United States
Washington, DC
EY
National Office
1101 New York Avenue, N.W. Washington, DC 20005 United States
Indirect tax contacts
Ali Vahdat +1 (213) 977-3941 (resident in Los Angeles) ali.vahdat@ey.com
Natalie Haynes +1 (314) 290-1782 (resident in St. Louis) natalie.haynes@ey.com
Karl Nicolas +1 (202) 327-6585 (resident in Washington, DC) karl.nicolas@ey.com
A. General
The United States (US) does not impose a national-level sales or value-added tax. Instead, sales taxes and complementary use taxes are imposed and administered at the state (subnational) and local (substate) levels. Currently, 45 of the 50 US states, the District of Columbia and Puerto Rico impose some form of sales and use tax (see the chapter on Puerto Rico). Only Alaska, Delaware, Montana, New Hampshire and Oregon do not impose such state-level taxes (note that several localities within Alaska do impose a sales and use tax at nonuniform rates up to 9.5%). Taking into account both the state-level and local-level aspects of sales and use taxes, approximately 13,000 taxing jurisdictions exist in the US.
The laws, rules and procedures with respect to US state and local sales and use taxes are not uniform among these jurisdictions, and issues such as tax-base calculation, taxability of specific items and tax rates vary considerably among the jurisdictions. Sales and use taxes are generally imposed on transactions involving the sale of tangible personal property. However, several states also tax certain specified services and digital property (for example, electronically delivered software).
B. Tax rates
Sales and use tax rates vary among the states. For each state that imposes a sales and use tax, most apply one uniform rate at the state level. However, several states impose a lower rate on certain items, such as food, clothing, selected services and medicine, instead of exempting such items outright, while some also impose higher rates on items such as alcohol. Excluding additional local sales and use taxes, US state-level sales and use tax rates range from 2.9% (Colorado) to 7.25% (California). The highest combined state and local tax rate is 11.5% (Gould, Arkansas.).
Local rates, if authorized within a state, may vary significantly. In addition, a single situs within a state may lie within several different local taxing jurisdictions. For example, sales made in one store may be subject to city, county and district taxes, in addition to the state-level tax, while sales made from a store in a different geographic location may be subject only to a county tax, in addition to the state-level tax. As a result, it is possible that two identical transactions within the same state may be taxed at substantially different rates based solely on the local sourcing of the transaction. In certain states, local rates may approach 10% and constitute a greater portion of the total sales tax due than the state-level rate.
specific state requirement may result in the seller becoming liable for any tax due on a transaction, plus penalties and interest.
E. Retail sales
State sales and use taxes apply to receipts from taxable property and services sold and purchased at retail. A “retail sale” generally is defined as the transfer of title and possession of property from the seller to the ultimate consumer in exchange for consideration. Wholesale sales (discussed below), also referred to as “sales for resale,” are exempt from sales and use tax in all states that impose a traditional sales and use tax scheme. However, Hawaii, whose sales and use tax effectively is a gross receipts-based tax on “doing business in the state,” imposes a 0.5% wholesale sales tax rate on resale transactions.
Taxation of services that are ancillary to the sale of taxable tangible personal property, such as delivery and installation, varies among the states. Most states have explicit statutory or regulatory provisions dealing with the treatment of such services. In many cases, such treatment is determined based on the state’s specific definition of “receipts” for sales and use tax purposes.
Drop shipments. Retail sales involving three parties (retailer, buyer and supplier), in which title to the property sold passes from the retailer directly to the buyer, but possession is transferred from a third-party supplier directly to the buyer, are classified as “drop shipment” transactions. In a drop shipment transaction, the retailer is generally responsible for sales and use tax collection. However, if the retailer does not have nexus with the buyer’s state, state law may determine that a supplier with nexus in the state may be held liable for sales and use tax collection on the transaction. Alternatively, states may attempt to assert nexus over the out-of-state retailer under a “flash title” theory (that is, by asserting that the retailer takes title to the property for an instant while the property is within the state and, accordingly, has physical presence in the taxing state) or assess use tax liability directly against the buyer.
