We have been contacted by clients who are confused by the new District of Columbia 2013 Budget Support Act and its requirement that DC employers file an annual use tax return if they are not currently filing a sales tax return.  This article is intended to answer some of the questions your organization might have about the DC use tax.

What is a use tax?

Every jurisdiction that imposes a sales tax also imposes a “compensating use tax” for items bought out of state on which no sales tax was paid.  The tax is literally imposed on the “use” of an item that was purchased tax-free outside of the state but used within the state.  The use tax has its origins in the theory that every sale should be taxed by someone.  If you already paid sales tax to one state when the item was purchased, then you are not required to pay a use tax.  But if you bought the item tax-free, then your home jurisdiction wants to impose a use tax on it.  The use tax rate is the same as the sales tax rate which for DC is 6%.

Is this a new tax?

Surprisingly, no.  DC has imposed a use tax since 1949.  What is new is the enforcement method. DC has found a new way to enforce an existing tax that most residents and businesses ignore. Any internet sales or other purchases from vendors outside of DC where sales tax was not paid are supposed to be tracked, and then the taxpayer pays a compensating use tax to DC for those purchases.

There are two unusual facets to what DC is doing.  First, it is unusual to single out a class of taxpayers (employers) for enforcement efforts.  Second, this new requirement for employers to file annual use tax returns just went into effect and is retroactive to Oct. 1, 2011.  This will create an administrative hassle for businesses to review all of their purchases in the past 12 months (including services, which are taxable in some cases), identify those on which no tax was paid, and then calculate and remit the compensating use tax to DC. Once businesses know that use tax reporting is required, it is fairly easy with most accounting software now to track those expenditures on which a use tax should be paid.  But going back and recreating records for the past year will take time.

What is the reporting requirement?

Employers in the District who are required to file a DC employer withholding tax return must also now file an annual use tax return if they are not already required to collect and remit sales tax.  The initial return is due October 20, 2012, for the period October 1, 2011, through September 30, 2012.  Thereafter, a return must be filed on or before October 20th each year.  Any use taxes due must be remitted with the return.

What sales are subject to the use tax?

Unless your organization has an exemption certificate for paying DC sales and use tax (more on that later), transactions that are likely to be subject to the use tax would be any purchases made online or made to vendors outside of DC who do not charge either DC or some other state’s sales tax.

Aren’t internet sales tax-free?

No, not unless the customer has a sales and use tax exemption certificate.  Internet sales are subject to sales tax where there is “nexus” for taxation.  Internet sellers with a brick and mortar presence in a state are required to collect that state’s tax on their internet sales.  Some companies – like Best Buy and Barnes & Noble – tried setting up separate companies for their internet sales in an attempt to avoid nexus and sales tax collection obligations, but that did not work.  Even Amazon collects sales taxes in states where it has a physical presence (New York, Texas, and California).  

The 1998 Internet Tax Freedom Act prohibits federal, state and local governments from taxing internet access and from imposing discriminatory internet-only taxes such as taxes on bandwidth or emails.  It does not prohibit the imposition of sales and use taxes.

The Multistate Tax Commission has been trying for years to come up with uniform tax rates and definitions to implement a uniform sales tax nationally and make it easier to calculate and collect sales taxes.  The member states agree to the concept in principal, but they don’t agree when it means cutting their state’s rates or changing their definitions.  Without a simplified national standard, small retailers can spend more on the tax collection process than they collect and remit in sales taxes. 

If our organization is exempt from sales tax, do we have to pay the use tax?

DC Code § 47-2206 states that the use tax is not imposed on sales that are exempt from the sales tax.   However, the exemption from paying sales and use tax only applies to purchases that are made in furtherance of the organization’s tax-exempt purpose.  If an organization conducts an unrelated activity, it might have to comply with the use tax reporting requirement.

How do we know if our organization has to pay the use tax?

The Office of Tax and Revenue (OTR) was supposed to distribute to all affected businesses information about their new use tax accounts and reporting requirements by October 1, 2012.  Those employers who want to file electronically and who are not already registered for electronic filings will need to submit an electronic Taxpayer Service Center Business Registration Application to the OTR.  These applications are available online at www.taxpayerservicecenter.com.

Do all DC corporations have to pay use tax and file the report?

The requirement to pay use tax applies to everyone, but the new reporting obligation is only imposed on businesses that file employment tax returns with the District.

Are employers located outside of DC but with employees who are residents of DC required to file the report?

Yes.   Employers who are located outside of DC but who have employees residing in DC should report their use tax on Form 800A which can be filed electronically.  The use tax return must be filed even if there is no use tax due.