Use tax scofflaws abound
By Kay Bell • Bankrate.com

Are you one of millions of shoppers regularly cheating your state treasury out of tax revenue? Probably. And it's even more likely that you don't even realize you're breaking the law.

If you live in a state that collects a sales tax, and most do, you're probably flouting the companion use tax. Its name says it all. Basically, it's a levy owed by consumers on items they bought elsewhere but will use in their home state.

Collection of use taxes has increasingly frustrated state tax collectors with the burgeoning of Internet shopping. True, some Internet (and catalog) merchants now collect tax if their companies have a location in the purchaser's state. But that's a big "if" depriving many state coffers.

A handful of states have passed laws trying to strengthen an out-of-area company's connection to a state for tax purposes. Others have opted to go directly to the consumer by beefing up use-tax collection methods on state income tax forms. And a national consortium of state tax officials continue to work on the Streamlined Sales Tax Project, an effort to craft a workable sales and use tax solution for cross-border sales transactions.

But until an agreement is reached, cash-strapped state treasurers will continue to search for piecemeal ways to collect on this long-standing, but ignored, tax.

Old laws, long misunderstood
Use taxes have been around for decades. But just because a law has been on the books doesn't mean that state tax departments have taken full advantage of it.

Collection of use taxes has been spotty at best, hampered by taxpayer misunderstanding of the charge, administrative difficulties in tracking out-of-state purchases, and, more recently, public misconceptions about taxes and the Internet.

Many consumers think there is a federal law prohibiting collection of taxes on Internet transactions. There isn't. The law only stops the taxation of the Internet service itself, meaning the company you use to connect to the Internet cannot add taxes to the connection fee you're charged.

It's a different story when it comes to retail enterprises on the World Wide Web. These vendors, like their catalog-selling colleagues, must collect sales tax from customers in areas where the companies have an actual outlet.

And then there are state use taxes. Every state that collects sales taxes also has a use tax, basically a sales tax on merchandise purchased beyond a state's sales tax boundaries. Consumers are required to pay use taxes, created in the 1930s, to their home state treasury on any merchandise they will use within the state, but which was bought sales-tax free from an out-of-state supplier. If the consumer paid a sales tax where he or she purchased it, they don't have to pay a use tax.

Revenue officials admit that enforcement efforts are virtually nonexistent, and that they rely heavily on community notification and voluntary tax compliance. If all goes according to this plan, once taxpayers learn of the use tax, they will get the proper form, fill it out with out-of-state purchase details and submit it along with the use-tax payment to their home state tax department.

But whether because of honest ignorance or willful disregard of use-tax laws, that approach generally has been a failure. Florida, for example, found that despite efforts a couple of years ago to get the word out about its use tax, only 1,813 people -- mostly Florida Department of Revenue employees -- complied with the law.

As the new millennium rolled in, several state tax departments took a more formal approach to use taxes. These more aggressive use-tax collectors generally have a state income tax (unlike Florida) and they used that familiar filing process to ask for use tax money right on the return form.

Asking directly for the money
Alabama, Kentucky, Michigan, North Carolina, Ohio and Virginia were among the forefront of states that began to specifically ask their residents for tax money on out-of-state purchases. The states' individual income tax return packages also provided worksheets and samples to help filers fulfill their tax responsibilities.

To further encourage taxpayers to fill out this line on their tax return, the income tax instruction booklets elaborate on each state's use tax -- its history, how it works and where the tax money goes. State officials hope that this extra information, along with the imprimatur of a formal tax return collection mechanism, will help them start recovering lost use taxes.

Is it working? In some cases, yes.

North Carolina reported that when it added the return line in 2000, it produced $4.9 million, dwarfing the mere $125,000 in use taxes collected the prior year.

Michigan, too, saw its use tax collection shoot up. Michigan's treasurer reported more than 62,000 people declared and paid use taxes in 2000, up from only 2,500 the year before, netting the state an extra $2 million.

But tax officials say there still is a lot of misunderstanding about the law -- and a lot more use tax money to be collected. And some states think that a less-aggressive approach may be a better way to go.

A few years ago, for example, Virginia eased away from hard-hitting collection of use taxes via state income tax returns. An early collector of the tax via state returns, Virginia redesigned its forms to make the use-tax request less obvious, reminding taxpayers of the tax only if they have to fill out Schedule ADJ to complete their state income tax return.

Only time will tell if this simplified form is as effective in bringing in the cash. If not, the state will have to decide whether what it earns in taxpayer goodwill is worth the cost in lost use tax collections.

And if other state tax collectors see their colleagues cashing in on use-tax lines added to income tax returns, taxpayers in other states can expect to see similar changes to their tax forms in coming years.

To find out how much of a bite your state takes out of your purchasing dollar, check this table of state and local tax rates.

-- Updated May 9, 2003