Sales and Use Tax

In this episode of How Tax Works, host Matt Foreman discusses Sales and Use Taxes.  Matt will define sales taxes and use taxes; describe the common and disparate features between states; what to do if you need to collect; and how to determine if what you sell is subject to sales tax.  This episode is for business owners, attorneys, accountants, and their advisors, as well as Wayfair, Overstock, and Newegg, whose decision to litigate against the South Dakota case ushered in a new era of tax collections.

How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M. at Falcon Rappaport & Berkman LLP, delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions.

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Transcript

Matt Foreman [00:00:07]:
Welcome to the second episode of how tax works. I'm Matt Foreman. In this episode, I'll discuss sales and use taxes. How tax works is meant for informational and entertainment purposes only. This may be attorney advertising and is not legal advice. Please hire your own attorney. How tax works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business choices that we all make. This episode is about sales and use taxes.

Matt Foreman [00:00:41]:
And first, I think it's pretty important, although as I'll kind of go through and make a lot of definitions here. To talk about the definitions, the first one is what is a sales tax? Right. A sales tax is a type of ad valorem tax, to use the fancy latin term. It's just some sort of gross tax. That is, instead of, you know, you think about income taxes, they're on a net basis. So it's income minus expenses or revenue minus expenses. That's your income tax. An ad valorem or gross tax is on the price that you actually pay at the top level without regard to expenses.

Matt Foreman [00:01:13]:
It's just a totally different base. They're most commonly on goods and services. They're fairly similar to a lot of excise taxes. So if you think about tariffs and other import taxes and things like that, they're all ad valorem taxes. They're very similar. Real property transfer taxes, real estate transfer taxes, a thousand different names, same basic idea. And they're actually sales taxes are imposed on the purchaser. So, right, you go into a grocery store, you buy some stuff, some of it subject to sales tax, some of it's not, right.

Matt Foreman [00:01:43]:
The purchaser pays for their goods, they pay the sales tax. The seller collects the sales tax on behalf of the collecting jurisdiction, which is generally, you know, in the US, it's a state, and then it's remitted back to the state. Sales taxes, conceptually, are extremely similar to the VAT value added tax. The biggest distinction is that the VAT is at every single level of purchase. So the person who takes the iron ore from the ground, then there's a vat, then the person refines the iron ore, there's a vat. Right, value added tax. Then the person uses it in their product. They sell the product that there's a VAT at each level.

Matt Foreman [00:02:21]:
There's exemptions, there's exclusions, there's little exceptions that change how the rates work, but that's basically what they are. Whereas sales taxes, the idea is that there is no sales tax until the final or end purchaser of that good. I'll get into sales for resale and a few of the other exceptions and exclusions as I go through this sort of, as it falls in. But that's the idea of a sales tax. It's only on the final sale of the good. One thing I always note is that if you buy a book and then you sell the book again, you go on eBay or whatever you sell again, a sales tax can be charged again. Right. So if when you buy it, you're thinking, I'm going to be the last person to ever buy it.

Matt Foreman [00:03:01]:
That's it. This copy of, you know, Huck Finn is mine forever. And that's great. That's good. That's great. But if you then five years later decide to sell it, there'll be another sales tax. It's a little goofy, but it's basically the intent at the time of the purchase. You'll notice in the beginning I talked about sales and use taxes.

Matt Foreman [00:03:20]:
So people always ask, what's a use tax? And sort of similar how a sales tax is on the sale of a good. The use tax very literally is on the use of a good. I'm largely going to ignore the constitutional issues that the rate for sales taxes must be the same rate as a use tax for the same purchaser, same user. Right. And I'm not going to go into why, but it's due to the constitution and it's really important, which is why people are like, well, why don't you just not have a use tax, only have a sales tax? The answer is it creates constitutional issues because it could treat taxpayers differently. So I think that that's important when are use tax imposed? Right. We're all very familiar with sales taxes. Even people who live in states that don't have sales taxes are pretty familiar with them.

