Use Tax Obligations for Individuals
Use tax is a complementary tax to sales taxes levied on the use of property within a state. Every state with a general sales tax imposes a use tax. A use tax is due when a sales tax normally would have been charged on a taxable transaction, but wasn’t.
States have a use tax to help protect in-state businesses and make sure states don’t miss out on tax dollars from interstate commerce. Without a use tax, remote sellers in effect offer a 7 percent to 10 percent discount on their merchandise, but more importantly, the state’s tax revenue also is less. The National Conference of State Legislatures estimated that states lost $23 billion of sales/use tax revenues in 2012 from some online and catalog sales. While that projection is debatable and includes business-to-business sales, it’s a large number that’s increasing.
States have become more creative and collaborative and now have tools to uncover unpaid use taxes—primarily through routine audits. Due to the volume of their purchases and wide variety of auditable taxes, it’s cost-efficient for taxing authorities to audit businesses. Those same efficiencies don’t translate to auditing individuals—states must look for other avenues.
A common tool used by 28 states is an individual income tax return line for disclosure of use tax obligations, but the effectiveness is questionable. Minnesota, a state considering adding such a line, published a report showing that in 2012 a total of $133.3 million was collected by states that used the tool. The actual percentage of income tax returns reporting a use tax obligation ranged from 0.2 percent in Mississippi and Rhode Island to 10.2 percent in Maine.
Colorado, Kentucky, Oklahoma, South Carolina, South Dakota, Tennessee and Vermont took a new approach: a notice or reporting requirement on out-of-state vendors. They require remote sellers without a physical presence in the state to either notify customers of their obligation to pay use tax and/or provide the states with a list of customers who received untaxed merchandise. While such laws are widely seen as an attempt to encourage remote sellers to begin voluntarily collecting and remitting sales taxes, they open the door for states with such laws to cross-check reports provided with voluntary use tax payments by residents.
States are attacking the problem of lost revenue from unreported remote sales in various ways. Most individuals who have some modest level of use tax obligation each year are encouraged to begin reporting and paying such taxes on a go-forward basis. If any individuals have significant unpaid use tax obligations on out-of-state purchases, e.g., artwork or jewelry, a voluntary disclosure program may be available to catch up on unpaid obligations. Most states offer a limited three to four-year look back period and will waive penalties for taxpayers who voluntarily come forward. If the state discovers the liability first, the look-back period is theoretically unlimited with significant penalties and interest.