Most business owners assume sales tax only applies if they sell physical products.
In reality, sales and use tax rules are far more complex. Businesses can create tax obligations by selling finished goods to the consumer (in a brick and mortar store or online), selling software subscriptions and providing certain services.
Many companies don’t discover these obligations until they’re selected for a sales and use tax audit—sometimes years after the issue began. By then, unpaid tax, penalties, and interest can add up quickly.
Understanding the basics of sales and use tax is the first step toward avoiding costly surprises.
What Is Sales Tax?
Sales tax is a tax collected on taxable sales of goods and certain services. When a business sells a product or service subject to sales tax, it typically charges the customer the tax and sends the amount collected to the appropriate state or local tax agency.
While the concept sounds straightforward, the rules are anything but.
Every state has its own laws regarding what is taxable, which businesses are required to collect tax, and when registration is required. In some states, professional services may be taxable. In others, they may be exempt. The same software subscription could be taxable in one state and exempt in another.
Because the rules vary significantly by jurisdiction, businesses cannot assume that tax treatment is the same everywhere they operate.
What Is Use Tax?
Use tax is often the lesser-known counterpart to sales tax—and one of the most common areas of noncompliance identified during sales and use tax audits.
Use tax generally applies when a business purchases taxable goods or services and the seller does not collect the appropriate sales tax. Rather than the vendor collecting the tax, the responsibility shifts to the purchaser.
For example, imagine your company purchases $20,000 of office furniture from an out-of-state vendor that doesn’t charge your state’s sales tax. That doesn’t necessarily mean the purchase is tax-free. In many cases, your business is responsible for calculating and remitting the applicable use tax directly to the state.
The same concept may apply to purchases such as:
- Office furniture and equipment
- Computers and technology
- Manufacturing equipment
- Software and certain digital products
- Supplies purchased from out-of-state vendors
- Certain leased assets, depending on the state
Because no tax appears on the invoice, many businesses never realize a use tax obligation exists.
What Types of Products and Services Are Taxable?
One of the biggest misconceptions surrounding sales tax is that only physical products are taxable.
Today’s economy looks much different than it did even a decade ago, and tax laws have evolved alongside it.
Depending on the state, taxable transactions may include:
- Tangible personal property
- Software licenses
- Software-as-a-Service (SaaS)
- Digital downloads
- Online subscriptions
- Maintenance agreements
- Installation services
- Certain professional or consulting services
- Memberships and digital products
The challenge is that there isn’t one nationwide set of rules. States define taxable products and services differently, and those rules continue to change over time.
As businesses introduce new offerings, expand their services, or adopt new technology, it’s important to periodically review whether those transactions create new sales tax obligations.
Why Businesses Accidentally Become Noncompliant
Most sales and use tax issues aren’t the result of intentional wrongdoing. Instead, they develop gradually as businesses grow.
Common situations include:
- Purchasing equipment from vendors that don’t charge sales tax
- Launching new products or services without reviewing taxability
- Adding SaaS platforms or digital offerings
- Expanding sales into new states
- Assuming accounting software automatically determines the correct tax treatment
- Never reviewing whether use tax should be accrued on purchases
Each of these changes may seem minor on its own. Over time, however, they can create significant exposure if tax obligations aren’t identified and addressed.
Why It Matters
State taxing authorities continue to increase their focus on sales and use tax compliance, particularly as businesses expand across state lines and conduct more transactions online.
When issues are discovered during an audit, businesses may be responsible not only for the unpaid tax itself, but also for interest and penalties that have accumulated over several years.
The good news is that many compliance issues can be identified long before an audit occurs. Periodically reviewing purchasing procedures, evaluating the taxability of products and services, and understanding where use tax responsibilities exist can significantly reduce the likelihood of unexpected assessments.
Final Thoughts: Don’t Wait for an Audit to Discover a Problem
Sales and use tax obligations often change as your business grows. New products, new vendors, new technology, and new markets can all create tax responsibilities that weren’t there before.
Taking the time to understand the difference between sales tax and use tax—and knowing what transactions may be taxable—is an important first step toward protecting your business from unnecessary risk.
If you’re unsure whether your business is collecting the appropriate sales tax or properly accounting for use tax, a proactive review can help identify potential exposure before it becomes an expensive audit issue.
Need help evaluating your sales and use tax obligations? Contact us today to discuss your business and identify opportunities to strengthen your compliance processes.