Matt Foreman [00:04:03]:
I think rightfully so. They're pretty pervasive. I don't know if that's the right word, but common in our life, use taxes. And I always give it by giving two examples. The first one is you go to say, for a state with no use taxes or no sales taxes, let's call it New Hampshire, for example. You buy some goods, a t shirt, a frisbee, whatever, I don't care. And you bring it back to Massachusetts. What's supposed to happen is when you bring that good back to Massachusetts, and I'm not picking on Massachusetts, but obviously it shares a border with Massachusetts.

Matt Foreman [00:04:34]:
It shares borders New Hampshire. And the premise is that you didn't pay a sales tax in New Hampshire, but you're going to pay a use tax when you use the good or service, whatever in Massachusetts. And it's actually fairly indifferent to whether you actually paid a sales tax. What you're actually theoretically supposed to do is if you say you go to New York, to New Jersey. Right. You pay the sales tax in New York, then you go to New Jersey and you use the good. Right. What's going to happen is you're actually going to pay the sales tax in New York, pay the use tax in New Jersey, and then request a refund on the sales tax that you paid to New York.

Matt Foreman [00:05:09]:
A little goofy, a little stupid. That's it. The other situation is that is when you buy something, let's, you know, most common is you buy it online and they don't charge sales taxes. That has really, really, really decreased over the past. I guess it's about six years now. And it has decreased as a result of wayfair. Right. Many, many more businesses are required to impose sales tax.

Matt Foreman [00:05:34]:
I'll get into Wayfair in a second or in a little bit more than a second. And the premise is that there are still some businesses that don't charge sales tax. They don't have a requirement. There's no Nexus, so they can't be forced to collect or make sales taxes or they're just not doing it. Right. They've made a decision. They don't care if you're just not charged it. Right.

Matt Foreman [00:05:53]:
I live in New York City, so I'm not charged on it. I have a positive requirement. I'm obligated. And if you read your state, your state income tax, it says, you know, at the bottom, New York has this, every state has it, that you have paid all of your income and sales taxes, all kinds of taxes. So it says it. So you're saying you are and you're actually supposed to, then you didn't pay the sales tax. You're supposed to file a form and pay the use tax. At this point, I suspect a lot of people are wondering, you know, do people actually do this? And the answer is no.

Matt Foreman [00:06:25]:
No, not really. A lot of businesses do it because they get audited and it's fairly easy to do it. You think about, you know, a large business in a city or even like a small business, right? You think a mom and pop, you know, some sort of business run by a mom and pop, are they paying sales and use taxes on their purchases? Right. You think of just like a bodega, right? Convenience store. They're going to have things that they buy, you know, to run the business. They're going to buy tape for the register. They're going to buy food right. When they buy stuff, not, not food to be resold, that's different.

Matt Foreman [00:06:58]:
But, you know, food that they eat and they're going to have, you know, various accounting expenses. They're probably going to have a computer in the business, et cetera, et cetera. When they buy that computer, they're going to pay sales tax. If they don't, they have to pay use tax and the state does audit it. But otherwise, you know, compliance rates are really, really low. And I don't think the states really necessarily want super high compliance rates on this type of thing. You think about suddenly an extra 200,000 sales tax returns every year might not be good. They're basically hiring needs are, they're probably a little bit underwater right now and they probably don't want a sudden influx of small returns.

Matt Foreman [00:07:36]:
The exception to this is large purchases, especially where registration is required, a boat or a car, very high compliance rates. But that's because you have to register it. It has to be basically licensed by the state. So if you don't pay the sales tax or the use tax, they're going to know some of the largest purchases people make often escape this. You know, a lot of people, especially before wayfair would ship, you know, rings and other jewelry out of state, can't really do that anymore. A lot harder. States are really looking into it. So I think that's interesting.

Matt Foreman [00:08:07]:
The next question that I think is really interesting is what our sales tax is imposed on. And I talked about it a little bit. But you know, there's two, there's two basic things you have to think about. One are taxable items, what's subject to sales tax, and two, what are the rates? And that's where there's a huge amount of variability between states. There are basically two ways to think about and how states approach the problem. The first one is everything is subject to sales tax except, and then they enumerate what is not right. And those enumerated exceptions or exclusions can be fairly broad. You know, we don't charge sales tax on any services.

