California tax collectors want their cut on out-of-state sales

California is targeting service businesses in its latest bid to collect more of the estimated $1.1 billion in taxes that go unpaid each year on out-of-state purchases.

California is taking the step, which it said will bring in an additional $631 million over the next three fiscal years, to bridge what is projected to be a widening gap between use taxes owed and those paid as both Internet sales and the service sector continue to grow.

“It’s $1 billion a year now, but the concern is it’s going to grow,” said Annette Nellen, an accounting and finance professor at San Jose State University who writes frequently about tax issues.

Under a law passed over the summer, the state Board of Equalization will send 184,000 letters by the end of the year to service businesses such as law firms, child care companies and Lasik eye surgery centers that have more than $100,000 a year in revenue.

The tax board is looking for out-of-state purchases, especially of expensive equipment, fixtures or software that might be subject to the levy, known as a “use tax.”

The notices order the companies to register with the tax board and, by April 15, report and pay tax owed for the last three years or prove why they are exempt.

If the tax board doesn’t hear back from a business, the agency will automatically register it in February.

“The idea is to give us a means to contact them where we didn’t have that before,” said Anita Gore, a tax board spokeswoman.

The agency, which used data from the Internal Revenue Service to compile the mailing list, administers the state sales and use tax program.

The state Franchise Tax Board, on the other hand, collects personal and corporate income taxes.

So far, the Board of Equalization has mailed 164,000 letters, received responses from 35,000 businesses and registration forms from 1,969, she said. Some 583 notices have been returned as undeliverable.

Companies with less than $100,000 in annual revenue still owe the tax but won’t be required to register, she said.

The board’s registration effort is likely to cull taxes mostly from smaller service businesses.

Many large businesses have sales and use tax specialists on staff to make sure they comply with the tax laws. And retailers are already required to be registered with the Board of Equalization.

There is a line to report use tax owed on the sales tax forms they have to file regularly.

Small-business owner Stephen M. Rousso, a certified public accountant in Sherman Oaks, received the registration letter from the tax board recently. He plans to register but said he doesn’t make many large out-of-state purchases.

He will owe tax on calendars he buys from a New York vendor once a year to give to his clients, he said.

“If I wasn’t reminded by this registration letter, I never would have thought to remit tax on it, but the tax is not going to be a large sum, maybe $50 or $60,” Rousso said.

Although he probably will be more apt to remind his clients of the use tax requirement now, other tax issues are more pressing for most of them, he said, such as paying payroll taxes, income taxes and the sales tax itself.

State use tax rates are the same as the sales tax rates, which vary by location. The basic state sales tax is 8.25%.

But many cities and counties add special district taxes on top of that. In Los Angeles County, for example, the sales and use tax rate in South Gate is 10.25%.

The use tax has always been difficult to collect. Unlike the sales tax, which is collected by sellers and handed over to the state on a regular basis, the use tax relies on buyers to keep track and pay up.

Although some get irate at the thought of paying use taxes on Internet purchases, the levy is hardly new.

Both the California sales tax and use tax have been on the books since the 1930s.

The use tax was added so out-of-state vendors not subject to California’s sales tax didn’t have a price advantage over in-state retailers who did have to pay the tax.

The use tax is also owed on almost any item ordered from a vendor out of the country and shipped to California for use or storage, such as a sophisticated microscope ordered from overseas to be used in a company’s California research lab.

The recent effort by the tax board, though, does not apply to out-of-state purchases of vehicles, vessels or aircraft, it said.

The state has to largely rely on the honor system to get the money because it has been unsuccessful in getting out-of-state vendors to collect the use tax for it.

It has also not been able to force online sellers, such as and, to collect sales tax on the grounds they have some sort of physical presence in the state through their affiliates. New York did, and challenges to that are now on appeal.

A California law added a use tax line to state income tax returns, but that expires this year. With or without the reminders, small businesses should keep track of their out-of-state purchases and pay the use tax they owe, tax experts say.

“The state is not looking to get something it’s not entitled to -- that use tax has been there, they are just trying to get what they are owed,” said Carol Kokinis-Graves, a senior state tax analyst at CCH Inc. in Chicago.