Use Tax & Out-of-State Sellers
Like many other budget-strapped states, California has taken measures to address the issue of uncollected sales tax for out-of-state transactions, particularly online purchases.
California sales tax rates only apply to customers who are state residents, but determining if sales tax needs to be collected can be a challenge for an out-of-state business.
The State Board of Equalization (BOE) requires businesses and sellers with a nexus in California to collect and remit sales tax for taxable transactions to California residents. But if the business or seller has no physical presence in California, then the buyer is required to pay a use tax on the purchase to the state. In other words, if a taxpayer buys something online from a business that has no physical presence in California, that buyer has a duty to file a use tax return and pay the tax related to that purchase to the state.
Unraveling the complex BOE sales and use tax rules is not easy. Where most other states use either origin-based sales tax or destination-based sales tax, California is actually a hybrid of the two, making its rules unique. Also, there are a variety of the exemptions applicable to goods and vendors when it comes to use tax.
Use Tax vs. Sales Tax
In general, if a business is located outside of California, sales of products delivered within the state are subject to use tax, which is simply a tax on the use, storage and consumption of personal property purchased from an out-of-state seller.
The use tax was enacted in 1935 to ensure the collection of sales tax on purchases made by California buyers even if the seller was not legally obligated to collect the sales tax. The intent of use tax is to put California retailers on “an equal footing with their out-of-state competitors” who could sell merchandise to state residents without the addition of sales tax.
While the collection of sales tax is the responsibility of the retailer, the use tax is legally imposed upon the buyer. The use tax is set at the same rate as the state’s sales tax and must be paid directly to the BOE or on a Franchise Tax Board (FTB) income tax return.
Items exempt from sales tax in California are generally exempt from use tax as well. These include:
- Purchase of items for resale
- Purchase of most food products
- Purchase of prescription medicines and devices
- Purchase of electronically transmitted products such as software, ebooks, mobile applications and digital images
An out-of-state business is responsible for registering its business activity with the state and collecting use tax if it has significant presence-or nexus-in California, such as:
- A permanent or temporary business location in California, which might include a store, warehouse, sales room or office.
- Any kind of representative or agent in California, even temporarily, who has made more than $10,000 in sales in the preceding 12 months.
- A person who installs/assembles merchandise or makes deliveries for your business.
- An arrangement or compensation agreement with a person or persons in California to direct potential buyers to the website or link of the out-of-state business.
- Overall “total cumulative sales price” more from directed sales to California residents that exceed more than $10,000 within the preceding 12 months.
- Overall total cumulative sales in California (both directed and otherwise) that exceed $1 million within the preceding 12 months.
- An affiliation with a commonly controlled group. For example, businesses owned by parent corporations in California or two corporations with at least one in California that has substantial overlap in stock ownership.
In general, these conditions only apply to large online retailers. However, small businesses or individuals who sell through Fulfilled By Amazon (FBA) might also be affected by affiliation. California considers FBA sellers to be multi-location businesses that are required to collect state use tax.
Special tax districts complicate this even more. For example, if an FBA seller has an Amazon order ship from a warehouse inside a special tax district to a resident within that district, then a district sales tax must be collected along with the state sales tax. However, if an order ships from that same warehouse to a resident outside that district, then only state sales tax is collected.
The BOE encourages out-of-state businesses to voluntarily register and pay use tax obligations due to the state. The Voluntary Disclosure Program provides incentives for unregistered businesses outside of California, including:
- Limits on the time the BOE can make an assessment for prior taxes to three years. The standard statutory period is eight years.
- The waiving of late filing or payment penalties.
Let Brown, PC Help
The experienced tax attorneys of Brown, PC can help you with California state use tax and issues with out-of-state sellers. We represent clients in Los Angeles and throughout California. To speak with an experienced California state tax lawyer, please contact the firm online or by calling 424-252-1100.