Matt Foreman [00:08:44]:
California, if it's a digital good, no, subject to sales tax. Generally speaking. The flip side to that is that some states have only visa numerated items or categories or groups are subject to sales tax. And everything we don't listen is list is not at this point. I think they're largely the same. They function a little differently at the margins, but, you know, the items are largely the same. And the way they do it, it really doesn't matter. And not only that, there are states that, you know, everything is taxable except for these six groups.

Matt Foreman [00:09:15]:
But out of these six groups, each group has 16 exceptions or exclusions or however you want to define it. So, you know, there's a, there's such a refinement at this point. You know, 30 years ago, not as much, but especially with the digital technologies that exist in the economy today. Just details, details get really drilling down. So it's largely the same. While there is significant variability within states, I would say that 75% of what states, you know, subject to sales tax. Again, there are a couple states that don't have sales tax, but pretty much 75% the same. The 25% is a significant variation.

Matt Foreman [00:09:51]:
You know, they can really vary wildly, especially with regard to, you know, what's taxed. Different rates, different things they're trying to do and stuff like that. I like giving a couple examples that are really specific. I like the New York ones, frankly. Look, I live in New York, so I'm going to know it the best. But also at the same time, New York has some really, really, really quirky rules. It's not uncommon for states have really quirky rules, but the New York ones, I think are kind of funny. So I'm going to kind of roll with it.

Matt Foreman [00:10:25]:
New York as a rule, you know, a lot of foods are subject to sales tax, but one way they create a distinction in that's really relevant in candy is basically if there is flour, right. It depends. That can decide whether there's sales tax. And the premise basically is that if you think about historically, a lot of candies didn't have flour, right? You think of like, you know, just basic Hershey bars, right. They wanted to subject that to sales tax, but exclude foods that had flour in them. So twix and snickers, right. Very similar. I know there's different ingredients, but similar ideas, similar markets, similar demographics that are going to get it.

Matt Foreman [00:11:02]:
Different result. My favorite one is yoga and pilates. Okay. So generally, New York state charges sales tax on membership or the use of a gym. Right. To work out. And so that's done. Pilates is subject to sales tax if you use it.

Matt Foreman [00:11:19]:
However, if you are paying a fee for a yoga class or the gym, the workout facility you go to only offers yoga, then there is no sales tax on that. However, and this next example, which I find really funny, is specifically in the pronouncement, if you allow people to rent towels or you sell beverages, those have to be subject to sales tax. Those are charged. So you may still have sales tax within it. But if you include the water, is it maybe, maybe not something you really want to talk about? And stuff like that can be really quirky and really clunky. A lot of services are not subject to sales tax and some kind of unexpected ones are. I always say our services somewhat is the answer. So, for example, a lot of professional services, lawyers, doctors, accountants, that tends to be excluded.

Matt Foreman [00:12:16]:
I generally use the phrase licensed professionals, but the truth is there's a lot of licenses issued by states that are subject to where their work is subject to sales taxes. You know, barbers are licensed by the state, right? Similar, obviously not quite the same as a doctor, but a barber still gets licensed. They still go through, you know, training requirements and things like that. That New York state subject to sales tax. Super quirky, super clunky. Look for specific because they can do it. The two biggest exceptions or exclusions that in a lot, basically every state follows this that I'm aware of are the sale for resale and capital improvements. So if you buy, you know, the example I always give is, and I did this, you know, in college somewhat is, let's say you buy computers, you upgrade them and you resell them, or you just buy something online, you know, it's a good price and you're just going to resell it.

Matt Foreman [00:13:11]:
Right? People do that on Amazon, they do that on eBay. It definitely exists. If you're buying it to resell it, you do not have to pay sales tax. Some people don't want to disclose to the initial seller that they're not. So what they actually do is pay sales tax and they request a refund from the state, which you can get. Not a problem, just takes a little bit of time, but actually pretty easy to get. States are definitely equipped to handle that. I don't recommend.

Matt Foreman [00:13:36]:
It's a little messy and there's a time value of money. You lose your money for a period of time, but you can do it. The other one is capital improvements. And this is a very nuanced line. So if you're painting an apartment, that's not a capital improvement. If you are putting in new walls in a building, that's a capital improvement. But if you replace a wall and then you remove a wall and then you repaint the wall after your work is part of a capital improvement. So there's no sales tax.

