Get ready for sales tax

A few years ago, when state coffers were flush with cash and online retail sales seemed headed for the stratosphere, state officials pushed the taxation of online sales as a fairness issue. “We figured if you had two identical people making identical purchases, but one buys downtown and the other buys online, someone is not paying their fair share of the cost of their government,” says Scott Peterson, director of the Business Tax Division in South Dakota’s Department of Revenue.

What a difference a few years and a sharply changed economy can make. Today, faced with mounting state budget deficits, the issue is no longer fairness—it’s the balancing of state budgets. “Back in March 2000 everyone had money and a positive budget balance, and some states were even giving money back to taxpayers. Now, this is one of our top issues, because sales tax is a huge portion of almost any state’s budget,” says Peterson, who co-chairs the Streamlined Sales Tax Project, a multi-state effort to lay the groundwork for the mandated collection of online sales taxes across state borders.

Perhaps no state illustrates the new push better than California. Two years ago, Gov. Gray Davis vetoed a bill that would have imposed sales taxes on online purchases. Now the proposal has a new life in the State Assembly and, facing a budget shortfall of $35 billion, Davis is looking more favorably upon the $1.75 billion that a sales tax on online purchases could bring in.

What happens in California could have a strong impact on building support for Internet taxes in other states. “It would cause a ripple effect throughout the country,” Peterson says.

Closing in

Peterson and other state officials say they are nearing their goal of forcing online retailers to collect and remit sales tax for most states from which they receive orders from customers—whether or not the retailers have a physical presence in those states, the current stipulation under which they’re supposed to collect sales tax. In February, Wal-Mart Stores Inc., Target Corp. and other major retailers agreed to start collecting sales taxes for purchases in 37 states and the District of Columbia in return for an amnesty on any back taxes that the retailers might owe.

The sales tax issue now has popped to the top of state lawmakers’ list of critical issues. Pointing out that two-thirds of states must cut their budgets by more than $25 billion in aggregate before the end of June to balance their fiscal 2003 spending plans—after having already cut $49 billion—the National Council of State Legislatures has ranked online tax among its Top 10 issues for this year, right up there with homeland security, education reform and health care issues. On top of that, the group says states are already facing a shortfall of $68.5 billion for fiscal year 2004.

The NCSL, noting that the University of Tennessee reports that states and municipalities lost an estimated $13.3 billion in 2001 — a loss projected to reach $45.2 billion in 2006 — in sales and use tax revenue due to online sales of products and services, is pressing for fast relief. “States have taken the lead in developing a blueprint for streamlining sales and use tax collection across the country, a move that would help local retailers stay competitive with online businesses,” the NCSL said in naming its Top 10 issues. Now it wants more action from the retail industry and the federal government, which must approve a multi-state tax collection plan before states can mandate tax collection across state borders. The University of Tennessee says its estimates of lost sales tax revenue are intended as a useful guide but will likely differ from actual numbers. “There’s a lot of approximation in these figures,” says Dr. Don Bruce, one of the study’s co-authors.

The Direct Marketing Association, contending the Tennessee study uses vastly inflated estimates of e-commerce activity, says states lost about $1.9 billion last year, not $13.3 billion. State officials say the DMA overlooks the actual growth of online activity.

For years, efforts to force online retailers to collect sales tax have lumbered along, facing steadfast resistance from pure-play online retailers, disorganization among states and a lack of wholehearted support from the federal government. Many opponents of online sales taxes contend that the tax would unduly stifle the development of a young industry that still accounts for only a tiny though growing percentage of overall U.S. retail sales. “Having to deal with multiple tax jurisdictions in each state would be onerous and expensive,” says Shannon Stowell, vice president of business development and co-founder of Altrec.com, a 4-year-old company that specializes in online sales of outdoor sports gear. “Online business is still struggling to get on its feet and is less than 4% of all retail.”

Consumers don’t care

Recent research indicates, however, that forced collection of sales tax may not harm retailers as much as they’ve expected. In a February report, “Sales Tax: Avoidance Is Imperative to Few Online Retailers and Ultimately Futile for All,” Jupiter Research reported that only 46% of online consumers it surveyed in November 2002 were aware that they could avoid sales tax by shopping online. And of that 46%, more than half don’t look for online retailers that don’t collect sales tax.

Some retailers have been collecting sales tax across multiple states without a problem. Williams-Sonoma Inc., for instance, has been collecting sales tax on web sales since it launched its first e-commerce web site in 1999, whether or not it has a physical presence in customers’ states. Another e-retailer, which uses special software to organize different state and local tax rates, has been collecting sales tax on catalog sales since 1989 and web sales after that for states where it has a physical presence. “We haven’t noticed an impact on sales,” says the retailer’s vice president of e-commerce.

