit taxpayers (and voters) for a tax they didn't realize they owed. Most people who go to Oregon to buy their stuff don't know about use tax. They just think they're avoiding sales tax legitimately.

But if you're a business, oh, yeah. They'll find you. It's called "being audited."

The problem for the states is that they can't charge you sales tax since the sale occurred in another state and they can't reach that transaction. But they can impose use tax. You did, after all use that TV once you unloaded it in your driveway.

So if you buy something in one state where the rate is lower than the one where you will eventually use it, the state will impose use tax on your use of it in that state.

Use tax therefore plugs the loophole of your buying stuff in another state.

Sales Tax Guy

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Picture note: the picture above is of the Columbia River, just east of Portland, Oregon and is hosted on Flickr. If you'd like to see a larger version, click here, then click on the "all sizes" button above the picture.