Does a seller owe use tax on items it gives away with a purchase?

Why a free item raises a use tax question

A retailer buys inventory without tax because a sale for resale is not a retail sale. California defines a retail sale as "a sale for a purpose other than resale in the regular course of business" (Rev. and Tax. Code section 6007), and New York excludes from "retail sale" a sale "for resale as such or as a physical component part of tangible personal property" (N.Y. Tax Law section 1101(b)(4)(i)(A)). Use tax then reaches what the retailer does with the property instead of selling it. California's definition of use "does not include the sale of that property in the regular course of business" (Rev. and Tax. Code section 6009), and Massachusetts uses the same exception (G.L. c. 64I, section 1).

A free item tests that line. If it travels to the customer as part of a sale, the retailer resold it. If the retailer gave it away to draw the customer in, the retailer used it, and the answer usually surfaces on audit, because the item came out of inventory bought on a resale certificate. California's rule is typical: when a purchaser that gave a resale certificate "makes any use of the property other than retention, demonstration, or display while holding it for sale in the regular course of business," the use is taxable to that purchaser when the property is first used, and generally "the sales price of the property to him shall be the measure of the tax" (Rev. and Tax. Code section 6094(a)). The exposure is the seller's cost, not the item's retail value, but it accumulates across every unit given away during the audit period.

An example frames the rest. A kitchenware retailer packs a branded apron in the box with every stand mixer it sells, and the receipt lists the apron at no charge. The same retailer hands a tote bag to every visitor at an in-store cooking event, whether or not the visitor buys anything. The tote bag is a gift in every state discussed here. The apron is the hard case, and the states answer it differently.

California: a certain premium is sold, a gift is consumed

Regulation 1670 sorts promotional property into four categories. Gifts come first: "Persons who make gifts of property to others are the consumers of the property and the tax applies with respect to the sale of the property to such persons" (Cal. Code Regs., tit. 18, section 1670(a)). The event tote bag falls here. So does merchandise distributed without charge generally; an early annotation applies the rule to a person "distributing containers and matches without charge" (CDTFA Annotation 280.0540 (May 19, 1954)).

Premiums are treated the other way. "When a person delivers tangible personal property as a premium together with other merchandise sold, and the obtaining of the premium by the purchaser is certain and not dependent upon chance or skill, the transaction is a sale of both articles" (section 1670(c)). Tax applies to the gross receipts from the purchaser for the goods and the premium together. The apron packed with every mixer is that kind of premium: the buyer is certain to receive it, so the retailer resold it, may buy it for resale, and owes no use tax on it. An older annotation reaches the same result for a premium offered to former customers who reopen or add to an account by buying other merchandise within a set period, calling it a resale of the premium (CDTFA Annotation 280.0780 (May 19, 1954)).

The regulation adds a rule for premiums that accompany exempt goods. When "the premium is delivered along with a food product for human consumption or other exempt item," tax applies to the gross receipts from the sale of the premium, "which will be regarded as the cost of the premium to the retailer, in the absence of any evidence that the retailer is receiving a larger sum"; if sales or use tax was already paid measured by the retailer's purchase price, "no further tax is due" (section 1670(c)). A grocer that packs a toy with a box of cereal owes tax measured by the toy's cost even though the cereal is exempt. Prizes are the fourth category: an operator that awards prizes won through chance or skill is their consumer (section 1670(d)).

Two further points shape California audits. First, the place of use matters. The Department's annotation on promotional gifts concludes that property "shipped free of charge as a promotional gift" to an out-of-state customer is subject to California use tax, because the use occurs when the property is handed to the carrier in California; property sent from California inventory to the donor's own out-of-state location for use as a gift there is not (CDTFA Annotation 280.1165 (Oct. 6, 1993)). Second, where a purchase serves both resale and some other purpose, the California Supreme Court looks to "the primary intent of the purchaser or primary purpose of the purchase" (Kaiser Steel Corp. v. State Bd. of Equalization (1979) 24 Cal.3d 188). Kaiser Steel held that furnace materials later sold as slag were bought for a "purpose other than resale," and that the SBE's practice of apportioning tax where the purchaser proves what portion serves an exempt purpose did not apply because the taxpayer "did not have dual purposes for the quantities purchased." A retailer that buys one lot of aprons, some to pack with mixers and some to hand out at events, is in the apportionment position Kaiser Steel describes, and the records that separate the two uses decide how much of the lot is taxable.