Matt Foreman [00:14:05]:
So what actually happens is you pay the contractor, the one making the capital improvement. The actual person doing the work pays sales tax on their goods. So paint, brushes, paint, wood, you know, whatever, drywall, what have you, you know, an electrician. Right, for electrical work, same idea. And then the end user, right. Me, if I'm paying someone to renovate my home, what would happen is then I would not pay them any sales tax. So basically what it does is it removes the service element of the capital improvement from sales tax, as opposed to just, you know, still the goods that go into it are subject to sales tax. That's the premise behind it.

Matt Foreman [00:14:49]:
Rates are really interesting. Rates are really, really one. Some states have a completely flat rate. You know, my example I always give is Pennsylvania, 4% for the state. But then there's an additional 1% tax in Allegheny county, which is Pittsburgh, and a 2% tax in Philadelphia county, obviously, Philadelphia. Some states are completely flat. Some states. Alaska has a real quirky one, where it has no state sales tax, but an individual municipalities can actually have sales taxes as high as 7.5%.

Matt Foreman [00:15:18]:
So Alaska might actually be the hardest state to comply. Connecticut has rates that go from 6.35% to 7.75. They used to have a 1% rate on the sale of computer services and data processing services, but I believe they actually got rid of that. Deborah took totally understood why, you know, I guess they figured it's just worth the tax, and people don't really care, and it's not doing what it's trying to do. The way that most states work bearing lead here, is basically, they take their rate, and it varies by jurisdiction. So a lot of states have a state rate, let's say 4%. They'll have a county rate, 2%. And then you have a municipality, borough, city, town, whatever, another 2%.

Matt Foreman [00:16:01]:
Right. So that's a total of 8%. Right. But the way you really figure that out, you actually don't worry about whether they're in New York county or Kings county or whatever. What you actually do a lot of times is you just look at the zip code, and the zip code will be able to tell you what the correct rate is. It's one rate for everything, but it depends where you live, and you can get pretty good variability. The quirky one in that is Texas has a really interesting thing. This is what they do generally, but for businesses that do not have any physical presence in Texas, and I'll get into what that is in a moment, that are what's called economic nexus only.

Matt Foreman [00:16:40]:
They can actually select a rate. I believe it's 8% to charge for everything. So they don't have to deal with the extra burden of figuring out the correct rate for each of their purchasers. I actually think that violates the Constitution I believe violates the dormant commerce clause that, you know, must be equal. The rate must be equal for in state and out of state purchasers and sellers. But no one has challenged it yet. I suspect no one will. And I actually think it's a really good idea.

Matt Foreman [00:17:10]:
I'm actually a believer that the rate should just be flat no matter what. I don't think the way it's varied within the state really works. I just, I think it's, frankly, I think it's kind of stupid because I think it just adds to compliance costs, headache and things like that make it easy. You know, sales taxes have a lot of complexity on what's taxable. Let's just make the compliance as easy as possible. And I think that's one thing from a policy perspective that I definitely think they should do. Moving on. So Nexus, the big thing is, you know, to be required to collect and remit sales taxes, you, you know, the business must have substantial nexus with the state.

Matt Foreman [00:17:48]:
That came out under complete auto transit versus Brady case out of Mississippi involved a jet, the delivery, a company that delivered GM vehicles to the railhead or picked them up from the railhead. I apologize. I forget which. And basically they picked them up and you know, like how do cars get, get transported? So they go on a train, you know, they go from the factory, they go on a train. The train then puts them on a truck. The truck brings them to the dealer and that's it. Right. You think of just how everything gets distributed.

Matt Foreman [00:18:20]:
The question there, you know, was, okay, you know, is that physical presence in Mississippi in order to be required to require for them to collect and remit sales taxes, really, you know, interesting. Basically they said, yeah, this is sufficient physical presence in the state to deliver it to the dealers. Right. So physical presence first, the first way you can have substantial nexus is physical presence, which is an employee or multiple employees working in the state or employees who visit there a lot and visits a loose word, right. If they're going there on vacation. No, that does not kick you over. Don't worry about that. What you're really worried about what the concern should be is if you're going on a lot of visits to sell, right? If you're going on a visit to meet with clients to talk about your product and things like that, that can trigger you over.