To get widespread participation among retailers, state officials have long sought a federal mandate, only to be set back by the U.S. Supreme Court. In the 1990s, the Court re-affirmed a 1960s’ ruling that states could not force collection of sales tax in any state where a remote business had no physical presence, or nexus. The Court decided that mandating collection of sales tax imposed an unfair burden on remote retailers and other businesses. This left states with two options: persuade retailers like Williams-Sonoma to voluntary collect tax or get Congress to pass a new law that would withstand any court challenges. Either way, they realized they’d first have to provide for a simpler way to collect tax.

Several developments have recently begun to swing the online sales tax issue in their favor, and it now appears possible that a federally mandated multi-state online sales tax collection system could be in place next year, if not later this year, several state officials and independent analysts say.

The most important of these developments is the work of the Streamlined Sales Tax Project. Formed by 34 states and the District of Columbia, the SSTP is working to simplify and bring more uniformity to the way states levy and define sales tax, in effect, making it easier for remote, direct-to-consumer merchants to collect sales tax in multiple states.

The SSTP, an outgrowth of the National Governors Association, the Multistate Tax Commission and the Federal Tax Administrators, is developing a sales tax simplification and uniformity plan under which states would agree to levy a single in-state general sales tax for all but exempted products such as food and drugs, which would carry a separate rate or no rate at all, depending on the state. Under current systems, some states impose several sales tax rates for a general range of products and services. Under the SSTP rules, states would still set their own rates, only fewer of them. “The agreement is not about telling states what they can set their rates at,” says Sherry S. Harrell, tax administrator of the Tennessee Department of Revenue and a coordinating member of the SSTP.

Common definitions

In addition, states participating in the project must agree on a common definition of products that are exempted from the general state sales tax rate and taxed under an alternate rate. “You can make any product exempt, as long as you’re using an agreed-upon definition of that product,” Harrell adds.

For example, if a state wanted to exempt apparel from its general sales tax rate, it would have to use an agreed-upon definition of apparel, which could state whether apparel includes accessories such as belts and shoes.

The SSTP is also working out variations in the way different states impose sales tax on bundled products. A retailer that sells a gift package that includes cheese, a knife and a cutting board, for example, might have to collect tax on only the cutting board sold to a customer in one state but on all three pieces sold to a customer in another state. The issue can be particularly troublesome for retailers who bundle services with products, because some states tax both services and products while others tax only products.

The SSTP has also been working on making sure that retailers have reliable software systems to help make tax collection less daunting. It’s developing a system under which retailers could use state-certified and pre-audited software systems, either through an outside service or installed on their own servers, to collect taxes from multiple states. This is considered a crucial element of the project, because there are more than 7,000 local taxing jurisdictions that impose tax in addition to states. If retailers use a state-certified service or installed software, they would not be subject to an end-of-year audit of their tax-collection records, says Diane Hardt, Wisconsin sales tax administrator and co-chair of the SSTP with Peterson.

After looking at numerous tax collection software systems, the SSTP has approved four vendors: GovOne Solutions LP’s Taxware International, a separate partnership of Taxware and Hewlett-Packard Co., a partnership of Pitney Bowes Inc. and Vertex Software Corp., and esalestax.com Inc., a unit of tax and legal publisher CCH Inc.

The 10/20 goal

To make its final plan more palatable to both the federal government and retailers, the SSTP is committed to getting approval from at least 10 states whose combined populations will equal at least 20% of the population of all states that impose sales tax. By having that critical mass, SSTP officials say, they figure they’ll present retailers with enough states and consumers to make their tax-collection efforts worthwhile. “It will make sense for retailers when there are enough people in participating states to make a retailer want to participate in the tax collection plan,” says Frank Shafroth, director of state and federal relations for the National Governors Association.

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After nearly three years of working out details, the project is nearly completed and SSTP officials say they’ll have no problem meeting their 10-state/20% threshold. As of mid-March, there were 32 SSTP member sates working on legislation to approve the SSTP’s plan for sales tax simplification and uniformity. “By this summer, we’ll have 15 states that have enacted their legislation, so by the end of 2003 we’ll be ready to go,” Hardt says. She adds that it’s even possible Congress could approve the project this year, though she admits that may be unlikely because Congress appears inclined to insist on having at least 20 states participating.

Once Congress approves the project, it’s expected to enact a law granting the participating states the authority to require retailers to collect tax on all online sales, regardless of whether they maintain a physical presence in a shopper’s home state. In effect, that would change what has been the status quo since the Supreme Court’s 1960s’ ruling.

Some retailers have opted to get on board with the tax-collection project ahead of any federal action. That’s where the Wal-Mart and Target deal came from. A Wal-Mart spokeswoman admits that increasing integration between WalMart.com and Wal-Mart Stores made the retailer realize that it could not avoid the tax-collection issue.

A number of legislative efforts, however, are also providing impetus for cooperation among retailers, analysts say. In California, in addition to the proposed legislation, the State Board of Equalization has ruled that online book retailers Borders.com and BarnesandNoble.com created a nexus by allowing online shoppers to return books to their affiliated physical stores.