Massachusetts: the promotional item rule and the integral component exception

Massachusetts begins from the opposite presumption. Its discount regulation provides that "where property is transferred from a vendor to a customer for no additional consideration, or for a nominal consideration, or for an amount substantially below cost, the property constitutes a promotional item for sales tax purposes, and the vendor is considered its consumer" (830 CMR 64H.1.4(1)). The vendor "must pay a sales or use tax based upon the amount the vendor paid for the item" and "may claim a credit for any tax collected from the retail customer." An item sold at 50 percent or less of the vendor's cost is presumed to be a promotional item, a presumption that clearance, going-out-of-business and similar sales can rebut. After Pixley v. Commissioner of Revenue, 102 Mass. App. Ct. 720 (2023), invalidated a later directive on bundled phones, the Department of Revenue confirmed that a carrier or retailer providing a phone for a nominal price owes tax on its wholesale price, with credit for tax collected on the nominal price (TIR 24-3 (May 7, 2024); Directive 94-2).

The coupon provision draws a narrower line. Where a vendor offers, on presentation of a coupon, "merchandise free of charge with the purchase of other merchandise, two items for the usual price of one, the sales price subject to tax is the amount the vendor charges the customer," while an item given "unconditionally free of charge upon presentation of a retailer's coupon" makes the vendor "generally considered the consumer of that item" (830 CMR 64H.1.4(2)(d)). The regulation does not say in terms whether the free item in a buy-one-get-one offer is resold or consumed.

Package pricing is the other path. Directive 94-3 (March 7, 1994) addresses taxable property combined with exempt property for one price, and treats a taxable item as a "give away," consumed by the party that combined the items, if "the price, marketing, value, and desirability of the tax exempt property remains substantially the same with or without the item." Its examples include a whistle in a cereal box. Letter Ruling 88-3 (Feb. 22, 1988) shows the contrasting case: a retailer offering a package of stove accessories with each stove for one dollar more than the stove price could buy the accessories for resale, because the package was sold and taxed on the price paid.

The Appellate Tax Board applied those authorities in McDonald's Restaurants of Massachusetts, Inc. v. Commissioner of Revenue, Docket No. C262528 (findings of fact and report promulgated April 22, 2005). The issue was "whether the Happy Meal Toys contained in Happy Meals were sold by MRM in the regular course of its business, or whether MRM consumed those toys." Applying its own earlier ruling that requiring the taxpayer to be "primarily engaged" in selling the item "improperly narrows" the phrase "regular course of business," the ATB looked to the "dominant purpose" of the particular transaction. On findings that every meal included one toy, that the meal's price exceeded the cost of every component including the toy, that the toys were advertised as the feature of the meal, and that sales tax was collected on the full meal price, the ATB concluded that each toy "was not merely used as an inducement to engage the customer in a nontaxable transaction, but was instead an integral part of the tangible personal property that was transferred to the customer and for which the customer was charged a sales tax on the total cost." The toys were "not 'give away' items" under Directive 94-3, and the ATB abated the full assessment. The taxpayer bore the burden of proof and met it.

New York and Tennessee: the giveaway is the seller's own purchase

New York's regulation, as the Department of Taxation and Finance has quoted it in its advisory opinions, provides that "[t]angible personal property which is purchased and given away without charge, for promotion or advertising purposes is not purchased for resale. It is a retail sale to the purchaser thereof, and is not a sale to the recipient of the property" (20 NYCRR 526.6(c)(4)(i), quoted in TSB-A-06(10)S (Mar. 9, 2006) and TSB-A-93(6)S (Jan. 7, 1993)). The same rule covers property bought for promotion "and sold for a minimal charge which does not reflect its true cost, or which is not ordinarily sold by that person in the operation of his business," and a resale certificate may not be used for either kind of purchase (20 NYCRR 526.6(c)(4)(ii), (iii), as quoted in TSB-A-93(6)S).

The Department's advisory opinions show how the rule meets a free item tied to a sale. In TSB-A-90(32)S (June 29, 1990), on facts close to the Massachusetts toy case, the Department concluded that a fast-food restaurant's premium toys were purchased "for use as advertising or promotional material" and that "their purchase is not one for resale," although the restaurant had to collect tax when a customer bought a toy alone. The Massachusetts ATB's report describes a later New York administrative determination that treated a restaurant franchisee's toys as sold, so the New York position on toys packaged into a taxable meal is less uniform than the 1990 opinion suggests. Advisory opinions bind the Department only on their own facts.

The documents carry weight in New York as well. In TSB-A-10(39)S (Sept. 14, 2010), a car dealer advertised free oil changes for life with vehicle purchases, and its invoices stated that the oil changes were included in the transaction. The Department concluded that the oil changes were provided "as part of the sale price of the vehicle," so the dealer's purchases of oil and filters for them could qualify for the resale exclusion; without those statements in the documents given to the buyer, the oil changes would be promotional giveaways. A retailer selling discounted phones in a package that earned service commissions was not selling at a "minimal charge," because the package as a whole was profitable (TSB-A-93(6)S). A shipping and handling charge alone does not turn a free trial product into a sale; the company owes tax on product withdrawn from inventory and distributed in New York unless the charge in substance covers the product's cost (TSB-A-06(10)S).

