Sales tax is often the most talked about tax for US remote sellers. However, there are several other taxes that sellers may need clarification on. Tax compliance around remote sellers involves other taxes, such as use, excise, and value-added (VAT) taxes.
People often face difficulty differentiating them and consider them as the same thing. If you are one of them, this blog is for you. It discusses the difference between sales tax and other types of taxes.
What is Sales Tax?
A sales tax is a consumption tax assessed on the sale of taxable goods or service. It is usually added to the selling price of an item, so the seller collects it when a customer makes a taxable purchase. The customer pays sales tax in addition to the cost of the purchased product or service to the seller, who collects and remits it to the US federal government. The seller is responsible for sales tax collection, remittance, filing, and reporting. As a seller, you must have an economic or physical nexus to become eligible to collect and remit sales tax to the state. Each state has its regulations and rates for sales tax. Glimpse and learn about various sales tax facts in each state in our earlier blog. Lastly, some key points to remember about sales tax are:-
- Sales tax is imposed on tangible personal property, including furniture, toys, clothing, and other goods.
- It is collected at the point of sale from the buyer.
- The sales tax rate is usually calculated as a percentage of the transaction price.
- If the seller fails to collect the due sales tax, they must pay it out of their pockets.
What is Use Tax?
Use tax is the tax on the use, consumption, or storage of taxable products and services. It is imposed on items where no sales tax has been paid earlier. If the sales tax is imposed on some products or services, use tax does not apply to such items. Use tax serves as a way to ensure that buyers who purchase items from online or out-of-state sales, where sales tax was not collected, still contribute to tax collection. Use tax is also called consumer use tax, as the buyer or consumer pays sales tax. Consumers directly pay use tax to the state’s Department of Revenue and file separate use tax returns.Example of Use Tax
If your business is based in any state that charges sales tax, such as Florida, and sells to local customers there, you must collect and remit sales tax. If a buyer purchases a taxable item from some state that does not impose a sales tax and uses it in another state, they must pay use tax as a consumer if they don’t plan on reselling the item.Key Differences between Sales Tax vs. Use Tax
Use tax and sales tax are often considered the same, but the two have some differences. Here are some of the critical differences between use tax and sales tax.- Use tax rates can be different from sales tax rates. It is complementary to sales tax.
- It is only applicable on the purchase of taxable products where no sales tax was paid at the time of purchasing.
- It may apply to items exempt from sales tax.
- In consumer use tax, the purchaser is responsible for remitting the tax to their respective taxing jurisdiction.
What is Excise Tax?
The government imposes an excise tax to generate revenue that could be used to fund state programs. Excise tax refers to the tax imposed on specific items, mainly luxury goods or non-essential activities. The tax is usually included in the price of the taxable product or service. Understanding excise tax implementation is relatively simple. It entails that all businesses pay excise tax on certain goods and services. However, goods used for a specific purpose, for instance, alcohol used in medicines, might be tax-exempt.Example of Excise Tax
Excise tax is usually imposed on fuel, alcohol, tobacco, airline tickets, and wagering. If a buyer visits a gas station to fill up their vehicle, a portion of the price includes excise tax. The seller collects and pays this tax to the government. In contrast, sales tax is imposed on a wide range of tangible goods, including furniture, toys, packaged food, and clothing.Key Differences between Sales Tax vs. Excise Tax
Here are some critical differences between excise tax and sales tax.- Excise tax only applies to specific goods and services.
- Excise tax is determined based on the volume of the taxable goods sold.
- The calculation for excise tax can be more complex than sales tax.
- Some excise taxes are known as sin taxes because they discourage certain activities harmful to society (such as cigarette production).
What is Sales Tax vs. Value-Added Tax?
Value Added Tax, commonly known as VAT, is a consumption tax on goods and services imposed throughout all phases of the supply chain where value is added: from sourcing, manufacturing, packaging, and order fulfillment until the point of sale VAT is imposed. Around 170 countries impose a value-added tax, but the US is an exemption. The United States does not have VAT; we impose excise, sales, and use taxes.Why Different Types of Taxes Exist
Many people assume that all consumption taxes serve the same purpose. In reality, governments use different tax structures to address different economic activities and policy goals. Sales tax, use tax, excise tax, and value-added tax were designed to apply at different stages of the economic cycle. While they all generate government revenue, they operate differently depending on when a transaction occurs and who is responsible for paying the tax. Several reasons explain why these separate tax systems exist:- Different points of taxation: Some taxes apply at the retail stage when a product is sold to the final customer. Others may apply earlier in the supply chain, such as during manufacturing or distribution. Governments use different systems depending on when they want the tax to be collected.
- Different policy goals: Certain taxes are created not only to generate revenue but also to influence behavior. For example, excise taxes on tobacco or alcohol are sometimes used to discourage excessive consumption of products that may affect public health.
- Different economic structures across countries: Some rely heavily on value-added taxes, while others prefer retail-based sales taxes. These differences reflect how governments structure their tax systems and administrative processes.
Why Use Tax Exist in the United States
Use tax exists primarily to prevent businesses and consumers from avoiding sales tax by purchasing products from out-of-state sellers. Without use tax, buyers could avoid paying tax simply by purchasing goods in jurisdictions where sales tax was not collected. Use tax works as a complement to sales tax, ensuring that taxable purchases remain subject to tax even when the seller did not collect it during the transaction. Here are several situations where use tax may apply:- Online purchases without collected sales tax: If a buyer purchases taxable goods from an out-of-state seller that does not collect sales tax, the buyer may still owe use tax to their home state.
- Business purchases for internal use: Businesses sometimes purchase equipment, supplies, or software from vendors that do not charge sales tax. If the items are used within the state, the business may be responsible for reporting and paying use tax.
- fInventory withdrawn for internal use: When a business removes inventory originally purchased for resale and uses it internally, that item may become subject to use tax because it is no longer being resold.
How VAT Works in Countries That Use It
Value-added tax operates very differently from the retail sales tax system used in the United States. Instead of collecting tax only at the final retail sale, VAT is applied incrementally at multiple stages of production and distribution. Each participant in the supply chain charges VAT on their sales but can also deduct the VAT paid on business purchases. This process allows tax to be applied only to the value added at each stage of production. A simplified example illustrates how the system works:- Manufacturer stage: A manufacturer sells goods to a wholesaler and charges VAT on the sale. The manufacturer remits the collected VAT to the tax authority.
- Distribution stage: The wholesaler sells the product to a retailer and also charges VAT. However, the wholesaler can deduct the VAT paid to the manufacturer from the VAT collected from the retailer.
- Retail stage: The retailer sells the final product to the consumer and charges VAT on the full retail price. The consumer ultimately bears the cost of the tax.
Why Businesses Must Understand These Tax Differences
For businesses selling products domestically or internationally, understanding the difference between these tax systems is essential for maintaining compliance and avoiding unexpected tax liabilities. Different taxes can apply depending on the type of product being sold, the location of the buyer, and the structure of the transaction. Here are several practical reasons businesses should understand these distinctions.- Preventing compliance mistakes: Confusing sales tax and use tax responsibilities can lead to underreported tax liabilities. Businesses that do not properly track these obligations may face penalties or audit risks.
- Managing cross-border sales: Companies selling internationally may encounter VAT systems in other countries, even though the United States primarily relies on sales tax and excise tax. Understanding the difference helps businesses prepare for international expansion.
- Improving financial planning: Taxes can significantly affect pricing, margins, and reporting obligations. Businesses that understand how these taxes operate can make more informed decisions about sourcing products and expanding into new markets.