USA VAT, GST, and Sales Tax Guide

United States

Washington, DC GMT -5

EY

National Office

1101 New York Avenue, N.W. Washington, DC 20005

United States

Indirect tax contacts

Anthony Robinson

+1 (312) 879-3026 (resident in Chicago) anthony.robinson1@ey.com

Michael Woznyk +1 (212) 773-3008 (resident in New York) michael.woznyk@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 chapter on Puerto Rico). Only Alaska, Delaware, Montana, New Hampshire and Oregon do not impose such state-level taxes. 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 addi tional 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 10.25% (Chicago, Illinois).

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 trans action. In certain states, local rates can exceed 4% and constitute a greater portion of the total sales tax due than the state-level rate.

Not all states authorize the imposition of local sales and use taxes, while some states that do not impose a state-level sales tax (e.g., Alaska) allow localities to impose the tax. Others require rate uniformity across the state or minimum local rates (e.g., California).

C. Imposition of tax

Sales taxes are transaction-based taxes imposed on intrastate retail transactions (sales made between a buyer and seller located within the same state) and are calculated as a percentage of the receipts derived from the transaction. The legal incidence of state sales tax laws may be on the buyer (“consumer” taxes) or on the seller (“vendor” or “privilege” taxes). However, regardless of the form of the tax, the consumer generally will bear the actual cost of the tax, while the vendor will bear the compliance cost.

Use taxes, which complement sales taxes, are imposed on the use, storage or consumption in a state of property or taxable services that have not been subjected to a sales tax. Essentially, use taxes are designed to prevent the avoidance of sales taxes on interstate retail transactions (sales made between a buyer and seller located in different states) by taxing goods and services procured in one state but intended for use or enjoyment in another state. To the extent that sales tax is paid in one state on such interstate transactions, a credit is allowed against any use tax that is ultimately owed.

D. Jurisdiction to tax

The key issue with respect to US state and local sales and use taxation is the jurisdiction to tax, or what is commonly referred to as “nexus.” This concept deals with the power of one state or local taxing jurisdictions to compel a seller to collect and remit the sales or use tax due on a transaction. Prior to the ruling rendered by the U.S. Supreme Court (the Court) on 21 June 2018 in South Dakota v. Wayfair Inc. (Wayfair), nexus was deemed to exist only if the seller had some physical presence within the taxing state or local jurisdiction (either by itself or through an agent or affiliate that had “established and maintained” an in-state market for the seller) and if such presence was more than de minimis.

Direct physical presence. Even if unrelated to a seller’s sales activity, direct physical presence automatically created (and still creates even after the Wayfair ruling) a registration and collection obligation. Physical presence may be deemed to exist based on the ownership of real or tangible personal property, the in-state presence of employees, the temporary storage of inventory or any other entry into the state by the seller or its employees (for example, delivery of goods sold in the seller’s own vehicles). Physical presence may also be attributed to a seller based on activities conducted by third parties in the state on the seller’s behalf. Essentially, if an agent or affiliate of a seller that does not have nexus with a state enters the state and conducts activities on the seller’s behalf that serve to “establish and maintain a market” for the seller’s goods (for example, solicit ing sales, providing repair or installation services or providing training services), the seller may be deemed to be physically present in the state and be subject to the state’s sales and use tax jurisdiction.

Remote sellers. Between 1999 and 2018, several states enacted laws that required remote sellers with no in-state physical presence to register for sales and use tax purposes, and to collect and remit tax on sales to in-state customers based on their in-state sales volume. These laws, which many considered unconstitutional under the case law at the time, were challenged in each juris diction where they were enacted. In April 2018, the Court heard an appeal of the challenge to the state of South Dakota’s law, which imposed a registration and collection obligation on any remote seller that had annual sales of USD100,000 or that entered into at least 200 transactions with South Dakota customers. On 21 June 2018, the Court issued its ruling in the Wayfair case, con cluding that the physical presence standard established under earlier precedent was “incorrect and unsound” under the Commerce Clause of the U.S. Constitution and was no longer applicable.

The Court further held that states were free to compel remote sellers to collect and remit tax so long as their mechanism for doing so did not unduly burden or discriminate against interstate commerce. As of May 2020, every state that imposes a sales and use tax has enacted new laws or adopted formal positions that apply an economic nexus standard based solely on sales directed to customers in the state.