Tennessee states the consumer rule without a premium exception. "Items of tangible personal property which are withdrawn from a dealer's stock for which a resale certificate has been issued his supplier, or which are purchased for use as premiums or gifts, are subject to the Sales or Use Tax" (Tenn. Comp. R. & Regs. 1320-05-01-.49(1)). The rule does not distinguish a premium the buyer is certain to receive from a gift, though one letter ruling, binding only on its recipient, allowed resale treatment for a free product wrapped with a product the retailer had bought (Tenn. Dep't of Revenue Letter Ruling 03-03 (Feb. 19, 2003)).

Wisconsin's statutory answer, and the free of charge definition

Wisconsin resolved the question by statute. A person that provides a product not distinct and identifiable "because it is provided free of charge" is the consumer of that product and pays tax on its purchase price (Wis. Stat. section 77.52(21)(a)). The exception covers the ordinary promotion: a person that provides such a product "free of charge to a purchaser who must also purchase another product that is subject to the tax imposed under this subchapter from that person in the same transaction may purchase the product provided free of charge without tax, for resale" (section 77.52(21)(b), subject to a cross-referenced exception). The Department of Revenue's explanation shows the history: for sales from October 1, 2009 through August 31, 2011, a retailer was the consumer of items given free even with a taxable purchase, and 2011 Wisconsin Act 32 restored resale treatment effective September 1, 2011 (Wisconsin Tax Bulletin 174 (January 2012)). The condition matters: the required purchase must itself be taxable, so a free item that accompanies an exempt purchase leaves the retailer as consumer, a result close to California's food premium rule, which also measures the tax by the retailer's cost though it treats the transfer as a sale.

The phrase "provided free of charge" has a defined meaning in the bundled transaction statutes several states share. Washington's version excludes from distinct and identifiable products "[a] product provided free of charge with the required purchase of another product," and states that "[a] product is provided free of charge if the sales price of the product purchased does not vary depending on the inclusion of the product provided free of charge" (RCW 82.08.190(2)(b)). Wisconsin's statute keys its rule to its own definition (Wis. Stat. section 77.51(3pf)(b)). The definition removes the free item from bundled transaction analysis; in Wisconsin, section 77.52(21) then decides who owes tax on it. The library's article on the true object test covers bundled transaction pricing more generally.

What decides the hard cases

Across these authorities, four facts recur.

• Certainty. An item every buyer of the qualifying product receives looks like part of the sale; an item handed to anyone who walks in, or awarded by chance, is a gift or prize. California's regulation turns expressly on certainty, and Wisconsin's statute on a required taxable purchase.
• Price structure. Whether the price of the required purchase includes the item, or would be the same without it, is the heart of the Massachusetts give-away test and of the "does not vary" definition. A package price that covers the cost of every component, with tax collected on that price, as in the Massachusetts toy case, supports resale treatment.
• Customer-facing documents. A receipt that lists the item as included, as in the New York oil change opinion, is evidence of a sale. Packaging marked not for resale and advertising that calls the item free point the other way. In the Massachusetts toy case the Commissioner relied on a "not for resale" label and on commercials that called the toys "available" rather than "sold," but the ATB read the label as more likely a restriction on the customer than on the seller and treated the advertising wording as "marketing semantics."
• Taxability of the required purchase. Where the main item is exempt, California taxes the premium measured by its cost, Wisconsin leaves the retailer as consumer, and Massachusetts asks whether the exempt item's price and appeal change without the taxable one.

Several questions remain open. No authority located for this article reconciles the Massachusetts regulation on property transferred "for no additional consideration" with the ATB's toy decision for an ordinary gift-with-purchase offer. New York's guidance points in more than one direction for items built into a taxable price.

Practice notes

The first question for any promotion is which category the item occupies in each state where it is handed over: gift, certain premium, prize, or component of a package. The answer is usually written before the promotion runs, in the receipt layout, the price list, the packaging and the advertising, which an auditor reads first. Resale treatment for a premium rests on a receipt that lists the item as included in the sale, evidence that the qualifying product's price reflects the item, and, where the item is also sold alone, that price list. For items given away, the sound practice is to track the cost of what leaves inventory by state and accrue use tax on it, since the measure is cost and the liability is the retailer's. One lot bought for both purposes calls for records separating the units packed with sales from the units given away. In an audit that treats every free item as consumed, the defense is factual, the taxpayer carries the burden of showing a sale in the regular course of business, and the record built during the promotion is the one that carries it. G&G State Tax Group provides use tax reviews of promotional and gift-with-purchase programs and representation in use tax assessments on promotional property alongside its state and local tax practice.