This blog was last updated on November 19, 2024
One of the core concepts in sales tax compliance is also one of the most frequently misunderstood: the differences between sales tax and use tax. These tax types may look similar on the surface, but knowing the differences is essential for staying compliant and avoiding costly mistakes. In this article, we’ll demystify each tax type—breaking down when each tax applies, the parties responsible for each tax type, and why understanding these distinctions is key to avoiding compliance headaches.
What is the main difference between sales and use tax?
Sales and use taxes are indirect taxes in that they are applied within the stream of commerce, as tangible property or certain services are sold or used. However, the circumstances of a given transaction determine which tax type applies. The following chart provides a quick guide as to when you should be thinking about a particular tax.
Sales Tax vs. Use Taxes
| Tax Type | Responsibilities | When It Applies | Common Example |
| Sales Tax | Seller collects and remits to state | Applies to intrastate sales (buyer and seller in the same state) | A customer buys a product in a retail store |
| Seller Use Tax | Seller collects and remits to state | Applies to interstate sales (buyer and seller in different states) when seller has nexus in buyer’s state | An online sale from a seller in State A to a buyer in State B /td> |
| Consumer Use Tax | Buyer self-assesses and remits to state | Applies when a seller does not collect sales or seller’s use tax, but tax is/becomes due. | A business purchases taxable goods from one state, and relocates them to another state with a higher tax rate |
Now that we’ve mastered the basics, let’s get into the details.
Who collects sales tax, and when?
Sales tax is charged by the seller and paid by the buyer on the sale of taxable goods or services when both parties are in the same state. Sales tax is often the tax type charged in a traditional brick and mortar retail setting. Once collected, the seller is responsible for remitting the tax to the Department of Revenue. But sales tax isn’t strictly limited to in-person retail sales. Sales tax may also be due on deliveries when both the buyer and seller are in the same state.
There are a handful of states that have special names for sales tax. While there are legal nuances, these tax types largely operate like traditional sales tax. Examples of alternate names for include:
- Transaction Privilege Tax in Arizona
- General Excise Tax in Hawaii
- Retailers Occupation Tax in Illinois
- Gross Receipts Taxes in New Mexico and South Dakota
Who collects use tax, and when?
There are two distinct types of use tax: seller’s use tax and consumer’s use tax. – The application of seller’s versus consumer’s use tax does not depend on the buyer’s and seller’s physical locations but rather on who holds the responsibility to assess and remit the tax.
What is seller’s use tax?
Seller’s use tax applies to interstate sales, where the seller is in one state and the buyer in another. Also referred to as retailers use tax, it is collected by the seller when they have established nexus—a tax connection—in the buyer’s state. Seller’s use tax is commonly applied to online sales, phone orders, and other remote transactions. However, it’s also possible for seller’s use tax to apply when the seller has a physical location in the buyer’s state, but only if that location is not involved in the transaction in any way.
Several states have recently taken steps to streamline compliance by combining sales and seller’s use together through legislation, rulings or policies. These states now suggest that most out-of-state sellers must collect, and remit sales tax just like in-state companies. Examples include Arizona, Colorado, Iowa, and New Mexico. Starting January 1, 2025, Illinois will implement a new component to their “Leveling the Playing Field” requirements, which will align the obligations of in-state and remote sellers by requiring both to collect and remit retailer’s occupation (sales) tax.
What is consumer’s use tax?
Consumer’s use tax is different in that it shifts the responsibility for remitting the tax from the seller to the buyer. This self-assessed tax applies to purchases when the seller either does not collect or collects insufficient sales or seller’s use tax. Based on the legal concept of “joint and several liability”, it becomes the buyer’s duty to calculate and pay tax directly to ensure the state receives tax revenue on all taxable items used within its borders.
Now, why would a seller fail to collect tax or collect insufficient tax on a sale in the first place? Well, with more than 12,800 taxing jurisdictions within the United States, accurate sales tax compliance is far from easy. There are other circumstances, beyond seller failure, when a buyer may be obligated to self-assess. Common scenarios where consumer’s use tax typically applies include:
- When buying goods from an out-of-state vendor without physical presence or economic nexus in the buyer’s state.
