Use Tax: What the heck is it?

We are all accustomed to paying sales tax when we buy products at a retail store.  It’s that nasty 7 percent that is added onto everything.  But many people have discovered what they believe to be a way around sales tax.  The solution: buy it on the internet.  If a company does not have a physical presence in the State of Indiana, they are not required to collect sales tax on internet sales. (Amazon is an exception – based on their negotiation with the state)  People will Google up the product or store they want to buy from and place the order.  In many cases, no sales tax is added to the price.  The item is shipped to their address in Indiana and is used in Indiana.  Sounds great, you just saved 7 percent.  Well, not really.  There is a law that has been on the books for many years that states, if you buy a product out of state exempt from sales tax, bring it into the state and use it in the state you’re are required to pay what is known as use tax. 

Use tax is simply the sales tax rate times the cost of the product.  It’s the same amount as the sales tax you would have paid if you bought the product at a local (in state) retailer.  Years ago, this was not a significant issue for the state but with the increased use of internet buying the state of Indiana has come to realize they are losing a lot of tax revenue.  With the economy in the condition it is in currently, all states are looking for ways to increase tax collections and this is an area that Indiana is starting to focus on.

Retailers in the state are also excited about Indiana cracking down on use tax.  They feel if people lose the advantage of buying products tax free on the internet, that many of them will start buying from local retailers again.  Ask most small retail business owners about this issue and you will likely get an ear full.

Use tax is paid on your annual individual or business income tax return.  If you pull out last year’s individual Indiana tax return and look at Schedule 4 you will see on line one the description “Use tax on out-of-state purchases”.  On this line you would report 7 percent of the cost of the purchases you made on the internet that was not subject to sales tax at the time of purchase.  That number finds its way to the front of the return on line 10 and is added to your income taxes.  If you have a business that is an S corporation, it is on line 13 of the corporate return.  If you are in a partnership, it is on line 5 of the partnership tax return.

Since this seems to be on the honor system, how does the state catch people that are not paying use tax?  The answer is by auditing income tax returns.  This question has come up in every audit I have represented someone in over the past year.  The auditors are requesting the charge card records during the course of an audit and looking for out of state purchases.  It then becomes the job of the taxpayer to prove that sales tax or use tax was paid on the items in question.  Here is where record keeping comes into play.  It is assumed that you did not pay the tax unless you can prove that you did by furnishing the sales receipt.

Business owners be aware that you need to keep the receipts for your purchases that are paid by credit card.  Many small businesses seem to feel that the credit card statement is adequate to verify a business related purchase and do not keep the sales receipts.  While the auditors will usually allow the expense as a deduction for income tax purposes, they are starting to assess use tax on items that do not have a receipt showing that sales tax was paid.  Your credit card statement only shows the total expense and does not show any sales tax.  This can create a significant amount of tax if you utilize a credit card to make purchases. 

It’s not only out of state purchases that the auditors are questioning for businesses.  If you are a retail business and you buy product for resale you are not required to pay sales tax.  You give the supplier a form with your retail merchant certificate number and they do not add the 7 percent sales tax.  However, if you buy supplies that are used in your business and not resold you must either pay sales tax at the time of purchase or use tax on your income tax return for those items.  If you pay for supplies by credit card, even from a local retailer, and only have a credit card statement to prove the expense, you run the risk of the auditor assessing sales tax on an item that you may have already paid sales tax on.  The burden of proof is on you.

This is one of those things that falls into the category of what you don’t know can hurt you.  The state will quickly let you know that ignorance of the law is no excuse.

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