What Is The Difference Between Sales Tax and Use Tax?

As a business owner, it gets daunting to talk about taxes as it seems never-ending. However, it is necessary to have at least a basic understanding of the various taxes you are subject to will keep you out of legal hot water and keep more money in your pocket.

Let’s get started on this by discussing the difference between sales tax and use tax.

You might be thinking how boring this would be, but I assure you this will be worth your while.

Sales Tax vs. Use Tax

Most people (even non-business owners) already know about sales tax. When we purchase something from the supermarket, we pay the product’s price plus another amount, the sales tax. Any purchase you make in your state is subject to sales tax.

A tax on sales or sales receipts is known as sales tax. Most taxable goods and services are subject to this tax on all retail sales, leases, and rentals. Local and state governments, including cities, counties, special purpose districts, and transit agencies, are responsible for enforcing it.

The business is not charging the tax; they are collecting it to report and remit to the State Comptroller.

Let’s learn how use tax is different. For some, use tax and sales are the same; the difference is that use tax is added to purchases a consumer makes online or from another state. Because you don’t live in the same state as the vendor, you will have to pay use tax to your home state instead of a sales tax.

Forty-five states impose the use tax, but about 1.6% of taxpayers in these states pay it.

Use taxes are reported on the same report and simultaneously as you collect the sales tax from your clients on the taxable sales in your business.

A Closer Look Into Sales Tax

Now that you know the difference between the two, you need to understand better how each tax works and how it affects your business.

Let’s start with sales tax.

I live in Texas, where the state sales tax is 6.25%, and Dallas, Houston, and San Antonio impose a local sales tax of 2%.

Whenever I purchase a taxable good or service from a seller in my home city in Texas, I pay the purchase price plus the total sales tax of 8.25%. So, if I bought something worth $100, I spent a total of $108.25. With this, $6.25 will go to the state of Texas, while the city where I live will get $2 as tax.

It’s worth noting that there are only five states that do not impose a sales tax. Consider yourself lucky if you live in Alaska, Delaware, Montana, New Hampshire, or Oregon. While these states do not charge a general sales tax, they may allow local sales tax or impose excise, meal, or lodging taxes.

Sales Tax vs. Federal Tax

Any business owner knows much about sales taxes, so why should you pay close attention to it?

The answer is simple: You must ensure your sales tax status is correct.

Otherwise, you can run into trouble with the IRS (which collects federal taxes) and the state comptroller (which collects state taxes).

Between the two, the state comptroller could be your worst enemy if you fail to manage your sales tax status properly.

I find the IRS to be much tamer than the state comptroller. The state comptroller can act swiftly to close your business down if you don’t abide by its rules and procedures.

With this in mind, there is a clear difference between the taxes you pay to the federal government and the sales tax you pay to your state government.

In addition to the payroll tax, you also pay the IRS income tax on the amount of income you have made in a given year, and Federal income taxes are not deductible.

On the other hand, the state comptroller handles the collection and accounting of state taxes in the localities where you are doing business.

Sales taxes are paid through the vendor. So, if someone purchased a product or service from you, you hold on to the sales tax until the state comptroller collects it. If you fail to hand over the tax, the state comptroller could close your business down or seize your bank account.

What’s more, you still owe the state comptroller sales taxes even if you didn’t collect them from your customers.

In any case, failing to handle your sales tax properly can quickly become a criminal offense.

Be Not Afraid of the Taxman

Your tax situation shouldn’t intimidate you. Dealing with the IRS and state comptroller properly can help you avoid a challenging situation.

After all, these agencies are just doing their jobs. You should do your part as well by being responsible for your tax situation.

The first thing you will need to do is to determine what items in your industry are and are not taxable.

To do this, contact your state comptroller’s office and document the conversation by writing down the date of the conversation, the badge number, and other details they provide.

You may get your CPA to do this on your behalf, but it’s much better to personally reach out to the state comptroller since you know your business better than anyone else (including your tax preparer).

Regardless, it would be best if you were clear on what you do and do not need to collect sales tax. You are still responsible for paying this tax even if you did not manage it. Moreover, check with the state comptroller for changes to local tax policies.

If the product you sell is not subject to sales tax, good for you! That’s one more miniature monkey off your back!

When it comes to direct sales companies, customers will need to pay the tax on the entire sales price when they buy the product.

If you earn through a direct sales company, your customers will pay the product’s total price and the sales tax. You report this to the comptroller and get reimbursed after the purchase. Direct sales companies provide training on how this arrangement works.

However, your products and services are taxable; keep in mind that you need to acquire a sales tax permit from the state comptroller.

As a permit holder, you are required to post the permit at your business, collect sales tax on all taxable sales, pay sales and use tax on all taxable purchases, file timely reports on sales and use taxes, and keep adequate records.

Typically reporting periods are monthly, quarterly, and annually depending on the volume you collect on your taxable sales.

How Sales Taxes Work

As a permit holder, you are entitled to buy wholesale the items you use for making your product. So, if you buy $100 worth of materials for your flower shop, you will pay only that amount to the supplier.

When a customer buys something from your flower shop that costs $250, you will have to collect that amount plus the sales tax. In Texas, that amounts to $20.63 in sales tax for a total bill of $270.63.

Now, let’s look at how this is accounted for.

You take the amount you collected and subtract the sales tax you paid to your state comptroller and the wholesale cost of the materials.

We get this computation:

$270.63 (Total Amount Collected) – $20.63 (Sales Tax) – $100 (Wholesale Costs) = $150 Net income from the sale (Taxable to the IRS)

In any situation, you are not to spend the sales tax since these serve as trust funds to the state!

The best solution is to separate these funds from your operating funds so you don’t spend them.

You can keep your sales tax situation in check through proper reporting and documentation and avoid trouble.

It also pays to follow the advice of a tax professional and set up a system to help you manage this critical area in your business.

Business Untangled can guide you through all the red tape of keeping your business compliant.

Call us today and find out how our system can help you pay less tax while you make and keep more money in your pocket.