Use Tax

Your company bought $340,000 of software licenses from an out-of-state vendor last year. No sales tax was charged on any of the invoices. Your state tax advisor flagged the purchases as likely subject to use tax, meaning your company owes the equivalent of sales tax on them, self-assessed, even though the vendor never collected it. Most finance teams don't track this exposure until it comes up in an audit. Use tax is a self-assessed tax imposed by states on purchases of taxable goods and services where the seller did not collect sales tax at the point of sale. It is the mirror image of sales tax: when you buy something taxable and no sales tax is collected (because the seller is not registered in your state, or because the purchase was made online or out of state), you are generally required to calculate and remit use tax directly to your state tax authority. The rate is identical to the sales tax rate that would have applied if sales tax had been collected. Use tax exists to stop sales tax avoidance through out-of-state purchasing; without it, buyers could buy from out-of-state vendors to avoid the tax that in-state purchases would carry. For businesses with significant out-of-state or online purchasing (software subscriptions, cloud services, equipment, professional services), untracked use tax exposure is one of the most common audit findings, precisely because it depends on the buyer self-assessing instead of the seller collecting.

How use tax works

Use tax applies when three conditions are met: the purchase is of a type that would be subject to sales tax if bought in-state; the seller did not collect sales tax (because they lacked nexus in your state, or the transaction was incorrectly coded as exempt); and the item is used, consumed, or stored in your state. When all three apply, the buyer must self-assess and remit use tax at the applicable state and local rate for the buyer's location. The obligation is automatic. No invoice, state notice, or collection mechanism triggers it; it arises simply because taxable property or a taxable service was bought without sales tax being collected. For software and SaaS, whether use tax applies depends on whether the state taxes that type of software, and that varies a lot. A state that taxes SaaS (such as New York, Texas, or Pennsylvania) will expect use tax on cloud software subscriptions bought from out-of-state vendors who don't collect. A state that doesn't tax SaaS (such as California for most SaaS arrangements) would not impose use tax on the same purchases. Use tax also applies to tangible personal property: a company that buys office furniture from an out-of-state vendor who doesn't collect the state's sales tax owes use tax on that purchase. The same goes for equipment, supplies, and materials consumed in the business.

How to assess use tax liability

Use tax assessment starts with a review of purchases. Each vendor invoice for the period is checked for (1) whether the purchase type is taxable in the state; (2) whether the vendor collected sales tax; and (3) if not, whether use tax applies. Where the vendor correctly collected sales tax, the obligation is satisfied and no use tax is owed. Where the vendor is registered but collected the wrong rate, there may still be a use tax obligation for the difference. Where no tax was collected and the item is taxable, use tax is due at the full applicable rate. AP teams often do this by flagging invoices where the 'tax charged' field is zero or lower than expected and routing them for use tax review. The output is a use tax accrual: a balance sheet liability for use tax owed but not yet remitted. Many states allow use tax to be remitted periodically (monthly, quarterly, or annually) instead of per transaction. Some states have a separate use tax return; others let you report use tax on the sales tax return. States with voluntary disclosure programs let businesses come forward, report historical use tax liability (often with a limited lookback period of three or four years), and pay the tax with reduced or waived penalties, which costs far less than a full audit that can look back further.

How platforms handle it

Tax automation platforms can be configured to assess use tax in the AP workflow: when an invoice is entered and the system detects that no sales tax was charged on a purchase that appears taxable, the system calculates the use tax due and creates an accrual entry. This requires the AP system to pass product or expense category information to the tax engine (so it can determine taxability), the vendor's state of origin (so the system knows whether the vendor had nexus and should have collected), and the buyer's location (so the correct use tax rate is applied). The practical challenge is data quality: AP invoices often lack sufficient product description detail for the tax engine to make a reliable taxability determination, particularly for services and software. Categories coded as 'professional services' or 'software' are too broad for jurisdictions where taxability depends on the specific type of service or software. In practice, fully automated use tax accrual in AP works reliably for high-volume, well-categorized purchases (equipment, supplies) and requires manual review for lower-volume, high-value purchases (software licenses, consulting engagements) where the taxability determination requires more context than the invoice provides.

Questions to evaluate your use tax exposure and process

• Do you have a use tax accrual process (a systematic review of vendor invoices for potential use tax liability), or is use tax only addressed when an audit forces it?
• Are your AP expense categories detailed enough to allow a taxability determination, or are most vendor invoices coded to generic categories that mask the use tax analysis?
• Have you assessed the taxability of your major recurring software and SaaS subscriptions in your operating states, specifically whether those states impose use tax on cloud software?
• Do you have a regular remittance process for assessed use tax, or does the accrual accumulate without periodic settlement?
• Has your company ever gone through a voluntary disclosure process in any state? If not, has your tax advisor evaluated whether a voluntary disclosure program would make sense given your historical use tax exposure?
• Are purchases made on corporate cards reviewed for use tax liability, or does the review only cover invoices processed through AP?

Where use tax exposure accumulates undetected

The most common failure is assuming that no sales tax charged means no tax owed. That assumption is exactly what use tax is designed to defeat. A zero tax line on a vendor invoice is a signal to review, not confirmation of an exemption. For software and cloud services in particular, a vendor's decision not to collect may reflect its own nexus analysis rather than a finding that the purchase is exempt. If the vendor is wrong about its nexus, or the state later decides the vendor should have collected, the obligation to pay the use tax still falls on the buyer. The second consistent failure is not building a use tax accrual process for significant vendor purchases. Without a formal accrual, use tax exposure sits unbooked and unremitted. When a state audit covers a three-year period and finds none of the use tax owed was ever assessed or paid, the assessment includes the full tax, interest at the statutory rate for the whole period, and failure-to-pay penalties. On a large software licensing portfolio, the retroactive interest alone can materially exceed what a proactive annual accrual and remittance process would have cost.

Use tax against sales tax

Same rate, different payer. Sales tax is collected by the seller at the point of sale and remitted by them. Use tax is self-assessed and remitted by the buyer when the seller did not collect, typically on out-of-state or online purchases and on inventory withdrawn for internal use. The exposure is usually found in audit, because accrued use tax requires the buyer to flag its own untaxed purchases.

Comparing tax engines

Tax engines separate on jurisdiction depth and on whether registration, filing and certificate storage are included or sold separately. Once use tax is settled as a requirement, read the Tax Software category guide for how the market splits, then weigh the Avalara profile against the Vertex profile on that requirement rather than on the feature list. Our Avalara pricing breakdown records what the vendor publishes and what is quote-based. The Avalara against Vertex comparison sets two of them side by side on the same criteria. Before you book demos, put your own numbers through the tax compliance ROI calculator so the business case is written down before a vendor writes it for you.

Frequently asked questions

Related terms

Indirect Tax, Sales Tax Compliance, and Sales Tax Nexus come up in the same workflow as use tax, and the rest of the tax engines cluster is indexed in the finance operations glossary.