Lease transactions. Leases are treated as taxable retail sales in most states. The tax generally applies separately to each lease payment. However, certain states, such as New Jersey, require lessors of tangible personal property to pay the sales tax in full on acquisition and before any subsequent lease or rental. In these states, tax is not charged on the subsequent lease. Complications can arise when regularly leased property is brought in from a state that allows a lessor to purchase such property exempt from sales tax. In such cases, the state into which the property is brought may assert that use tax is due on the entire original purchase price or value of the property that is subsequently leased in the state. Careful consideration of the origin of leased property and the relevant and varied state approaches is recommended.
Lease transactions that are deemed to constitute “financed sales” (i.e., arrangements under which total lease payments approximate the sales price, with the lessor having the option to purchase the leased item for a nominal price at the end of the lease term) are generally treated as straight sales in most states and are subject to immediate sales and use tax. Thus, if a lease is reclassified as a financed sale, in virtually all states, sales or use tax is due in full at the time of inception of the lease, generally at the original purchase price of the leased property.
Taxable base. Sales and use taxes are imposed on receipts derived from taxable retail sales transactions. In most states, taxable receipts may be reduced by the value of any goods traded in by the purchaser as part of the transaction and by any coupons, rebates or discounts issued by the vendor.
F. What is taxable
State sales and use taxes generally apply to sales of tangible personal property, which is defined by statute in most states as personal property that can be seen, touched, measured and weighed
Entity-based exemptions. Sales made to entities that qualify for exemption in a state (for example, religious or charitable organizations and state and federal governmental agencies) are not subject to tax. Issues may arise with respect to contractors performing work for or on behalf of such exempt entities. In general, contractors must pay tax on items purchased in fulfilling a contract with an exempt entity. However, tax is generally not due if the contractor is acting as an agent for the entity in procuring items for the entity’s own use. Wide variations in these exemptions exist among the states and, in some cases, certifications of the exemption may be required.
Property-based exemptions. Many states deem certain specific items to be exempt from tax as a matter of policy. For example, several states do not tax the purchase of grocery food, clothing or medicine, or they provide for a reduced tax rate on such items. Certain states set thresholds for such items. For example, Massachusetts exempts clothing purchases up to USD175 per item. With the recent trend toward taxing digital products, including SaaS, at least one state (Maryland) has enacted a broad exemption for customization of SaaS and software, in addition to an exclusion for SaaS and software used for commercial purposes in an enterprise environment.
Use-based exemptions. Items that otherwise are subject to the tax may be exempt based on their actual use by the purchaser. Most notably, items used in manufacturing, research and development and pollution control typically are eligible for exemption. In addition, many states provide specific exemptions for enumerated items purchased and used in designated enterprise and economic development zones in the state.
Transaction-based exemptions. The most common sales and use tax exemptions are based on the type of transaction involved. In the retail context, the “sale for resale” or “wholesale sale” exemption is most often claimed. Such exemptions are a structural component of the sales tax in the US intended to generally provide that tax only applies to the ultimate retail sale to the consumer.
Sales for resale. To avoid multiple taxation and maintain the general objective of only imposing tax on the last transaction involving the ultimate consumer, most states that impose a sales and use tax regime provide an exemption for wholesale sales. To claim this exemption, the purchaser must purchase the taxable items with the intention of reselling or leasing the items at retail. Any subsequent use by the purchaser of the items purchased under a resale exemption (e.g., taking items from inventory and distributing them as samples to customers) results in use tax becoming due. However, the seller is not required to collect such tax unless it knew at the time of sale that the purchaser intended to use the items.
Occasional sales. Most states provide an “occasional sale” exemption, also referred to as the “casual sale” or “isolated sale” exemption. This exemption typically applies in the context of business restructurings, mergers and acquisitions, and infrequent sellers, such as individuals selling personal property in single, limited transactions such as a garage or yard sale. Again, as with other exemptions, the occasional sale exemption rules vary widely among taxing jurisdictions. The theory underlying this exemption is that the sales tax is meant to apply to retail transactions only, and one-time sales are not sufficiently systematic to indicate that the seller is in the business of engaging in such transactions. In states that do not provide specific exemptions for business reorganizations (for example, incorporations, mergers and spin-offs), the occasional sale exemption may apply to limit the application of sales and use taxes to transactions that involve the transfer of assets.
Temporary storage. Several states allow an exemption from use tax for property that is not used in the state but is stored temporarily in the state and is intended for ultimate shipment outside of the state. This exemption typically applies to items fabricated or produced in a state and to items purchased and warehoused in a state but intended for ultimate transport outside of the US.
