Cory logs onto Etsy and purchases a pair of artisan-made cufflinks for $80. Shipping to his house in San Francisco costs an additional $3.50 USD. Though Etsy is a Brooklyn-based company, the seller, Oak, is located in Boston. What sales and use taxes do Cory, Etsy and Oak owe?

Normally, businesses that have “brick and mortar” stores in a particular state must pay sales tax when they make a sale in that state. More and more, though, goods are purchased online outside of the state, and shipped to a state for consumption in a different state.

Cory’s purchase is no exception, as it resembles many purchases of goods online. In this hypothetical example, Oak has a physical presence: a store on Newbury street in Boston, Massachusetts. Oak would have to pay sales tax if a good was purchased at their store, but no sales tax is charged on the cufflinks being purchased online from another state.

This is because of something called a “use” tax. The use tax was created to capture situations exactly like this one. Use taxes pre-date the internet; they evolved in a time when orders were made by mail in one state, and shipped to another state for consumption in the other state.

The use tax picks up where the sales tax leaves off. In this case, a resident of California buys goods over the internet from a store in Massachusetts for use in California, so Massachusetts does not require the seller to collect sales tax.

Instead, California requires that the buyer of the goods pay tax in California on the sale in Massachusetts in the form of a use tax. In other words, use tax is sales tax for someone who buys goods in one state and uses it in another state.

Many of the 10 largest online retailers now collect state sales tax online as states become more aggressive in tax collection. However, for those that do not, if there is a substantial nexus to the state, then use tax is probably owed to the state.

Although use tax is not the best enforced, several states have a separate line on their personal income tax returns for the reporting of use tax by individuals. In 2007, 22 states, including New York and California, have included a separate entry on the personal income tax form for the use tax. Practically, use tax is hard to enforce, though legally it is required to be paid by the end consumer of the goods on their personal income tax returns.

Cory, therefore, would owe use tax on his personal income tax return form for the purchase of the cufflinks that he bought and uses in California. Since sales and use taxes vary by county, Cory will have to pay the sales and use tax rate of San Francisco, or 9.5%. Cory will therefore owe $80.00 x 9.5% or $7.60 in use taxes for the purchase. He will report this on his California personal income tax return in the line that says use tax.

Oak, the seller, doesn’t owe sales tax on the cufflinks purchased, but instead passes the tax burden onto the consumer/purchaser here. Likewise, Etsy does not owe sales tax as it is not the seller the goods.

Oak may, however, owe corporate taxes. For a discussion of corporation taxes, see my post from last week. If an Etsy store is operating in more than one state, it may also need to calculate formulary apportionment.