Matt Foreman [00:19:10]:
A lot of people are like, hey, what about PL eight, 6272 right. Public Law 86 272. It's a law from the 86th Congress, which was in 1959, and that protects people for income tax relating to, if the activities are solicitation only, basically, sales in that state, so does nothing for sales tax, and it only deals with tangible personal property. So if you're selling digital goods, also doesn't protect you. So really, just going into a state, a lot can be enough. How much is too much? It depends. Wouldn't be a lawyer if I didn't say that a whole bunch, but it really depends on what you're doing, how frequently regular, contiguous versus occasional. There's also often a lot of times exceptions.

Matt Foreman [00:19:54]:
If you go to trade shows, because they want people to come to trade shows, come, pay hotel fees, pay those taxes, get people moving, I think that's enough. I always work out, especially with the pandemic, people moved all over. I always talk with clients. I'm like, hey, where are your employees? Do you even know then the big change? I mean, we're six years now. Kind of crazy to think about is economic nexus. So, Wayfair, I assume everyone's familiar with the company not going to go into what they do. And what basically happened was they tried to fight and they were not successful. You know, one of the laws in South Dakota, and basically what it said is, look, you know, if you have enough sales into employees in a state that's substantial nexus, the law in South Dakota was $100,000 in sales over the course of a year, or 200 transactions.

Matt Foreman [00:20:51]:
The Supreme Court did not actually say that was sufficient, though they didn't say it wasn't. And I suspect it probably will meet the requirements. But I've always wondered if that's correct, because if you think about companies, right, let's say you're a company that sells EKG machines or mris. An MRI is hundreds of thousands of dollars. Some of them could be half a million dollars, depending on specifics. So is selling one good into a state sufficient? Is that really substantial for a substantial nexus? I don't know. And the 200 transactions, what if you're selling stickers and you sell $162 into a state, but it's oats, 400 transactions? You know, to me that seems insubstantial. I think those should be higher.

Matt Foreman [00:21:32]:
I know I'm making a policy argument, but I feel pretty, pretty strongly on it that the numbers are too low. New York does $500,000 of sales over the past four quarters. Then in the fifth quarter, right, the next one you trip over, some states are retroactive. So if you go over during the year, you have to start in the year, and that can create issues where you owe money to the state for taxes you did not collect. Not great. Not a huge fan of that. I just think that's kind of silly. So, you know, you really have to watch out.

Matt Foreman [00:22:02]:
What if you're going there? What if you're doing it? The situation I always see clients, always a strong word I have seen clients get into is when a product goes viral. Right. You make purses. You make purses. And someone very famous, you know, walks around with it, right. I'm not going to name anyone famous. It's not worth it. I don't really care.

Matt Foreman [00:22:21]:
I ended up naming baseball players, which really wouldn't work for the joke. But, you know, that can do it. So you can be doing, you know, $30,000 a total $100,000 total revenue, and all of a sudden, you're doing 2.6 million in a quarter. Right? Crazy. The thresholds vary by state, but my rule, you know, what I tell my clients is look out for states where you're getting close to $100,000, right? 200 transactions. Very few clients hit 200 transactions without the $100,000. So definitely think about that. I always say, look, what if I get audited? There's two questions left.

Matt Foreman [00:22:55]:
01:00 a.m. i in compliance. And two, what if I get audited? Right? Am I in compliance? Probably not. Most companies, even large companies, aren't getting it perfect. I will tell you that I've dealt with enough states over the years where they seem perfectly happy to let companies be mostly in compliance, is the phrase I will use. And as long as you're putting forth a good faith effort, you're probably okay. So I always say to look, if you get audited, right, what you must prove is that your sales, what your sales were, you didn't have more sales. You didn't have less sales.

Matt Foreman [00:23:31]:
You're not taking sales in cash. You must prove that you collected the sales and use tax on the items and that you remitted it. Right. They're less concerned if you actually collected it. They're more concerned if you remitted it. Right. State's a revenue agency. The state revenue agencies, what's going to be looking at it.

