Sales tax on large purchases, like a car, is crucial to factor into the price. Depending on where you live and the price of your car, sales tax can cost you thousands of dollars. But did you know there are legal ways to get out of paying sales tax on a used car? Let’s go over how sales tax affects your purchase and how to avoid paying sales tax on a used car.
If you’re looking to buy a car, a financial advisor can help you create a financial plan to reach your savings goals.
How Much Is Sales Tax on a Used Car?
Before we talk about how to avoid sales tax on a used car, let’s put sales tax into perspective. For example, say you buy a used car from a dealership in Los Angeles. The used car sales tax is the state’s tax rate (7.25%) plus the city’s rate (2.25%), for a total of 9.5%. If you spend $20,000 on a used car, you’re paying $1,900 in sales tax.
However, if you buy a car in Michigan or Idaho, they both have a flat state rate of 6%. $20,000 on a car there results in $1,200 sales tax.
How to Avoid Paying Sales Tax on a Used Car Legally
There are a few ways to avoid sales tax on cars. You may qualify for an exemption if it’s a farm vehicle or it’s used for a church. You also may be able to get a tax rebate for turning in your old car.
But there’s one way to legally avoid paying sales tax on a used car, without an exemption or rebate. That’s to buy it somewhere that doesn’t charge sales tax and have it registered there. Five states don’t charge sales tax on used cars:
- New Hampshire
- Montana (no car tax on used or new cars)
- Delaware (no car tax on used or new cars)
If you live in one of these states, you can easily avoid any legal gray areas by just buying the car.
Why Buying a Car in Another State Doesn’t Work
You may think you can avoid sales tax by just buying a car in a state that doesn’t charge sales tax, but it doesn’t work that way. Say you live in Vermont (6% sales tax) and drive to New Hampshire (0% sales tax) to buy a car. When you buy the car, you won’t pay the sales tax.
However, when you go back to Vermont and register your vehicle, your local DMV may notice you didn’t pay the tax and may charge you then. This can also happen if you buy the car from the owner in cash, or if you buy in a city with a lower rate than where you live. It all depends on how your locale collects revenue.
The Montana LLC Loophole
Now that we’ve covered how to avoid sales tax on a used car legally, let’s talk about a gray area. Especially when buying an expensive car or RV, you can save a lot of money by avoiding sales tax. One way people have tried is to set up a limited-liability corporation (LLC) in the only state that doesn’t charge sales tax on vehicles to resident LLCs: Montana. The vehicle is then bought by and registered to the LLC.
While this sounds like a pain, think of the savings. It’s relatively simple and cheap to set up an LLC (generally, around $1,000). If you’re buying a $300,000 motorhome and you live in Los Angeles, with a 9.5% sales tax, that’s an extra $28,500.
However, states are aware of this tax loophole and may still seek their payment. If they find out you’re driving the vehicle primarily in a state it’s not registered in, you can get in legal trouble. In fact, the California Highway Patrol has a form for citizens to report vehicles they suspect are driven by people trying to avoid taxes.
The problem with this loophole is that what’s legal in one state isn’t necessarily legal in another. It’s legal to set up an LLC in Montana to buy a car in Montana, but what you do with that car in your state is up to your state. If you need legal advice, talk to a lawyer.
Other Ways to Save on a Used Car
Maybe avoiding sales tax on a used car is unlikely for you. You can still save some money in other ways. Here are three:
- Negotiate a better price: Used cars have much more flexible pricing than new cars. You can look for cars that have been listed for a long time that sellers are more likely to be flexible on.
- Avoid dealerships: If you’re looking to save some money, you might have better luck with a private seller. Dealerships can get you to spend more with add-ons, whereas private sellers may just be looking to get a decent price for their cars.
- Come with cash: Cash is going to give you more negotiating power because it’s immediate. No financing is involved. And because of avoiding a car loan, you won’t be paying interest.
The simplest way to avoid paying sales tax on a used car is to live somewhere that doesn’t charge it. You can try to buy in another state or city, but it’s likely your state will come to collect. Instead, it’s better to find other ways to lower your used car costs.
Tax Planning Tips
- If you’re navigating the complexities of taxes, it helps to have a professional in your corner. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Budgeting can be extremely useful to improve your finances and help you save for big purchases like a car. SmartAsset’s budget calculator can help you create a budget to reach your financial goals.
Photo credit: ©iStock.com/chanakon laorob, ©iStock.com/praetorianphoto, ©iStock.com/gilaxia