The board also ruled that Barnes and Noble stores, by giving customers coupons good for online sales, also established a nexus for its online affiliate. “That created an agency relationship between online businesses and stores, so the state board said they were liable to collect taxes,” says John Logan, a tax analyst at CCH Inc.

The sales tax project may also affect other tax-related efforts in regards to the Internet and business in general. One effort involves the business activity tax, such as may be levied on business income, and whether it can be imposed on a company by a state where it has no physical presence. Although there is no federal action related to BAT imposed on remote businesses, the South Carolina Supreme Court has upheld that state’s imposition of corporate income tax on the royalty income a national retail chain paid to the affiliated holding company that controls its stores’ logo.

Unbundling

Now, concerned that other states may follow South Carolina, some businesses want to link a BAT exemption deal with the SSTP plan. “Businesses want legislation that would require that, if states are granted sales tax-collection authority from Congress, states would not also be authorized to impose BAT on out-of-state business,” Logan says.

The outcome of the SSTP plan could also impact the existing moratorium on state taxation of Internet access fees. Because the moratorium is due to be either extended or terminated on November 1, when Congress could be considering the SSTP plan, it may want to address both issues at once, state officials say. The potential bundling of the two measures is important, they add, because of past expectations of Internet sales tax opponents to make the moratorium permanent and cover sales as well as access taxes.

“Congress could tie it altogether,” Hardt says. “It could extend the moratorium permanently, but then, we hope, allow the states to mandate collection of online sales tax.”

paul@verticalwebmedia.com

Illinois says “No” to sales tax amnesty

As hard as states are trying to make it easy for online retailers to collect sales tax—and, in turn, help states rebuild their revenue—the cooperation from states will only go so far. The state of Illinois is taking legal action to force Wal-Mart Stores Inc., Target Corp., Office Depot Inc. and two smaller retailers to pay uncollected back sales tax, a move that would disqualify them from a much-heralded tax amnesty program offered by most states.

Illinois State Attorney General Lisa Madigan says the collection of back online sales tax would help her state make up a current budget shortfall estimated at $2.5 billion to $5 billion. “We have to bring in revenues where we can,” she says.

Illinois State Sen. Steven Rauschenberger, a former retailer of home furnishings who has played a key role in working out details of the Streamlined Sales Tax Project, says the amnesty provision is vital to motivating retailers to begin to voluntarily collect tax for online sales. “The amnesty provision is critical to the passage and the success of the project,” he says. “Why would any retailer put his head in the noose voluntarily? We can’t use retailers’ participation to turn our lawyers loose on them.”

But the amnesty provision, he adds, was not intended to give a blanket reprieve to retailers who have already been cited for not complying with existing tax-collection laws. “It wasn’t intended to give freebies to anyone already under litigation or a collection action,” he says. Because Illinois has yet to sign on to the Streamlined Sales Tax Project (though Rauschenberger predicts it eventually will) any retailers cited now in the lawsuit would not be able to participate in the amnesty program, he says.

The Illinois lawsuit, which the state recently joined as a plaintiff, was filed under the state’s whistle-blower statute by Stephen Diamond, an attorney with the Chicago law firm of Beeler, Schad and Diamond. Diamond, who stands to collect at least 15% of any fines the state may collect in the lawsuit, contends that he personally made several purchases on Target’s web sites and was never taxed. He contends all the retailers in the suit have been obligated to collect tax for online sales because they maintain stores in Illinois that support their web sites. Although consumers are obligated to remit sales tax if it’s not collected by retailers, they seldom do, state officials say. Diamond says he paid the sales tax on his online purchases. Diamond also says he is working with lawyers in 45 other states to expand the number of states suing retailers.

Wal-Mart and Target have begun collecting tax for online sales under the amnesty program, which began in February. Although Wal-Mart admits that it has been more closely integrating its online and store operations, a spokeswoman says Walmart.com denies that it broke the law in Illinois. Target and Office Depot did not return calls for comment.

Amnesty for Back Sales Taxes
(States that have agreed to let Wal-Mart, Target and other participating retailers off the hook for any uncollected back sales taxes, in return for their voluntarily beginning to collect taxes earlier this year.)
Alabama
Alaska*
Arkansas
Colorado
Connecticut
District of Columbia
Florida
Georgia
Hawaii
Idaho
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota
Mississippi
Missouri
Nebraska
New Jersey
North Carolina
North Dakota
Ohio
Oklahoma
Rhode Island
South Dakota
Tennessee
Texas
Utah
Virginia
Washington
West Virginia
Wisconsin
Wyoming

Considering the amnesty plan
Illinois
New Mexico
New York
Pennsylvania
Vermont

Rejecting the amnesty plan
Arizona
California
Nevada
South Carolina

States with no sales tax
Oregon
Montana
Delaware
New Hampshire

* Alaska has no state sales tax but participates for its local tax jurisdictions.
Source: Streamlined Sales Tax Project