Matt Foreman [00:23:47]:
So they're looking at their revenue. So as long as they get the numbers that are right, you know, not, not a big issue, they'll say, oh, yeah, I'm sure you collected it. Right. That's it. And it's. You're proving a negative. You're proving that you did not have more sales. You're proving that you did not collect or you actually collected.

Matt Foreman [00:24:03]:
So you have to prove these things. And it's tough. I have seen state auditors stand in buildings, right? Stand in restaurants and watch them. The employees punch in the sales into the machine. How do you do it? Are you doing it correctly? Are there problems? I've seen them in borderline phone booth size places that sold bagels, sandwiches and salads. If you've been in New York enough, you know that there's a ton of those. Some of them are really good, and they'll stand there and it's really, really uncomfortable for everyone, for the customer, for the person who works for the state, for everyone. So not a great situation, but they do it.

Matt Foreman [00:24:41]:
You know, if you have sales that are sale for resale or capital improvement, you can get us. You have to get a certificate. What I tell people to do when you enter into a contract, right. It's tougher for sale. For resale. It's often one off. But for capital improvement, when they hire you, included, you know, include the w nine because they're going to ask the board at the end of the year or, you know, and, and include the sale for resale certificate, give it to them, say, I'd like you to fill this out as part of it. Do it in the beginning.

Matt Foreman [00:25:08]:
In the beginning, everyone's happy, everything's great, and that's what you're going to do. Like I said before, the states are not looking for perfect, but they're looking for compliance. They want to see that you put forth meaningful, substantial effort to try to comply. I think that's pretty reasonable. If you yourself, you're not audited your business and you're like, boy, I'm not in compliance. I have real issues. What should I do? And I always say there's four issues. There's four options.

Matt Foreman [00:25:32]:
One is do nothing, which is a bad idea. Eventually, long enough timeline, they'll catch you. Two is register and comply going forward. That's a good idea. But I would recommend that you consider the other two because you have liability in prior years. And if you haven't filed returns or they're incorrect, there could be, especially if you haven't filed. The statute of limitations is open. They can always audit if it's incorrect.

Matt Foreman [00:25:56]:
The statute of limitations may be for longer than three years, so we should do it. There's what's called quiet disclosure, which I've done with a number of clients, which is basically you just going forward. You know, you comply going forward and going back, you just file a bunch of returns, pay the interest, pay the penalties, maybe request penalty abatement, and then you move on. Then there's what's called voluntary disclosure. Every state has one for income tax and sales tax. And basically what it is, the entire premise of voluntary disclosure is that you come in, you disclose what happened. There's a limited look back period. The longest, I think, is California, six years.

Matt Foreman [00:26:33]:
Most are three, there's some that are four. And you basically say, okay, these are the years I got wrong. I'm going to pay the tax, I'm going to pay the interest, and then I'm done. You know, as long as I have, I've done it correctly, and there's no fraud or I haven't tried to mislead, we're done. The disclosure is over. And I'm a huge, huge, huge proponent. Anyone who knows me knows that I really do like these programs because I think they're good. You know, they're encouraging compliance, which is a good thing.

Matt Foreman [00:26:58]:
And they raise revenue in a very, very inefficient way for the states. So some people say, oh, they shouldn't have them because it encouraged people not to comply, because they can just later comply. But if they've started the audit, you can't go into a voluntary disclosure. So, look, in terms of just return on investment for states, voluntary disclosures are incredible. They have two people working in voluntary disclosure, maybe sometimes as much as four, and they're pulling in 100,200, $300,000 at a clip, basically every day from different clients. You know, they work through a process, takes a month or so per state, and then you're done. And I think that's good for the taxpayer. They're done.

Matt Foreman [00:27:37]:
They have certainty. It's good for the state. They've raised the revenue, and everyone wins. Right? They don't have to hire another 300 auditors or 30 auditors to try to figure out who's paying what and who owes what. No, no, no. They can just hire no more auditors. They hire two people. They process, and that's it.

Matt Foreman [00:27:55]:
So that's my overview. That's the podcast, the second episode of how tax works on sales and use taxes. Thank you for listening. Have a nice day.