December 26, 2000, 9:55 AM

To Tax or Not To Tax

Every time an out-of-state retailer sells someone in California a product over the Internet-a toy, a book, a CD-the state, and perhaps a city or county within the state, has a right to collect sales tax on the transaction.

But state and local governments rarely see the money. Few Internet retailers collect sales tax and states can’t require them to. It is legally up to the Californians who buy products over the Internet to pay the tax on their own. And hardly anyone does.

But are California tax officials complaining? “It doesn’t offend me a bit,” says Dean Andal, vice chairman of the California Board of Equalization, the state’s elected tax commission.

It doesn’t offend him even though California is missing out on an estimated $200 million a year in sales taxes from Internet purchases. Yet that is less than 1% of the $32 billion the state collected in sales tax last year, and it’s not worth worrying about, Andal says. “I say we just let the Internet grow unabated; let it come to its maturity as fast as possible,” he says. “Then, if we have a tax problem, we can address it.”

While Andal is taking the long view of the Internet, many other governmental bodies aren’t being so forgiving. They want to take advantage of the tax opportunities Internet sales are generating and they want it now. And they want online retailers, like stores in the physical world, to collect the taxes.

For starters, politicians and government trade groups are challenging the legal standards that exempt retailers from collecting sales taxes in states where they do not have a physical presence. State and local government groups would like Congress to pass a law requiring online retailers to charge customers sales taxes based on where the customer lives. Retailers would have to send the money to the states.

“Our top concern is lost revenues as the Internet grows,” says Ralph Tabor, associate legislative director at the National Association of Counties in Washington, D.C. “The growth on the Internet has been explosive, and if we continue to lose that sales tax revenue at the state and local level, we won’t be able to continue to finance services.”

But there are plenty of Web advocates who cringe at the thought of taxation. Not only are they tolerant, as is Andal, of the lack of tax revenue, they are downright opposed to any taxation at all of the Internet. Sen. Ron Wyden, a Democrat from Oregon, sponsored the Internet Tax Freedom Act, “because he doesn’t think the Internet should be strangled in its crib,” says a spokesman for Wyden. And the anti-tax sentiment is a bipartisan issue. Sen. Bob Smith, a Republican from New Hampshire, has proposed legislation to make the 1998 moratorium on new Internet sales taxes permanent.

The debate is picking up steam in Washington and across the country. It’s an issue that online retailers need to be aware of, and one that could affect the way they structure their businesses, analysts say. The federal government has created the U.S. Advisory Commission on Electronic Commerce to investigate the issue. The commission will make recommendations to Congress in April-if it can agree on anything to recommend. Early meetings of the commission have resulted in little common ground.

Online retailers are keeping a close eye on what happens, preparing for the eventuality that they may have to pay taxes. If Congress requires Internet businesses to collect taxes for every state and locality, would comply, says Kim A. Miller, vice president of Internet strategies. “But obviously we hope it doesn’t happen that way.”

Retailers who do business over the Internet today are legally required to collect sales taxes in states where they have a physical presence. automates the collection of sales tax, so when a customer types an address into the Web site, software automatically checks it and applies the appropriate tax when necessary.

Some nationwide companies, such as Sears, simply collect tax on everything they sell over the Internet. Other retailers have set up their online businesses as a separate entity, which means they have to collect sales tax only on items sold in the state where the Internet business is based.

Technology is helping Art Munson, owner of the Cassette House (, collect tax in his home state of Tennessee. Munson sells cassettes and related recording supplies online. When he sells items to people who live in Tennessee, Munson’s Mail-Order Manager software adds sales tax to the customer’s total cost.

If Congress requires online retailers to collect sales tax for every state, Munson’s software would manage that as well, down to the county level, he says. But Munson also has to keep track of the paperwork for Tennessee companies that have tax-exempt status, and he has to fill out forms and mail the sales tax he does collect to the state of Tennessee. Those tasks could be overwhelming if he had to do it for each of the 46 states and Washington, D.C., that impose a sales tax, he says.

Keeping up with tax rules and product definitions for each state also would be a tremendous burden for Internet retailers, says Robin Lebo, director of customer acquisition at Crutchfield, an online seller of electronics equipment for homes and cars. Crutchfield only collects sales taxes for purchases made by consumers in Virginia, where the company is located.

Many retailers are concerned about the sort of tax rules that exist in Pennsylvania, where clothing is not taxable unless it is a luxury item.

A tax nightmare

Retailers’ primary concern is being saddled with the responsibility and all the obligations that go along with the collecting taxes for all states and subdivisions-estimated to exceed 30,000 entities-that want to impose a sales tax, says Mark Nebergall, vice president and counsel at the Software and Information Industry Association, Washington D.C. “You hear a lot about figuring out the correct rate, but that is only the tip of the iceberg.” Varying state filing requirements make compliance a “nightmare” for Internet retailers, he says. For instance, states all have different forms that retailers must fill out and file with different schedules for submitting the taxes collected.

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