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U.S. State Returns - USE TAX PROCESSING NOTES
6/10/26
Note: the following notes are based on treatment of Use Tax in California and South Dakota. I believe that the procedures listed would apply to most states that impose a Use Tax.
What is Use Tax?
Use Tax is the term used to describe the “Sales Tax Equivalent” that applies when an organization purchases a taxable item/items from a vendor and the invoice for the purchase does not contain a charge for the appropriate sales tax. The amount of the Use Tax is typically the same amount as the Sales Tax that would have applied on the purchase if the vendor had included such tax on the invoice and is nearly always based on the total tax that would apply at the delivery point of the product. This total tax may be comprised of the following components of tax, depending on the state tax laws at the point of purchase.
• State sales tax.
• County sales tax.
• Municipal tax.
• District tax.
• Other applicable taxes imposed by state tax law.
Contact should be made to the appropriate state revenue or tax agency responsible for sales tax law to determine the appropriate taxes to be applied.
Why is sales tax not charged on some purchase invoices?
There are a variety of reasons that sales tax may not be charged on purchase invoices.
• The most common is that the vendor from whom the purchase is made is in a different state than the purchaser and the vendor does not charge the purchasing state sales tax for some reason. This is quite common with internet purchases, as current law excludes such sales when the annual sales volume is under a specific amount. The most common amount is $100,000 annually, but this should be verified with the state agency in the state where the purchaser is located.
• Another reason is that when the vendor purchases both taxable and non-taxable items from the vendor and has provided the vendor with a “resale” certificate. Unless the purchaser specifically tells the vendor that the purchase IS taxable, it is most likely that the sales tax will not be charged because of the tax-exempt coding in the vendor’s software system.
• Sometimes in-state vendors assume that non-profit organizations are “tax exempt” from sales tax when that is not the case. In fact, many such software documentations, including QuickBooks (Online and Desktop) and Xero and others incorrectly make a blank statement that non-profits are exempt from sales tax, which is NOT correct. While 501(c)(3) and (c)(6) organizations are exempt from income tax, they are most generally NOT exempt from sales tax. When this happens, it is necessary to accrue Use Tax on the invoiced amount, AND the in-state vendor should be contacted and advised to charge tax on future invoices.
• Some small local vendors may erroneously believe they are exempt from charging sales tax, or they simply refuse to do so. While you must accrue and pay Use Tax on such purchases, you may want to consider using alternate vendors in the future unless the vendor is the only source of the items purchased. Frequently, these small vendors are the same ones that assume non-profits are exempt from all tax, not just income tax.
 
Process for accruing and payment of Use Tax:
The following steps are needed to accrue and pay Use Tax.
1. Use Tax is typically paid at the same time and in the same form as the state sales tax return. The information typically required on the return is as follows:
a. The total amount of invoice purchase for taxable items delivered to the purchase location, and
b. The total amount of sales tax that should have applied for the taxable purchase.
2. This would require a General Ledger liability account in the Chart of Accounts. This would typically be in the same numerical sequence and located in the same section as the Sales Tax Liability.
3. Use Tax would be composed of the same sales tax components as the Sales Tax that would apply in the location of the purchaser. This may include the state sales tax, a county tax if applicable, a municipal tax if applicable, and all district taxes if applicable.
a. Ideally the software system should allow for the purchase total and the applicable sales tax component amounts for each of the components. These components may all post to the Sales Tax Liability GL account even though they are first listed under a Use Tax total in the first portion of the Sales Tax return.
b. If the software does not allow for the component portions of the tax, it would be calculated as the return is prepared.
4. If the software system used by the company does not allow for the component portions to be identified separately and does not provide for a way to capture Use Tax purchases, it will require manual effort to capture the appropriate purchase and component value totals.
Note: This should be a consideration when reviewing software systems for use in the organization. Many software systems state that they manage Sales Tax Reporting but do not include any software to address Use Tax Purchases. If their software systems also claim to “automatically” file the organization sales tax returns, this would result in incorrect sales tax filings. Organizations using such systems should NOT allow automatic filing of sales tax returns but instead realize that they must manually complete such returns to appropriately include Use Tax purchase data.
5. When making a payment of sales and use tax for the sales tax return, you will need to …
a. If you created and posted to a Use Tax Liability account to track Use Tax totals separately, you will need to do one of the following when paying the sales tax return:
i. When making the payment, you will need to post the appropriate amounts to both the Sales Tax Liability and the Use Tax Liability accounts, OR
ii. You will need to make a transfer of the Use Tax Liability portion of the payment from the Use Tax Liability into the Sales Tax Liability and then record the entire payment as offset to the Sales Tax Liability account.
iii. Either is correct, the choice would be what level of tracking your organization wishes to do for Use Tax.
6. Use Tax is normally not a frequent or large dollar item but is required to be reported on by states that impose a Sales Tax, so it is something that needs to be addressed. During sales tax audits, they will always search for invoices that do not contain sales tax and dig deeper into finding out whether Use Tax was accrued and paid. Penalties and Interest will apply if Use Tax is ignored.
 
Process to enter the invoice to capture Use Tax Payable:
When an invoice is received for a taxable purchase (typically an expense or fixed asset item(s)) but does not include a charge for the sales tax on the purchase, use the following workaround. This assumes that you have created a liability account for Use Tax Payable.
For the example presented, assume that the item purchased is $100, and the aggregate sales tax is 7%. Further assume that the taxable invoiced amount for the period is $5000.
1. Enter the invoice as follows:
a. The credit to Accounts Payable is $100.00, the amount of the invoice.
b. The debit to the expense or fixed asset account is $107.00
c. An credit of $7 is made to the Use Tax Payable GL account.
d. Credits = $100 + $7=$107.00 Debits = $107.00
2. When the sales tax return is due to be filed & paid to the state, we would include $100 as the “Purchases subject to Use Tax”, which is normally then added to the total taxable invoice amount. Example: $5000 + 100 = $5100.
3. Tax would calculate at $5100 x .07 = $357.00
4. Thus, the $7 accrued for Use Tax is included in the total owed to the state.
5. In this example, a manual journal entry would be made to transfer the $7 from the Use Tax Payable account into the Sales Tax Payable account to allow the full liability to the state to be paid from the Sales Tax Payable account.