Use Tax Reality

This is beneficial because otherwise additional tax forms would have to be filed. In the first three years that the use tax line was included on the income tax forms, only $13 million was collected (per analysis to AB 969). Clearly, the line on the income tax form is only having a small impact on collecting the missing $1 billion of use tax each year.

Greater awareness and payment of the use tax would help sellers and the California budget. Today, many Internet purchases look like better deals because the sales tax is not included and most people don’t know about the use tax. This can hurt sales for businesses with in-state stores, as many local bookstores have lamented for years. Use tax compliance helps to level the playing field among sellers. Also, with ongoing budget problems and discussion of new taxes, it is past time to do a better job collecting a tax already on the books.

Is it unrealistic to expect better compliance? No, but improvements are needed in order for collection to become a reality. Here are some suggestions for what legislators, tax collectors and others can do to improve use tax collection:

Improve public awareness: A public awareness campaign should help – ads on television, magazines and the Internet. All websites for California offices, agencies and legislators should have a use tax message such as “have you paid your use tax?” or “don’t cheat our schools – pay your use tax!” The message should link visitors to information on the use tax including how to compute it and pay it. State offices should have posters with the same messages.

Create role models: Certain government positions, such as those for tax agencies or legislative committees, should include a requirement that the employee be tax compliant, with an option period for becoming so without penalties or interest unless non-compliance was willful. Community organizations that rate candidates for California public office should include a question as to whether candidates have paid their California taxes. If the public demands greater accountability and compliance from elected officials, that message should also lead them to pay greater attention to their own tax obligations. Let’s have the governor, lieutenant governor, secretary of state, treasurer and the elected officials of the Board of Equalization make public statements confirming that they paid their use tax in order to heighten awareness and respect for this tax.

Simplify compliance: California could follow the lead of Maine and New York and let buyers use a table that estimates use tax based on a person’s income. Consumers can then chose to keep records to measure actual use tax owed or avoid record keeping and use the table. AB 1957 (2007-2008) included the table approach. It passed in the Assembly Revenue & Taxation Committee, but not in the Senate committee.

Take advantage of technology: Technology could help. Internet vendors and tax collectors could work together to allow two charges to a buyer’s credit card: one by the seller for the cost of the goods and the other by the tax collector for the use tax. Advantages include no need for recordkeeping, knowledge of the full cost of the goods at time of purchase, and immediate tax collection for the state.

Encourage vendors to collect: Out-of-state vendors are justifiably reluctant to voluntarily collect a tax they are not legally required to collect. There are costs associated with compliance including filing returns and additional credit card fees due to higher charges by customers (because the sales tax would be included in the charge). There are also competitive disadvantages of complying when other vendors do not as it will look like the compliant vendor’s goods are more expensive.

An advantage to collecting the use tax even when not legally required to do so would probably only exist if the state did a good enough job of educating taxpayers about their use tax obligations. Vendors could then advertise that customers need not worry about use tax recordkeeping when they buy from them because they handle it for their customers. Incentives might include paying vendors for collecting the use tax (to help cover their compliance costs), and offering simplified compliance techniques, such as annual rather than quarterly reporting for small vendors and providing technology tools to aid compliance. State agencies could also be restricted in purchasing from out-of-state vendors that do not collect California sales tax.

There are at least three solutions that are sometimes mentioned that would not be workable. First, repeal of the use tax is not a solution. As long as we have a sales tax, the use tax must also exist. Otherwise, great deals could be had by buying goods from sellers not present in California (and more sellers would likely strive not to be present in California). This would not be fair to sellers physically present in the state or to buyers and would harm the California economy.

Second, Congress could eliminate the physical presence rule so all sellers must collect sales tax. While this would certainly help collections because vendors would be responsible for collecting the tax rather than consumers, it won’t result in collecting all use tax. Legislation proposed by Congress, such as S. 34 and H.R. 3396 (110th Congress), exempts small businesses from collection obligations. Thus, consumers would still need to self-assess and remit use tax on purchases from these small, exempt businesses. In addition, when Californians purchase taxable items from foreign businesses, they would still be required to self assess use tax because the foreign seller would not be subject to collection.

Third, following New York’s lead in enacting what was dubbed the “Amazon tax” would not help. In 2008, New York modified its sales tax law to create a rebuttable presumption that if a vendor had representatives in the state who were compensated for directly or indirectly referring customers and the sales totaled over $10,000 in the four prior quarters, the vendor was required to collect sales tax. Amazon and a few other companies fit the profile because of their associates in the state who earn a commission if a buyer links to Amazon from the associate’s website.

Court challenges on the constitutionality of this scheme resulted in a victory for New York in January 2009, although appeals are likely. Subsequent to the decision, a few states introduced similar proposals including California (ABX3 27). But, this is not the solution to solving the $1 billion use tax gap. First, it remains to be seen whether the New York rule will be viewed as favorably by higher courts. Second, this rule is easy to avoid by just not letting others include links to the vendor’s website or earn a commission. Finally, this approach doesn’t reach all out-of-state vendors because many do not use the business model of letting others include a potential commission-earning link on their website or otherwise use in-state people or organizations to publicize the Internet vendor.

Increased awareness of the use tax, simplified compliance methods, techniques to encourage out-of-state vendors to collect, and public role models should lead to increased use tax collection. Legislators and tax agencies must take greater action to make more people aware of this tax and make it easier for individuals and businesses to pay it. We’ll all reap the benefits through improved state revenues, reduced need to raise taxes, greater taxpayer fairness, and more fair business competition.

Annette Nellen, CPA, Esq. is a professor of accounting and taxation at San José State University. For more information on California and federal tax reform, see www.cob.sjsu.edu/nellen_a/TaxReform/21st_century_taxation.htm.