On May 6, 2013, the U.S. Senate passed the “Marketplace Fairness Act,” which allows states to collect sales tax on online purchases, whether or not the online retailer has a physical presence in the state. If this bill becomes law, it would change the structure that has been in place since the 1992 Supreme Court ruling in Quill v. North Dakota, 504 U.S. 298 (1992), which held that states could collect sales tax on online transactions only if they also had a physical presence in the state such as a warehouse, a store, or in some cases, an online affiliate.
The act would allow states to require all retailers with more than $1 million in sales to collect and remit sales taxes to state and local jurisdictions. Retailers would collect the tax at the point of purchase, code each sale by zip code, and remit the taxes to the eligible states and local municipalities. Although states would not be required to implement a tax on online sales, many would probably choose to do so as they look for ways to generate much-needed revenue to compensate for budget shortfalls. By taxing online sales, states could generate an estimated $23 billion a year in local and state sales taxes. Additionally, states are likely to receive pressure from local businesses seeking to level the playing fields for brick-and-mortar retailers who feel that they’re at an unfair advantage for having to charge tax on goods that customers can often buy tax-free online.
As Internet sales taxes become more common, one group likely to benefit is Internet affiliates. Prior to this bill, states such as Illinois sought to circumvent Quill by stating that Internet affiliates created the requisite “nexus” of a physical presence within a state. This caused online stores, including retailer behemoth Amazon, to cease using affiliates in any states where the affiliate would constitute a nexus. If a physical nexus is no longer required, affiliates would no longer be singled out and terminated due to their presence in any particular state.
Considerable support for a bill of this sort was likely inevitable. When online shopping was still new, online sales were minimal and most people did their shopping locally, meaning that the loss of state and local tax revenue was minimal. However, the dramatic increase in the choices available online, along with quick and free shipping, means that by some estimates up to 85 percent of Internet users do at least some shopping online. The corresponding decrease in patronage at local stores meant that states were missing out on taxes from those purchases. As a result, this bill would give states the opportunity to collect what they see as lost revenue.
That is not to say, however, that the bill will eventually become law. The bill faces stiff opposition in the Republican-controlled House, where some lawmakers see the bill as a tax increase. They face additional pressure from the Conservative Action Project, which has obtained more than 50 signatures from business and political leaders in a letter opposing the Marketplace Fairness Act on the premise that “retailers would be subject to laws imposed by states with which they have no direct connection, and in whose political system they have no voice. It is regulation without representation, allowing politicians to raise revenue, without fear of a public backlash.”
Currently, it appears that the bill is unlikely to become law. However, politicians will continue to raise revenue regardless. If the federal law does not pass, states will likely continue to issue broad and increasingly strained interpretations of what constitutes a “presence” in the state in order to collect revenues from online merchants.
An organization that represents online affiliates filed suit in federal court this month challenging the constitutionality of a new Illinois law targeted at collecting sales tax from Web retailers. Internet retail giant Amazon.com has threatened to cut off its marketing affiliates in Illinois in an effort to avoid paying the tax, and other companies are threatening similar action. We have previously examined the potential effects on affiliates of this type of state tax.
Internet retailers cite a 1992 Supreme Court decision, Quill Corporation v. North Dakota, which ruled that states could require only companies that had a physical presence within the state to act as a tax collector. Online retailers have used this ruling to justify the payment of taxes only in the few states in which they have a physical presence.
The suit claims that the Illinois law goes beyond the state’s power to regulate interstate commerce, since the state legislature seems to be taking the view that an online retailer, with no physical presence in the state, establishes a presence in Illinois merely by advertising on websites owned by Illinois affiliates.
With many states facing significant budget shortfalls, legislative momentum is growing throughout the country to tax Internet retailers. A University of Tennessee study has estimated that between 2007 and 2012, states will sustain over $52 billion in losses from uncollected taxes on e-commerce sales. Connecticut has already signed into law a state tax on online purchases earlier this month, and California lawmakers have passed a bill, now awaiting approval from the governor, that would force out-of state Internet retailers to collect taxes. Bills are pending in at least five other state legislatures.
These bills are all, in one way or another, efforts by the states to circumvent the court’s ruling in Quill. Last year, New York enacted a law that stated that the practice of paying commissions to marketing agents based in the state constituted a presence in the state. Amazon has challenged the law in court. Several other states, including Arkansas, Colorado, Illinois, North Carolina, and Rhode Island all followed by passing laws similar to New York’s.
With companies threatening to leave states that enact taxes and in some cases actually cutting all ties with the states, state legislatures are debating what to do. While some states are looking at enacting their own taxes, other states are considering different routes. In April, the South Carolina legislature defeated a law that would have provided a five-year sales tax exemption to Amazon in exchange for Amazon building a distribution center in the state. Amazon then cancelled its plans to build a distribution center in South Carolina.
The one action that would break the logjam would be federal legislation requiring states to collect sales tax on Internet retailers. Last summer a bill entitled the “Main Street Fairness Act,” (H.R. 5660) was introduced in Congress that would require all businesses to collect taxes in the state where the consumer resides. The bill did not make it out of committee, but some feel that the tides are shifting towards federal action. Sen. Dick Durbin (D. Ill.) has stated that he plans to reintroduce legislation to tax online retailers, calling the idea “overdue.” However, federal legislation could be complicated if voters perceive this as a new tax.
As states look to close the gap on budget shortfalls, there will be continued debate on the viability of taxing Internet retailers. Unless action occurs at the federal level, states will have to decide if it’s preferable to tax Internet retailers and risk losing their presence in the state or not to tax them in an attempt to maintain or grow their presence in the state.