- Businesses may buy items tax-free for resale using a resale certificate. If these items are later used internally, they must assess and remit consumer’s use tax themselves.
- It may also apply if a business relocates taxable goods from one state to another, especially if the tax rate in the receiving state is higher. For example, if a buyer pays 7% tax when they bought the item in state A, they may owe additional tax if they then move the item to state B with an 8% total rate. Now, most states would give the buyer credit for any tax properly paid to State A so it’s not like they are starting from scratch.
Why Knowing Your Tax Types Matters
For businesses operating in multiple locations, a clear understanding of these distinctions can make the difference between smooth, accurate filings and costly penalties. In this section, we’ll break down why knowing tax types is more important than ever and how these details directly impact your business’s compliance and operational efficiency.
Tip: Be skeptical of any place that purports to charge a use tax rate that’s higher than their sales tax rate. The Commerce Clause of the US Constitution makes it illegal to charge out-of-state sellers higher taxes than those charged to in-state businesses.
In states that impose sales tax, the state-level sales tax rate, seller’s use tax rate, and consumer’s use tax rate are typically the same. However, differences can happen at the local level, as use tax rates across counties, cities and districts may differ from the sales tax rate. Alternatively, some localities may have no local use tax rates at all.
Tax rate complexity of this type manifests in a handful of states including Colorado and Arizona, where it’s common for localities to have different rates for sales and use tax. Perhaps this is why, as noted above, both states now require in-state and remote sellers to collect sales tax. The same is true in New Mexico which has no local use tax at all. The state of Missouri, one of the last to require sales tax compliance from remote sellers, allows localities to adopt local use taxes and unsurprisingly, many did so as not to miss out on tax revenue from online sales.
One of the most complex states for tax compliance remains Alabama, where localities can adopt unique rates for each tax type. While there seems to be an effort to simplify rate variations, there are 17 cities and one country that currently collect sales taxes, but do not have use taxes at all. Relatedly, there are 19 cities and six countries with lower use tax rates compared to sales taxes.
For instance, while some parts of Morgan County impose a 3% rate on both sales tax and seller’s use tax, they only apply a 1% rate for consumer’s use tax. In a small part of Escambia County, they may need a refresher course in Constitutional law as their sales tax rate of 4% is complimented by a use tax rate of 5%. Thankfully, there are no cities or counties in Alabama where sales, seller’s use, and consumer’s use all different from each other.
Distinct Reporting Requirements
The second reason the distinction is so important relates to reporting. At a minimum, states will have separate boxes or reporting codes on their tax returns to delineate tax paid on sales versus purchases. Many also have special boxes and codes to report sales originating from out-of-state locations. But in some states, there are entirely separate tax returns for each tax type. This is especially common, but not exclusive, to those states that can have differing local use tax rates.
Some examples of these reporting requirements include:
- Separate returns for all three tax types in states like Alabama, Colorado, Missouri, Oklahoma, and Virginia.
- Separate Consumer’s use tax filings in Kansas and New Mexico.
- Combined reporting for seller’s and consumer’s use tax in Ohio and Mississippi, with separate sales tax returns.
- Separate consumer’s use tax returns in Washington and New York, intended for businesses buying goods in-state but not selling there.
Final Thoughts
In the future, it’s possible that other states will follow the trend started by Arizona, Colorado, Iowa and New Mexico and the concepts of sales and seller’s use tax could coalesce into simply “sales tax.” Such a development seems logical and is also consistent with the notion of equality between in state and remote sellers. However, the requirement of self-assessing consumer’s use tax on purchases isn’t going anywhere.
As such, understating the differences between tax types and why those differences meaningfully affect how tax is determined and reported remains a fundamental first step in ensuring that you are correctly paying and reporting your tax obligations and remaining compliant.
