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The California Use Tax

According to California tax law, you must pay California sales tax on your out-of-state purchases even if the company you bought from did not charge you any state tax. So all those books and gadgets you buy from Amazon or Tiger Direct that you thought you were getting sales-tax free are still subject to sales tax. In technical jargon, this tax is known as the use tax, but it's exactly the same as the sales tax.

How do you report and pay this tax? On your California state income tax return 540, on the second page, there is a line towards the end call the Use Tax. See the picture below.

California Use tax line 95

Examples

Say you live in San Francisco, where the sales tax is 9.50%, and you bought $2,439 dollars of stuff online, and no sales tax was collected. According to the law, you must track your out-of-state purchases where no sales tax was collected and on line 95 enter 9.50% of $2,349, or $223.15. This increases your state income tax by $223.15.

But it gets more complicated. If you additionally bought $100 of stuff where sales tax was collected at a lower rate of, say 6% for example, then you should pay just 3.50% of $100 on these items. In most cases, this should not happen.

In addition, not at all items are subject to use tax. Groceries and prescription medicines are not subject to sales or use tax in California.

A letter I received

I got a letter from the California Board of Equalization (BOE) today which says they plan to step up collection efforts of use tax. This is obviously due to the budget crisis. The letter reads:

March 4, 2011

Dear Tax Professional:

California loses a significant amount of tax revenue because many businesses and individuals do not realize that they may owe use tax on their out-of-state purchases. Due in large part to recent large budget deficits, any states, including California, are increase collection efforts that may catch some taxpayers and their tax practitioners by surprise. Penalties and interest may be charged when this tax is not paid by purchasers in a timely manner. Practitioners who are already helping clients to be use tax compliant should take steps now to avoid potential future problems.

INTERNET TAX FREEDOM ACT

Some consumers mistakenly believe that purchases made on the internet are not subject to tax because of the Internet Tax Freedom Act. This 1998 law placed a moratorium on charging taxes on Internet access fees. However, it does not provide an exemption from tax for purchases made on the Internet. These purchases are subject to tax just like any other purchase. This misunderstanding may be a reason the tax gap has increased in recent years.

EFFORTS TO REDUCE THE TAX GAP

Several states, including California, have simplified reporting by adding a line for use tax to the state income tax return. This eliminates the need to file a separate tax return to report and pay any use tax. Detailed information about use tax is included in the tax instruction booklets that accompany the California state income tax returns.

The Board of Equalization (BOE) has taken steps to improve use tax compliance including:
  • Sending teams of BOE specialists to visit businesses across the state to ensure that they are properly registered and reporting correctly.
  • Pursuing service industry businesses for unpaid use tax. We identify businesses that are likely to have incurred a use tax liability and send contact letters reminding them to report any use tax due.
  • Identifying property subject to unpaid use tax being shipped into the state via personnel at California Department of Food and Agriculture and California Highway Patrol inspection stations.
  • Receiving information from the U.S. Department of Customs to identify items purchased outside of the country which are subject to use tax.
  • Receiving reports from out-of-state sellers of cigarettes and other tobacco products to identify consumers owing unpaid excise and use taxes on these purchases.

Use tax deductible for business

On the plus side, reporting use tax for your business allows you to expense or depreciate the tax, so you get back some of what you paid. Say you live in San Francisco where the tax rate is 9.50% and purchase $1000 of office supplies online. You must pay use tax of $95, but if you use the supplies exclusively for your business you can expense the $95. The $95 is deductible is deductible on both your state and federal income tax returns. Assuming you're in the 28% federal income tax bracket (for single taxpayers, taxable income between $82,400 and $171,850 in 2010) and 9.55% state income tax bracket (for single taxpayers, taxable income between $46,766 and $1,000,000), then the deduction saves you around $35.

For another example, say you bought a computer online for $1000 and you use your computer 100% for business. You must pay $95, but you can depreciate this $95 as part of the cost of your computer. Technical aside: computers are normally depreciated over 5 years, but through a special law called section 179 you may be able to deduct the entire cost at once as an expense. When you sell or dispose of your computer you have to recapture the depreciation, including the $95, if you sell it for anything other than $0.

 

Official documentation:



Contact Pacific Tax 1040

 

IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.