Sales Tax and Use Tax in the United States
Companies that operate in the United States do not only have to face direct taxes. They also have to face a lot of indirect taxes. Indirect taxes, such as value-added taxes are not levied by the United States federal government. Instead, the federal government has passed on this authority to different states and local municipalities. Hence, the rate can vary from as low as 3% to as high as 11% depending upon the states in which the business has its operations. Even within the same state, the tax rates can vary depending upon the county or city that the business is present in.
In this article, we will have a closer look at what the sales tax and use tax system is and how it works in the United States.
The Meaning of Sales Tax and Use Tax
- As the name suggests, a sales tax is a tax that has been imposed on the sale of certain types of goods and services. As opposed to income tax, the tax base for this tax is not the income which is generated by the firm. Instead, such taxes are charged directly on the revenue generated by the firm. Therefore, if a sale is made for $100 and there is a 5% tax, then the company has to pay $5 sales tax regardless of whether it makes a profit or loss on the sale after deducting all the expenses.
- There is a finite list of goods and services on which sales tax is exempted. This list is updated from time to time, and it is the onus of the business to prove that they have an exemption. For all other goods and services, the state decides the rate which will be charged. Earlier, the tax used to be applied only on tangible products and some services such as leasing. However, over time governments have realized that a lot of sales happening now use the digital medium. For instance, books, courses, music, etc. are all sold through the digital medium. This is the reason that several states have amended their laws in order to be able to charge sales tax on such sales.
- The rules of the state decide whether it is the responsibility of the buyer or seller to pay the sales tax. In most cases, the responsibility falls upon the seller. This means that the seller has to pay the tax regardless of whether they are able to collect it from the buyer. It is for this reason that in many states, it is not even mandatory to collect mention sales tax as a separate line item on the invoice. However, companies still prefer to do so since they want their customers to know the amount which is being collected to pay for taxes.
- It also needs to be understood that sales tax is, in effect, an intra-state tax. This means that sales tax becomes applicable only when the buyer and seller are both present in the same state. If the sale happens in another state where the company does not have a nexus (i.e., taxable presence), it needs to report the sales to the concerned authorities.
- Use tax is quite different from sales tax in the sense that it is primarily the responsibility of the buyer. The tax becomes applicable for a buyer if they purchase goods from a seller who is not registered in the state. If the product is being stored, processed, or used in the state, then a use tax is payable in the state. The use tax is simply a way to prevent corporations from buying from other states in order to avoid paying the sales tax. Hence, use tax can be thought of as an inter-state tax which complements the sales tax. It needs to be understood that only one of the use tax or sales tax is charged. Both the taxes cannot be charged concurrently.
How Sales and Use Taxes Affect Businesses
- Sales and use taxes increase the cost of doing business in the United States. These taxes make local manufacturing more expensive. Hence, companies that only sell in the United States are forced to raise their prices and pass on the taxes to the consumers. Companies that operate outside the United States are not able to pass on the taxes to the consumers. Hence, inevitably their competitiveness reduces, and they are able to sell fewer goods because of the high costs.
- In many states across the United States, sales and use taxes are levied upon business inputs as well. This creates an inefficient system wherein pyramiding happens. Pyramiding means that the same inputs are taxed over and over again as they pass through the various stages of production. As a result, prices go up in a disproportional manner.
- Also, it needs to be realized that the record-keeping for sales and use tax is quite complex. Companies have to employ specialists and need to have a system in place in order to report the relevant transactions to the state. The system that needs to be created in order to do this as well as the compliance norms that need to be followed cost a lot of money and end up raising the overall cost of doing business in the United States
- Lastly, the tax rates vary from location to location. Also, the rates vary in the same location in different years. This makes it difficult for businesses to locate an area where they can set up their business.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- History of Corporate Taxation
- Why must corporations be taxed?
- Different Forms of Corporate Taxation
- How Corporate Taxes Impact Corporate Behaviour?
- Is Corporate Tax Progressive?
- The Rise of Flat Tax
- Understanding Tax Terminology: Tax Base
- Understanding Tax Terminology: Tax Rates
- Arguments in Favor of Tax Competition
- Arguments against Tax Competition
- Tax Co-operation: A Primer
- Elasticity of Taxes
- Strategies Used by American Companies for Tax Avoidance
- How Corporate Dividends are Taxed?
- Capital Gains Taxes
- State Corporate Taxes
- A Primer on Tax Deferral
- The Corporate Alternate Minimum Tax
- Sales Tax and Use Tax in the United States
- Why Amazon and Netflix Pay $0 in Corporate Taxes?
- How are Losses Treated in Corporate Tax?