Marketplaces. Also, in response to the Wayfair decision, and as of May 2021, every state that imposes a sales and use tax has extended collection responsibilities to marketplace facilitators and providers (i.e., businesses that operate and maintain a platform to allow sellers to market and sell their goods and services). In most instances, the states have required that the marketplace facilitator or provider have a physical presence in the state or meet the state’s economic nexus sales threshold, A few states (e.g., Colorado, Hawaii, Maryland), however, have remained silent on whether such stand-alone nexus is required. In these states, sales and use tax collection and filing responsibilities with respect to any transactions made through the marketplace are with the marketplace facilitator or provider. These new laws have created significant complexities, given that the state definitions of “marketplace facilitator” and “marketplace provider” vary considerably and can be broad, pulling in a number of businesses that would generally not be perceived as operating “traditional” marketplace forums.

Businesses that are not physically present in the US should be aware that the US states believe that their remote seller economic nexus and the marketplace facilitator/provider provisions apply equally to businesses that lack any US presence or permanent establishment. Moreover, while enforcement by the states may present a challenge, noncompliance creates potentially significant accounting and financial statement risks, pursuant to Accounting Standards Codification (ASC) 450, for non-US companies that do not comply with these collection and registration require ments.

Third parties. In addition to these economic nexus provisions, more than 30 states have also enacted laws that specifically attribute certain activities of in-state third parties on behalf of remote sellers to such remote sellers, thereby creating a presumption of an in-state physical pres ence. These laws operate parallel to the new economic nexus standards and present a separate consideration. In many states, certain affiliate relationships with in-state entities also will create a presumption of an attributional physical presence for a remote seller. Finally, since 2010, more than 10 states have adopted a requirement for remote sellers that lack nexus with a state but make sales to in-state customers to provide notice to their customers that use tax is due and is the responsibility of the customer, and to provide the state revenue agency with a list of in-state customers and the value of their annual purchases. Despite the historic ruling in Wayfair, which drastically expanded the reach of states to enforce sales or use tax compliance by remote sellers, these provisions remain in effect and apply in the event nexus is not otherwise established (either through direct physical presence, meeting one or more state-specific sales or transactions thresh olds, or by way of attributional or affiliate presumptions).

If a seller does establish nexus with a state for sales and use tax purposes through one of these means, the seller is generally required to register in that state for sales and use tax purposes, and the seller is required to collect and remit sales and use taxes due on its taxable transactions with customers in the state. The seller is also required to file monthly, quarterly or annual sales and use tax returns (depending on state law) and remit all taxes collected. Failure to comply with the specific state requirement may result in the seller becoming liable for any tax due on a transac tion, plus penalties and interest.

Between 2000 and 2018, legislation had regularly and routinely been introduced in the U.S. Congress that, if enacted, would have established a uniform national sales and use tax nexus standard for remote sellers (i.e., businesses that sell and ship goods to customers from points

outside of the customer’s state and that lack physical presence in the customer’s state). However, with the Court’s decision in Wayfair, such efforts have largely been abandoned.

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 (dis cussed below), also referred to as “sales for resale,” are exempt from sales and use tax in all states that impose a sales and use tax scheme. However, Hawaii 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 regula tory 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 collec tion. 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 Illinois and 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 trans actions. 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 or is otherwise perceptible to the senses. On the other hand, services are generally not broadly subject to sales and use taxes unless the state’s sales tax law specifically enumerates such

services as taxable. The sales tax treatment of both sales of tangible property and services is not uniform across the states.

Real property. Real property (e.g., land, buildings and fixtures) is not considered to be tangible personal property, and the sale or lease of real property is not subject to sales and use taxation (except in certain limited circumstances, the leasing of real property is subject to sales and use tax in Arizona and Florida while in New York City a specialized lease transaction tax applies). State and local jurisdictions may, however, impose transfer taxes on real property that are admin istered separately and apart from the state or local sales or use taxes. Among the oldest taxes levied in the US, these tax laws vary widely from state to state and even within some states can vary not only as to rates but also applicability from locality to locality.

Intangible property. The sale of intangible personal property, such as securities and intellectual property, is generally not subject to sales and use taxation. However, the sale of certain intangible digital goods (such as computer software and electronically delivered photographs, music and video files) may be subject to tax, depending on the specific state’s laws. For example, items such as music downloaded from the internet and canned (non-custom) computer software that is delivered electronically may be considered to be tangible personal property in several states and are subject to tax. California sales and use tax law, on the other hand, continues to treat any such goods delivered electronically as intangible property not subject to tax. Similarly, depending upon the jurisdictions involved, cloud-based software (SaaS) may be classified as taxable tangi ble personal property, nontaxable intangible property or a service (that may or may not be taxable).

