Tariffs: Impact on State and Local Sales and Use Tax

Tariff use has surged following growing protectionism, which is reshaping global supply chains and increasing the cost of imported goods into the United States. Although tariffs are imposed at the federal level, their impact can cascade into state and local tax regimes in unexpected ways, particularly when it comes to calculating sales and use taxes. For instance, businesses that import goods are grappling with whether tariffs should be included in the taxable base for sales or use tax purposes, a question complicated by inconsistent state guidance and the structural limitations of indirect tax software.

Tariffs in a nutshell

A tariff is a tax imposed by the U.S. federal government on goods imported into the United States. It is considered a federal indirect tax because it applies to transactions and often is passed along to consumers through higher prices. The importer of record is the owner, purchaser, or consignee of the goods and the party that directly incurs the duty liability collected by U.S. Customs and Border Protection (CBP). The amount of duty owed generally depends on the tariff classification, value, and origin of the imported goods. Although the importer pays the tariff upfront, the cost is often included in the final price of the product sold.

State treatment of tariffs

In most states, sales tax is calculated based on the total sales price of a product, often referred to as gross receipts or gross proceeds of sales. This amount can include freight, handling, federal and state excise taxes, and other charges.

Crowe observation

How states treat tariffs for sales and use tax purposes can vary depending on the specific facts and circumstances, especially when it comes to determining what is included in gross receipts.

For example, for sales and use tax purposes, California defines gross receipts as the total amount received from the retail sale, lease, or rental of tangible personal property, valued in money, without deductions for costs such as materials, labor, transportation, or certain federal excise taxes.

Additionally, the importer of record can have an impact on whether the tariff is included within the amount subject to tax. When a seller is the importer of record and includes the tariff as a separate charge to its customer, whether the tariff is included in the amount subject to tax is dependent on whether the state provides a deduction for this charge. Conversely, when the buyer is the importer of record and pays the tariff to CBP, the amount subject to use tax generally will not include the import duty.

California regulations, for instance, provide that the determination of whether a tariff is included in the sales or use tax base is determined by the person who pays the tariff. If the seller is the importer of record and passes the tariff cost to the customer, the tariff is part of the seller’s taxable sale price, and, therefore, subject to sales tax. However, if the customer is the importer of record, the tariff is considered a cost incurred by the buyer and is not subject to sales tax. Illinois and Washington recently took a similar approach. While most states have not specifically addressed the tariff issue, it is anticipated that most will take a similar position.

Indirect tax software and tariffs

Tax departments should review and analyze their indirect tax software system to determine the correct tariff taxability. When a sale includes both taxable and nontaxable goods, the taxability of any associated tariff charges generally follows the taxability of the underlying items being sold. For instance, if a tariff is passed through to the buyer in connection with medical supplies not subject to sales tax, the tariff amount typically also would be nontaxable. Conversely, if the tariff relates to the sale of taxable items, such as furniture, the tariff is included taxable gross receipts. In mixed transactions with both taxable and nontaxable goods, the proper allocation of the tariffs can become complicated, particularly when the amount of the tariff on each item is not clearly identified on the invoice.

Managing the taxability of tariffs when using sales tax software can be a challenge and adds another layer of complexity for tax departments. Most tax engines require customized logic or manual configuration to correctly determine the taxability of tariff charges based on product taxability. Careful review and testing of the available tax categories within indirect tax software is critical to determine if standard mapping logic within the software is sufficient or if custom rules might need to be added to the software as part of the solution design.

Looking ahead

Although imposed at the federal level, tariffs can directly affect the calculation of sales and use taxes depending on how they are passed through to customers and who is legally responsible for their payment. Whether tariffs are taxable often hinges on invoice presentation, the taxability of the underlying goods, and the jurisdiction’s specific rules. States differ in their treatment of tariffs, with California and other states focusing on the identity of the importer of record as a determining factor.

For businesses, especially those operating across multiple states or selling mixed taxable and nontaxable products, these nuances create compliance challenges for sales and use tax that should be addressed proactively. Testing and proper configuration of indirect tax software for tariffs is critical for accurately computing tax. With heightened state sales and use tax audit scrutiny and increasing tariff exposure, companies should consult with tax advisers regarding their sales and use tax obligations, maintain clear documentation, and implement software logic to manage tariff-related sales and use tax risks effectively.