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Online Retailers May Soon Need to Collect Sales Tax on ALL Sales

The Marketplace Fairness Act, if signed into law, will empower state governments to require out-of-state online retailers and mail order companies to collect sales tax, or more specifically use tax, on interstate sales.

To date, online retailers have been required to collect sales tax only if the business has a presence (e.g. warehouse or store) in the same state in which the consumer resides. Currently, if an online retailer sells a product to a consumer living in a different state, the consumer is expected to pay the tax.

Many consumers usually do not pay use tax on their Internet purchases because they are unaware of the requirement or they know it is difficult for states to enforce.

Brick-and-mortar retailers say this gives online retailers a price advantage over local sellers. Online retailers say the fact that there are more than 7,500 tax jurisdictions in the U.S. places an unreasonable burden on Internet-based businesses.

Hence, lawmakers in Washington, D.C., have been debating for years about how to allow states to require online retailers to collect sales and use taxes.

Highlights of the Marketplace Fairness Act

The Marketplace Fairness Act, introduced November 9, 2011, is the third U.S. federal bill proposed this year dealing with sales tax collection and out-of-state retailers. It was sponsored by five democrats and five republicans.

The first two bills, the Main Street Fairness Act and Marketplace Equity Act stalled due to disagreements on requirements for tax code simplification and exemption criteria for smaller businesses.

If enacted, the Marketplace Fairness Act will:

  1. Give states the option to collect the sales taxes they are owed under current law from out-of-state businesses, rather than rely on consumers to pay those taxes to the states—the method of tax collection to which they are now restricted.
  2. Streamline the country’s more than 7,500 diverse sales tax jurisdictions and provide two options by which states could begin collecting sales taxes from online and catalog purchases.
  3. Exempt sellers who make less than $500,000 in total remote sales in the year preceding the sale to qualify for an exemption and not be required to collect the tax.

(Source: press release, U.S. Senator Michael Enzi (R-Wyo.).

Regarding the second item, streamlining the collection process, the bill offers states two methods of simplification. They can join the Streamlined Sales and Use Tax Agreement or they can adopt a set of simplification guidelines listed in the bill. Those options are discussed in more detail later in this post.

Why is Congress involved in a State Sales Tax Issue?

You might be wondering why the federal government is involved with state tax rules. The answer stems from two U.S. Supreme Court cases:

National Bellas Hess v. Illinois Department of Revenue (1967)

and

Quill v. North Dakota (1992)

In both cases, the top court reversed a lower court ruling allowing a state to require an out-of-state company to collect sales tax from customers. Essentially, the same reasons were given for both reversals:

  1. If a business does not have a physical presence (substantial nexus) in a state (e.g. warehouse, store, employees) it should not be required to collect taxes for that state.
  2. The administrative and record keeping complexities involved with variations in tax rates and allowable exemptions across many states would place an undue burden on interstate commerce. The Supreme Court justices said that, under the Constitution, Congress has the ultimate power to resolve this issue.

Potential Financial Impact of the Marketplace Fairness Act

According to Forrester, an independent research company, U.S. online retail sales grew 12.6% in 2010 to reach $176.2 billion. Moreover, their forecast calls for continued double-digit growth through 2015. While they identified several reasons for the trend, one factor is the increasing consumer familiarity with and preference for online shopping (and the cannibalization of store shopping).

Due to the abovementioned Supreme Court rulings, as retail sales continue to shift from brick-and-mortar to online, a portion of state revenue in the form of sales tax is essentially rendered uncollectible when the consumer and seller reside in different states. The question is how large is the revenue loss?

A study by the University of Tennessee published in April, 2009, attempted to answer that question. Under current law, it projects that annual sales tax losses arising from remote e-commerce could amount to $10.4 billion by 2012. (That is a net number after accounting for the small business exemption threshold of $500 million as specified in the Marketplace Fairness Act.)

The focus of the study was e-commerce, not all remote sales. Other types of remote commerce include mail order, telephone orders, and deliveries made across state lines by unregistered businesses. The authors point out that when considering all remote commerce, revenue implications were much larger than what they estimated in the report for e-commerce.

In response to the findings published by University of Tennessee, a similar analysis was funded by NetChoice, a coalition of trade associations and e-commerce businesses promoting convenience, choice, and commerce on the Internet. Members include AOL, eBay, and Overstock.com among others. NetChoice is opposed to the Marketplace Fairness Act.

The NetChoice study, conducted by Jeffrey Eisenach, projected that total uncollected state revenues for 2012 could amount to $4.7 billion, considerably less than the $10 billion estimate in the University of Tennessee analysis.

Contrary to the NetChoice opinion and beyond the University of Tennessee estimate, the National Conference of State Legislatures (NCSL) has reported that if the Marketplace Fairness Act becomes law, “in FY 2012 alone, states stand to gain $23.3 billion in revenue from sales taxes that currently exist but cannot be collected.” (Source: NCSL news release.)

