By David Hall, Vice President Sales and Marketing, Cutting-Edge Solutions
The Internet takes tax-free shopping to a new level. Shopping without that added out-of-pocket expense has become an effective motivator to influence customers away from their favorite brick-and-mortar music stores. But contrary to what you might hear, some Internet sales are subject to sales tax. Even when a Web site doesn’t collect sales tax, consumers might actually be responsible for remitting any unpaid sales tax for their online purchases directly to their state.
If an online retailer has a physical presence, such as a store, business office or warehouse, in a particular state, it must collect sales tax from customers in that state. No physical presence, no taxes. This rule is derived from a 1992 Supreme Court decision, which held that mail-order merchants did not need to collect sales taxes for sales into states where they did not have a physical presence.
For example, let’s say “Dan” is passionate about unusual ukuleles, but can’t find them in New York, his home state. So, he orders his ukuleles and supplies online from a music retailer in Wisconsin that specializes in ukuleles and unique acoustic instruments. The retailer has all its facilities in Wisconsin and collects and processes payments there. In this scenario, Dan does not have to pay state sales tax (neither New York nor Wisconsin) for his purchases.
A few months later, the retailer’s business is booming and it decides to open a second location in New York. Dan continues to order his instruments and accessories from the headquarters in Wisconsin, but, because of this new physical location, he must now pay New York sales tax.
As Internet sales initially took their foothold in the retail landscape, mass merchants with local stores sold their products tax-free over the Internet, essentially skirting the tax-collection issue. Today, influence from “support your local business” initiatives, lawsuits by several states and pressure from the Streamlined Sales Tax Project (a group comprised of states that support the Streamlined Sales & Use Tax Agreement) have ended that practice.
When consumers are required to pay tax directly to the state, it is referred to as “use” tax rather than sales tax. The only difference between use tax and sales tax is who—the seller or the buyer—pays the money to the state. Ideally, use taxes are intended to make sure that the state collects revenue on every taxable item that is purchased within its jurisdiction. Unfortunately, collecting use tax on smaller purchases is very difficult and is causing states to focus on the greater potential for revenue from sales of big-ticket items that require licenses, such as automobiles, motorcycles and boats.
Sounds messy, right? That might be changing. With so many states looking to scrape together as many tax dollars as they can, many are reevaluating their attitude toward collecting use taxes. For example, New York State has added a line to income tax returns requiring all residents to calculate how much they should pay on Internet, mail order or out-of-state purchases. California has begun a campaign to educate taxpayers on what’s owed, as well.
Now that the stage is set and more states are taking action to collect tax, the real question is where this will lead. Simplifying Sales Tax initiatives are popping up all around the country. For decades, state governments have struggled with the challenges of collecting sales and use taxes on purchases from out-of-state retailers. It began with mail-order catalogs and telephone sales, and is snowballing with online transactions. And, proposals to simplify sales tax systems are not really all that simple.
The Streamlined Sales Tax Project (SSTP) was started as a result of a 1992 U.S. Supreme Court ruling for a catalog business that sold office supplies, long before eCommerce had arrived. This ruling affirmed a 1967 decision that state sales tax systems are so complex that no retailer, whether storefront, catalog or online, can be required to collect sales tax for states in which they have no physical presence. As a result, states had to either dramatically simplify their sales tax systems or persuade Congress to force these types of retailers to collect sales taxes, regardless of how complicated it would be.
States started asking for more taxing authority as eCommerce sales began ramping up in the ’90s, and then pushed harder as the U.S. economy slowed and spending outpaced revenues. State tax officials blamed eCommerce for their fiscal problems and warned of huge future tax losses based on eCommerce growth forecasts.
Unfortunately, much of their information is based purely on speculation. Certain states, big-box retailers and other proponents of the SSTP continue to use revenue-loss estimates that just don’t add up. Some cite a 2004 University of Tennessee study that blames eCommerce for more than $22 billion in lost sales tax during 2005. This figure was half of what the same researchers had forecast in a 2001 study. Their lower estimate recognized greater use-tax compliance by businesses and the growing trend where big chains like Wal-Mart and Home Depot already collect sales tax on their online sales.
Surprisingly, the $22 billion estimate from the University of Tennessee is four times greater than what the loss possibly could be, according to retail surveys by the U.S. Department of Commerce. Census Bureau surveys of 11,000 retailers show total retail eCommerce in 2005 at $70 billion. This would generate approximately $5 billion in total sales tax. Even if none of this sales tax was collected, the loss would be just one-quarter of the university’s estimates.
Confusion is a powerful weapon, and overly aggressive estimates from a variety of sources are only complicating whether Congress should enact the provisions of the SSTP. Some large, multi-channel retailers are already required to collect taxes for their online sales. However, it would take a congressional mandate to force all Internet retailers to collect sales taxes and remit them to the respective states. Lobbyists are pressuring lawmakers in Washington for this new level of taxation, citing the progress of the SSTP and the urgency of states with financial hardships.
Where does this all lead? In my opinion, the SSTP would generate revenue that’s just a fraction of these tax estimates. Add to this the overwhelming compliance costs, especially for independent retailers who need to sell online to compete, and we will all be faced with higher prices.
There are other ideas being presented, including helping states to continue their own efforts to simplify their individual tax codes. There should be more focus on ways to enforce tax compliance by abusers and ensure that those who are liable now under the current tax laws are compliant. Please contact your state legislators and tell them only to support tax changes that minimize the extra accounting burdens this current path is leading toward.David Hall is Vice President – Sales & Marketing for Cutting-Edge Solutions. Its eCommerce products, The Generator and Pro-Active Websites, are utilized by leading vendors and retailers within the music products industry. Contact him at firstname.lastname@example.org.