Compensating tax, usually called use tax, is a state tax you owe when you buy something without paying sales tax and then use, store, or consume it in a state that would have taxed the purchase at a local store. The rate matches your state’s sales tax rate, so you never pay more than a local buyer would have paid. The classic trigger is an out-of-state purchase the seller didn’t tax: buy a $2,000 laptop from a retailer in a no-tax state, use it at home in a state with a 6% rate, and you owe $120.
What the Tax Covers
The purpose is to keep sales tax from becoming optional based on where the seller happens to sit. A taxable event occurs any time the seller didn’t collect your state’s sales tax at the point of sale, whether because the seller had no obligation to collect (a private party selling you a used boat) or the seller was located in a state with no sales tax. Storing the goods in your state counts as “use” even if you haven’t opened the box. So does exercising any ownership rights over the property within the state’s borders.
The tax applies to tangible personal property: furniture, electronics, vehicles, equipment. Many states also reach certain services and digital products, but coverage varies widely from state to state.
Why Most Online Orders No Longer Trigger It
Before 2018, compensating tax was a much bigger deal for ordinary shoppers. Online retailers generally didn’t collect sales tax unless they had a physical presence in your state, so nearly every out-of-state online order left a use tax bill in your lap. Most people either didn’t know about the tax or ignored it.
That changed with South Dakota v. Wayfair, Inc. (2018), in which the U.S. Supreme Court overruled the physical-presence rule and upheld a South Dakota law requiring out-of-state sellers to collect and remit sales tax if they delivered more than $100,000 of goods or services into the state, or completed 200 or more separate transactions there annually. By January 2023, every state with a sales tax had enacted its own economic nexus law on this model. Marketplace facilitator laws reinforced the shift by requiring platforms like Amazon, eBay, Etsy, and Walmart Marketplace to collect and remit tax for their third-party sellers.
The practical effect: most large online retailers now collect at checkout automatically, and the compensating tax obligation has disappeared for the majority of routine online purchases.
When You Still Owe It
Several common situations still leave you on the hook to report and pay use tax yourself:
- Private-party purchases: buying a car, boat, furniture, or equipment directly from another individual. No marketplace is involved and private sellers don’t collect tax.
- Small out-of-state sellers below your state’s economic nexus threshold, often $100,000 in annual sales, who have no obligation to collect.
- Out-of-country purchases. International sellers generally don’t collect U.S. state sales tax, whether you’re ordering online or bringing items home from a trip.
- In-person purchases in a no-tax state. Alaska, Delaware, Montana, New Hampshire, and Oregon don’t charge sales tax, so nothing is collected at the register, but you owe compensating tax when the item comes home.
- Business equipment, raw materials, and consulting services from vendors who didn’t collect tax. The dollar amounts tend to be large, which means the exposure is too.
Vehicles are the most heavily enforced category. Nearly every state collects use tax on out-of-state vehicle purchases at title transfer or registration, so there’s no practical way to avoid it. Buy a car in a no-tax state, register it at home, and your DMV will collect the compensating tax before issuing a title. States also cross-reference boat and aircraft registrations, and in some cases building permit records, to catch untaxed materials brought in from elsewhere.
Credits and Exemptions That Reduce What You Owe
The most important relief is the credit for tax already paid to another state. If you bought an item in a state with a 4% sales tax and your home state charges 6%, you owe compensating tax only on the 2% difference. If the other state’s rate was equal to or higher than yours, you owe nothing. The credit prevents the same purchase from being taxed twice.
Items bought for resale are exempt in every state with a sales tax, because the end customer will pay sales tax when the product is sold. Government agencies and qualifying nonprofits are generally exempt as well. Other exemptions tend to track what your state exempts from sales tax: groceries, prescription medications, and certain medical devices in many states, and manufacturing equipment and raw materials used directly in production in roughly 40 states. Claiming any exemption requires documentation, whether that’s a resale certificate, an exemption certificate, or proof of nonprofit status.
How to Report and Pay It
If You’re an Individual
Many states put a use tax line directly on the state income tax return. You estimate your untaxed purchases for the year and report the total on that line. Some states offer a lookup table based on adjusted gross income, letting you pay a flat estimated amount rather than tracking every receipt. If you had no significant untaxed purchases, enter zero; leaving the line blank may be treated differently than reporting zero in some states. In states without a use tax line on the income tax return, you file a standalone use tax return with the state revenue department, usually once a year.
If You Run a Business
Businesses generally report compensating tax on the same return they use for sales tax, filing monthly or quarterly based on volume. The return asks you to categorize purchases by type and identify the jurisdiction where the property is used or stored, because local rates vary within each state. Base state rates currently range from 2.9% to 7.25%, and combined state and local rates can run significantly higher once county and municipal surcharges are added.
Most state revenue departments offer electronic filing through an online portal, which reduces processing errors and produces an automatic confirmation. Payment options typically include ACH bank transfers, checks, and credit cards; credit card payments usually carry a convenience fee of about 2% to 2.5%, charged by the payment processor rather than the state.
Keep receipts, invoices, and shipping records for out-of-state purchases. They establish the purchase price (including shipping and handling, which is part of the taxable amount in many states), the transaction date, and the seller’s location. If you claimed a credit for tax paid to another state, keep proof of that payment too.
Penalties and Audit Exposure
State penalties for skipping compensating tax follow a common pattern: a percentage penalty on the unpaid tax plus interest that accrues from the original due date. Penalty rates across states generally run from 2% to 30% of the tax owed, and the percentage often climbs the longer a return goes unfiled. Interest typically accrues monthly or daily.
For businesses, the bigger risk is the audit lookback. Most states can audit three years of returns, but that stretches to six years or more if you significantly underreported. If you never filed a use tax return at all, many states impose no statute of limitations, meaning they can assess tax for the entire period you should have been filing. Common audit triggers include filing sales tax returns without ever reporting any use tax, large swings in reported liabilities, and audits of your suppliers that surface purchases you didn’t report.
For individual consumers, enforcement is lighter on small purchases but close to automatic on big-ticket items caught through registration systems.
Federal Deduction If You Itemize
Compensating use tax you paid to a state is deductible on Schedule A if you itemize, just like regular sales tax. The IRS allows a deduction for actual state and local general sales taxes, including use tax, as long as the rate matched the general sales tax rate. You choose between deducting state income tax or state sales and use tax, not both. In states with an income tax, the income tax deduction is usually larger; in states without one, the sales and use tax deduction can be worth claiming. The total deduction for state and local taxes combined is capped at $10,000 under current law.