Have a Sales Tax Exemption? Don’t Forget Use Tax

When structuring a transaction to minimize sales tax, don’t forget to consider use tax, particularly when the state of purchase and the state of use are not the same, as illustrated by a recent Alabama Tax Tribunal ruling.

Taxpayers often think of sales and use taxes as one and the same. However, these are two distinct taxes with a difference set of rules. When you walk into a store, purchase a taxable item and pay the sales tax to the retailer, your tax obligations with respect to that purchase are not complete. Upon using the item purchased, you become subject to the state’s use tax. However, due to Constitutional principles, the use tax is required to provide a credit for sales tax paid, and since a state’s sales and use tax rates are equal, that credit eliminates any use tax liability. This example assumes that the state of purchase and the state of use are the same, which is often the case.

What happens if your purchase is exempt from state sales tax? Do you owe use tax since you do not receive a credit for sales tax paid? Again, assuming both the sale and subsequent use happen in the same state, the answer will almost always be “no,” since state use tax rules provide exemptions for property purchased that was exempt from that state’s sales tax. However, a completely different result occurs if the state of purchase and the state of use are not the same. For example, assume an individual New York resident takes a day trip to a New Jersey mall to take advantage of New Jersey’s sales/use tax exemption for clothing. Upon returning to New York, the individual will owe New York use tax – there is no credit because sales tax was not paid, and there is no exemption because clothing is not exempt in New York.

When taxpayers seek to minimize sales and use tax exposure, they often seek to arrange transactions so that the title or possession of property passes in a jurisdiction with low or no sales/use tax. However, that arrangement only addresses tax exposure in the state where the sale takes place, and a recent Alabama Tax Tribunal (the “Tribunal”) ruling reminds us taxpayers must also consider tax implications of the subsequent use of that purchased property. [1]

In that case, the Tribunal addressed the applicability of Alabama use tax on 81 trucks and 22 trailers purchased by the taxpayer, an Alabama-based trucking company. [2] The items were purchased from an Alabama dealer but were delivered to the taxpayer’s office in Mississippi, where the taxpayer paid a pro-rated Mississippi tax that was less than the Alabama tax that would have been paid if the transfer had occurred in Alabama. [3] The taxpayer’s drivers picked the items up and used them to haul goods in interstate commerce. Thirty-five of those trucks first picked up and hauled goods from an Alabama location; the others first did so outside of Alabama.

The state argued that all of the trucks and trailers were subject to Alabama use tax, but the Tribunal, relying on a prior Alabama case, held that only those trucks that were first used in Alabama were subject to the tax. [4] That court ruled that in order for the use tax to apply, (1) the items must be purchased at retail, (2) the purchaser must intend at the time of purchase to use, store or consume the items in Alabama and (3) the items must actually be first used, stored or consumed in Alabama. [5] The Tribunal concluded that only the 35 trucks that first picked up goods inside Alabama were subject to tax; the 46 trucks that first picked up goods outside of Alabama clearly failed the last requirement and were not subject to Alabama tax. Furthermore, since 35 out of 81 trucks were subject to Alabama use tax, the Tribunal applied the same percentage to the 22 trailers and determined that Alabama use tax was due on nine of the trailers.

It is worth noting that the second requirement above does not expressly require an intention at the time of purchase to first use, store or consume the items in Alabama. The taxpayer’s owner testified that, due to the fact that there is usually a significant delay between the time the trucks are ordered and when they are delivered, the company did not know specifically where they would first use a truck at the time it was ordered, but only that the truck would be used in Alabama or elsewhere depending on customer needs. The Tax Tribunal determined that such an intention to use (whether or not first use) the trucks in Alabama satisfied the second requirement, which would have resulted in all 81 trucks being subject to Alabama tax had prior case law not already established the “first use” requirement to impose use tax.

HA&W’s SALT group can assist taxpayers with understanding the sales and use tax implications of their transactions and recommend alternative structures to minimize potential exposure. We continue to monitor multi-state sales and use tax developments and will provide important updates in future issues of the newsletter.

Contact Jeff Glickman, partner-in-charge of HA&W’s SALT practice, at jeff.glickman@aprio.com for more information.

[1] Wright Transportation, Inc. v. Alabama DOR, Docket No. 14-806, July 9, 2015.

[2] Ala. Code § 40-23-61(c) imposes a two percent use tax on cars, trucks, trailers, etc.

[3] The Alabama DOR’s assessment did provide a credit against the Alabama use tax for the Mississippi tax paid by the taxpayer.

[4] Boyd Brothers Transportation, Inc. v. State Department of Revenue, 976 So.2d 471 (Ala. Civ. App. 2007)

[5] The Boyd Court was interpreting Ala. Admin. Code § 810-6-5-.25(1).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.