Claiming exemptions. The process for claiming any of the exemptions described above varies depending on the type of exemption claimed and the state or states involved. In most instances,
to claim an exemption, purchasers must provide the seller with a valid exemption certificate or statement in the form prescribed by law. In a number of states, the parties to the transaction must be registered for sales and use tax purposes in order to validly claim the exemption.
If the seller takes an exemption certificate in good faith (that is, the seller does not know of any reason why the exemption does not apply), the seller is relieved of any tax collection requirement with respect to the transaction. “Good faith” standards are not uniform among the states. If a seller does not accept such a certificate and if the seller is otherwise required to collect tax but does not do so, the seller may be personally liable for any tax due on the transaction. In several states, a seller making an exempt sale must be registered for purposes of that state’s sales and use tax to be able to accept an exemption certificate from a purchaser in good faith. This requirement may present a challenge for sellers not based in the US that are making sales for resale, or sales under some other exemption to customers located in the US, because registration often requires that the seller first obtain a federal employer identification number. In recent years, several states have greatly increased their scrutiny of the exemption certification process.
Exclusions, whereby an item or transaction is per se deemed not to be taxable, do not require an exemption certificate, but should be documented internally.
I. Local (substate)-level sales and use taxes
Local sales and use taxes are authorized in 37 states (including Alaska and Montana, which have no state-level sales and use tax). In most of these states, the local sales and use tax base mirrors the state-level sales and use tax base. On the other hand, rates may differ significantly among the localities within a particular state and multiple local taxing jurisdictions (such as counties, municipalities and special taxing districts) may impose separate rates. Thus, as indicated above, a single address within a state may fall within multiple local taxing jurisdictions for determining the applicable rate to apply to a specific transaction.
In most states, local sales and use taxes are administered at the state level. However, in a limited number of states, such as Alabama, Colorado and Louisiana, such taxes may be administered by the locality imposing the tax. Thus, separate registrations and filings may be required in addition to registrations and filings with the state. In these states, not only may rates differ but so may the applicable tax base (i.e., transactions exempt from state tax may nevertheless be subject to local sales and use taxes). Sellers that have nexus with a state are generally considered to have nexus with every locality within that state, regardless of whether they maintain any physical presence within a specific locality, but this position is not universal (e.g., Colorado’s Department of Revenue recently declared that despite the decision in Wayfair, physical presence was still required to collect local sales and use tax by those few jurisdictions in the state that exercised home rule authority).
J. Registration, filing and compliance issues
Sellers that have nexus with a state (see Section D) must register with the state taxing agency for sales and use tax purposes. Registered sellers must collect and remit sales and use tax on all taxable transactions and maintain exemption certificates received from their customers. Sales and use tax returns are due on a monthly or quarterly basis, depending on the specific state’s laws. Sellers that do not make any taxable sales for a given period may be relieved from filing regular returns, or they may be required to file “zero” returns indicating that no taxable sales occurred. Most states impose successor liability on the purchasers of substantially all of the assets of a business for any sales or use tax deficiencies of these businesses. This liability may be avoided if the seller complies with certain bulk sales and notice requirements, the rules for which vary between states, and they often are required in addition to the general requirements applicable to commercial transactions generally under the applicable commercial law of the state.
K. Penalties
All states impose penalties for failure to file returns and pay sales and use taxes as required by law. Penalty rates vary among the states. With respect to cases not involving fraud, the penalties range from 5% to 25% of the tax due. In cases involving the failure to file or pay as a result of fraud, penalties can exceed USD100,000 and result in imprisonment for any officers deemed responsible for the willful failure. The penalties here are not based on percentages but are applied as a fixed penalty amount and/or prison time limit. In both instances – civil and criminal – company directors may be held personally liable for the payment of any taxes due by the business entity to the state, but not remitted.
Similarly, all states impose interest on tax determined to be due that was not paid. In general, interest is assessed from the due date for any tax determined to be payable until the date of payment. The interest rate charged varies among the states. In general, interest rates vary from 1% to more than 15% annually. Some states determine their interest rates based on the prime rate, plus some additional percentage. Other states set rates legislatively. Rates set legislatively change less frequently, while those tied to the prime rate generally change quarterly, semiannually or annually, depending on market conditions.