Many states classify utility services, such as the sale of natural gas or electricity, as the sale of taxable tangible personal property. In such states, sales of these utility services may be subject to sales and use tax in addition to any applicable utility transmission fees or excise taxes that may be applied and collected separately.

In recent years, the number of states that have introduced legislation that would extend the sales and use tax to cover certain digital products and services has grown significantly. In early 2021, Maryland became the first state to adopt a broad-based excise tax (separate from the state’s sales and use tax regime) on revenue from Maryland-sourced sales of digital advertising services. As of late 2021, that new tax was the subject of two legal challenges arguing that it violates both the US federal and Maryland state constitutions. Several other states introduced identical legislation or proposals to expand their existing sales and use tax to cover these and other transactions, such as the selling of customer data. Still more states have proposed a flat per-user fee on entities that operate as “social media companies.” While none of these measures were enacted – apart from Maryland – it is expected that more proposals will be introduced and acted upon in 2022.

G. Situs of sales

Where a sale is deemed to take place is crucial in determining which jurisdiction’s tax laws and rates apply. For intrastate sales, the situs of the sale determines which local sales and use taxes (if any) are imposed in addition to the state-level tax and which locality receives the revenue. For interstate transactions, the situs of the sale determines which state’s laws have control and which state is entitled to the tax revenue.

In general, sales are sourced based on the nature of the transaction. For example, if a sale occurs at a fixed location, such as an over-the-counter sale at a store, the sale is sourced to that location.

For intrastate remote sales that involve a buyer and seller (and possibly the goods sold) at sepa rate locations, the transaction may be sourced to where the goods are received by the buyer, where the order is accepted by the seller or from where the goods are shipped.

For interstate remote sales, tax generally is imposed at the destination (that is, where the goods are received by the buyer), regardless of where title passes to the ultimate customer. In such

cases, use tax, rather than sales tax, is due, and it must be collected and remitted by the seller if the seller has nexus with the destination state. To the extent that the seller lacks nexus with the destination state, the purchaser must self-assess and pay use tax to the state. The elimination of the physical presence requirement by the Wayfair decision is expected to make such use tax transactional obligations much less frequent.

Sourcing for intrastate sales varies among the states. Most states apply local taxes on a destina tion basis, which means that local sales and use taxes at the customer location will apply. Others apply local taxes on an origin basis, which means that local sales and use taxes at the vendor or shipper location will apply.

Sourcing of intangible goods (e.g., digital products, software) or services that may be used in multiple locations present unique challenges. Many states will allow a purchaser to allocate the sales tax due based on usage, either by providing the seller with a use allocation schedule at the time of sale or by filing refund claims subsequent to the purchase and payment of tax. The appro priate procedures and methodology for dealing with such transactions will vary from state to state.

H. Tax exemptions

Exemptions from state sales and use taxes is a significant component of the sales and use tax system in the US. Many of these exemptions are largely driven by tax policy and they may be based on federal or state law.

Federal exemptions. Exemptions based on federal law include excluding from state and local sales and use tax transactions that involve Indian tribes or occur on Indian reservation lands (although many Indian tribes may separately impose and collect their own sales and use taxes independent of the states in which such reservations are located). Moreover, sales made to the federal govern ment may be expressly exempt from state and local sales and use tax and also would be excluded under precedent issued by the U.S. Supreme Court.

State and local exemptions. Other state- and local-level exemptions vary by jurisdiction, but may be grouped into the following four distinct categories:

• Entity based

• Property based

• Use based

• Transaction based

Like other aspects of state and local taxation, the availability and operation of sales and use tax exemptions and the procedures for claiming the exemptions vary widely among the states and, in some cases, even among the local taxing jurisdictions in the same state that impose such a tax.

Entity-based exemptions. Sales made to entities that qualify for exemption in a state (for exam ple, 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 exemp tions 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.

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 develop ment 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” exemp tion 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.

I. Local (substate)-level sales and use taxes

Local sales and use taxes are authorized in 37 states. Fortunately, 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 juris dictions (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 can 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 – com pany 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 14% 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.