Ashlea Ebeling

Ashlea Ebeling, Forbes Staff


2/27/2008 @ 6:00AM

States To Consumers: Pay Up

If you live in California, New York, Ohio, Michigan, North Carolina, or in one of 17 smaller states, you might have noticed a nagging little line on your individual state income tax forms this year.

In California, it reads–cryptically–”Use Tax. This is not a total line (see page 16).” In Michigan, the line is a bit more helpful, instructing: “Enter use tax due on Internet, mail order or other out-of-state purchases from worksheet 1, line 3, p. 9.”

So what’s “use tax”? Sales tax, by another name. If you buy something online, at an out-of-state retailer or even abroad, and don’t pay sales tax, and you then use that purchase in your home state, you owe use taxes to your state. In fact, even if you pay sales taxes when you buy out-of-state, you might still owe use tax; if the state tax you paid is lower than your home state’s rate, technically, you owe your home state the difference. Really.

The nagging line on the tax return is meant to get you to cough up what you owe voluntarily. “The states are asking people to send in money as good citizens,” explains Verenda Smith, a government affairs associate at the Federation of Tax Administrators, an organization of state tax officials.

Sure. Last year, when the Minnesota House of Representatives Research Department surveyed 19 states with a use-tax line question, it found only 1.6% of taxpayers have been fessing up to owing use tax on their returns.

That’s suspiciously low, considering that sales taxes are collected on only about 50% of online purchases. (See: “Point, Click, Pay Tax.”)

States have tried a couple of tricks to boost voluntary compliance. Some require taxpayers to write “zero” if they say they owe no use tax–meaning they’ve got to actively fib to skirt the tax. But according to the Minnesota study, that mind game has virtually no impact–it only boosts the percentage of income tax filers paying use tax from 1.56% to 1.63%.

Other states have tried the more enlightened–and somewhat more effective–approach of cutting the paperwork hassle for residents who actually do want to comply. They provide tables where taxpayers can “look up” their use tax liability for smaller purchases, based on their income. Say you make $150,000; you might pay $75, depending on the state’s rate, in use tax, to cover all your likely out-of-state purchases of items under $1,000. In addition, you’re supposed to pay extra use tax for any item you bought out-of-state that was over $1,000.

In states with the lookup tables, 3% of taxpayers self-report use tax; in states without look-up tables, just 0.3% of taxpayers do the same, according to the Minnesota report.

Minnesota itself has had an unusual provision, since 1997, designed to help its citizens stay on the right side of the law. If your total out-of-state purchases don’t exceed $770 in a calendar year, you don’t owe use tax. “We had a sales tax advisory commission which noted that nobody really paid this,” explains Nina Manzi, a legislative analyst and author of the report. “Technically, a lot of people in the state were ‘criminals’ for not paying. So the commission said, ‘Let’s make a de minimus exception.’”

Truth is, a lot of upstanding folks who wouldn’t dream of cheating on their income taxes still blithely ignore the use tax line, even if it does make them law-breakers. Faced with this huge compliance gap, the states have been lobbying Congress to require all but the smallest sellers to collect sales tax for all states–putting the burden on the merchant, not the consumer.

But that seems unlikely to become federal law anytime soon. So meanwhile, the states have begun to enforce their use-tax laws against consumers, particularly high-income purchasers of big-ticket items.

Virginia, for example, routinely sends use-tax bills to residents who buy furniture in North Carolina and have it shipped home, Smith notes. How does Virginia know? North Carolina audits the furniture sellers and gets a list of tax-free sales to Virginia residents, which it shares with Virginia tax authorities. Such interstate tax sharing agreements are now common.

Connecticut, which has targeted high-income taxpayers for use-tax enforcement, reviews customs declarations forms, another increasingly common tactic. So that hedge fund manager who has shipped a sculpture he bought from an art dealer in France to his Greenwich estate will likely–eventually–get a bill from the state, including penalties, unless he voluntarily coughs up the sales tax. In 2006, residents with adjusted gross income of more than $2 million paid $13 million of the $14.8 million in use tax Connecticut collected.

If you do get a use-tax bill from your state, it can pay to call the state auditor to talk over your case before you send in a check. Maybe you don’t actually owe the tax. If for example, your cousin from Italy shipped you art from your late aunt’s estate–that’s not a retail sale, so the use tax doesn’t apply. Bill canceled. Or if you did buy an item, you might still be able to get the penalties wiped out.

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