Supporters and Opponents

Amazon.com, the world’s largest online retailer, endorsed the Marketplace Fairness Act in a press release stating:

“Amazon strongly supports enactment of the Enzi-Durbin-Alexander bill and will work with Congress, retailers, and the states to get this bi-partisan legislation passed,” said Paul Misener, Amazon vice president, global public policy. “It’s a win-win resolution – and as analysts have noted, Amazon offers customers the best prices with or without sales tax.”

This may have been a surprise to many because for years Amazon has opposed this type of legislation. According to Publishers Weekly, “while Amazon staunchly opposed state-by-state tax initiatives, it would back a national policy.” While the Marketplace Fairness Act is not a national requirement, it is a solution focused on standards and simplification.

But that apparently is not the only motivation for the Amazon turnaround. In an article published in the Los Angeles Times, Marc Lifsher writes “the company is now looking to profit – by hiring itself out as an Internet tax collector.” (See Amazon offers to serve as tax collector – for a price.)

On the other side of the debate, eBay, the largest online auction and shopping site, opposes the Marketplace Fairness Act. In a press release of their own they said:

“This is another Internet sales tax bill that fails to protect small business retailers using the Internet and will unbalance the playing field between giant retailers and small business competitors. It does not make sense to expand Internet sales tax burdens on small businesses at a time when we want entrepreneurs to create jobs and economic activity.”

The bill has wide support from brick-and-mortar retailers such as Home Depot, Wal-Mart, and Target. They believe online retailers (with minimal or no infrastructure in most tax jurisdictions) have an unfair advantage by not having to charge sales tax.

How will Online Retailers Collect and Remit Taxes with over 7,500 Jurisdictions in U.S.?

As cited above, the first time the U.S. Supreme Court struck down a state’s decision to require an out-of-state business to collect sales tax was over 40 years ago. It is interesting that their opinion still very relevant in today’s debate. To quote:

For if Illinois can impose such burdens, so can every other State, and so, indeed, can every municipality, every school district, and every other political subdivision throughout the Nation with power to impose sales and use taxes. The many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle National’s interstate business in a virtual welter of complicated obligations to local jurisdictions with no legitimate claim to impose a fair share of the cost…

That opinion was rendered in 1967, two years before ARPANET was created – the precursor of the Internet.

Today, more than four decades later, in a world in which small startups can compete with multinational companies due to the wonders of the World Wide Web, the logistics concern is still valid. Without standardized, scalable, quality software for collecting and remitting tax funds across many jurisdictions, along with developers committed to ongoing software maintenance and support, the Supreme Court opinion of 1967 will still apply. Time will tell.

States must Streamline and Simplify

In order to require non-exempt out-of-state retailers (including online retailers) to collect sales tax, the Marketplace Fairness Act stipulates that a state must first implement certain minimum simplification requirements. A state can achieve compliance by joining the Streamlined Sales and Use Tax Agreement (SSUTA) or by implementing Alternative Minimum Simplification Requirements which are specified in the bill.

The minimum simplification requirements enumerated in the bill are listed here but in some cases are abbreviated:

(1)     A single State-level agency to administer all sales and use tax laws and a single sales and use tax return for remote seller;

(2)     Provide a uniform sales and use tax base within a state;

(3)     Require remote sellers and providers to collect sales and use taxes pursuant to the applicable destination rate, which is the sum of the State rate and any applicable local jurisdiction rate;

(4)     Provide adequate software and services to remote sellers and providers that identifies the applicable destination rate for sales sourced to the State, and provide certification procedures to providers to make the software and services available to remote sellers and hold providers harmless for errors or omissions due to information provided by the State;

(5)     Hold remote sellers using a provider harmless for any errors and omissions by that provider;

(6)     Relieve remote sellers from liability (including any penalties or interest) to the State or locality for collection of the incorrect sales or use tax if it is the result of information provided by the State;

(7)     Provide remote sellers and providers with 30 days notice of a rate change.

Local rate changes may only be effective on the first day of a calendar quarter. A remote seller or provider will be held harmless for collecting tax at the immediately preceding effective rate during the 30-day period. Each state must provide updated rate information as part of the software and services required under the previous paragraph.

Regarding item 4 in the above list, six certified service providers are listed on the Streamlined Sales Tax (SST) website.

According to the SST FAQs page, at the time of this post, twenty-four states so far have passed the necessary conforming legislation to be eligible to require out-of-state retailers to collect sales tax. Nine states have introduced the conforming legislation. It seems reasonable to assume that more states will get on board if the Marketplace Fairness Act is enacted.

If that happens, it looks like there will be some real benefits for businesses to use the Streamlined Sales Tax Registration System. See the registration section of the SST website for more information. But remember, the Marketplace Fairness Act excludes businesses that generate $500,000 or less in out-of-state sales in the U.S. in the preceding calendar year.

Video: Introduction of Marketplace Fairness Act on the Senate Floor

U.S. Senator Lamar Alexander (R-Tenn.), a co-sponsor of the Marketplace Fairness Act says the bill would “close an online sales tax loophole.” He presents his case in this YouTube video.

 

What do you think? Should online retailers generating more than $500,000 in out-of-state sales be required to collect sales tax? Feel free to leave a comment below.

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