August 1, 2010, 12:00 AM

Tax Attack!

Cash-starved states are circling e-commerce, aiming to feast on new online sales tax revenue.

Lead Photo

In Louisiana, retailer Mike Hackley is in the midst of his usual busy summer season, selling barbecue grills to outdoor chefs around the country. But this year the heat under his collar is turned up more than usual, and Hackley is fixing to form an organization of online retailers to address in court an issue hotter than the red coals in one of his ceramic smokers: a move by the state of North Carolina to get Hackley’s and many other e-retailers to begin collecting sales tax on orders shipped to North Carolina customers.

North Carolina contends that ShoppersChoice and all other retailers that work with online affiliates based in North Carolina have a physical presence, or nexus, within its borders. If a retailer has a presence in a state, the state can require the merchant to collect sales tax under the controlling U.S. Supreme Court ruling. New York and Rhode Island have passed laws similar to North Carolina’s, seeking to collect more revenue from taxing online sales.

Hackley and other retailers are crying foul.

“I will fight it,” says Hackley, founder and CEO of ShoppersChoice. He figures the back taxes North Carolina alone wants amount to $110,000. “I’m a small company, but I’ll take them to court to say we don’t employ anyone in North Carolina and don’t have nexus.”

North Carolina is just the tip of the iceberg for Hackley and other e-retailers. Legislation before Congress would authorize dozens of states to require online retailers to collect sales tax. Such legislation has been proposed before, but the sorry state of state government finances raises the chances of passage.

Such a law would end the luxury web-only retailers have enjoyed of not charging sales tax on most orders. And it would pose the question: How much would shoppers cut back on buying online if they had to pay sales tax? It could be quite a lot. A study by e-commerce technology provider GSI Commerce Inc. found that sales declined by more than 10% for one retailer client that had to start collecting sales tax in certain states.

‘Internet sales tax is coming’

Hackley figures it’s a question many e-retailers soon will face. “I realize an Internet sales tax is coming,” he says. “And I want to make sure our system is ready for it.” While preparing for a nationwide system, Hackley figures any pressure he can apply at the state level will help push for a fair nationwide system.

Should the federal legislation pass, retailers could ultimately be forced to collect sales tax on Internet and catalog sales in the 45 states that have a state sales tax law, plus the District of Columbia and some cities in Alaska. However, today the law would only apply in the two dozen states that have joined the Streamlined Sales and Use Tax Agreement, or SST. That’s a compact that standardizes sales tax rules, including how taxable items are defined, aiming to make it feasible for retailers that operate nationwide to accurately collect taxes in the more than 10,000 state, county and local jurisdictions that have sales tax.

While only about half of states belong to SST now, others say they will join once Congress passes the legislation enabling SST member states to require all retailers to collect sales tax, says Scott Peterson, the executive director of the Streamlined Sales Tax Governing Board. Consumers are supposed to pay so-called “use” taxes when an online retailer does not charge sales tax, but hardly anyone does. At a time when many states face big budget deficits, Peterson notes, the SST could provide much-needed revenue.

U.S. Rep. William Delahunt (D, Mass.), who last month introduced the new sales tax bill, the Main Street Fairness Act, estimates states could collect $18.6 billion in additional revenue this year. That would cover 27% of states’ budget deficits this year, estimate the National Conference of State Legislatures and the SST.

Delahunt also projects states would take in another $23.3 billion by 2012. That figure breaks down as follows: $11.4 billion from online sales, including sales to consumers and taxable business purchases, according to a study by the University of Tennessee; and another $11.9 billion from catalog sales, according to an SST estimate.

But the methodology used in those studies is in dispute. NetChoice, an organization backed by online retailers that opposes taxing online sales, estimates that states would take in only $4.7 billion in 2012 for web sales instead of $11.4 billion.

New $100,000 threshold

Whatever the revenue figure, the system would affect many more retailers than previously contemplated. SST was initially set up to cover sales tax collection by Internet and catalog retailers with at least $5 million per year in “gross remote taxable sales”–in other words, $5 million in sales outside of their home states, sales that would be subject to sales tax for the first time.

But the Delahunt bill grants the SST Governing Board the option of setting a new threshold. Peterson says it’s likely that e-retailers with as little as $100,000 in annual remote sales would have to collect tax.

“At the $5 million threshold, at least half if not more of online retailers would still not be required to collect remote sales tax, so if the SST is to support fairness among retailers, we can’t leave the threshold at $5 million,” he says.

Will online sales suffer?

That lower threshold would cover the vast majority of online retail sales, raising the question about how consumers would react to having to pay sales tax.

Retailers have differing views on whether conversion drops in states where they have to collect sales tax. Hackley says the sales tax he collects in his home state of Louisiana does not appear to have hurt sales to Louisiana residents. But Neil Kugelman, CEO of web-only jewelry retailer Inc., believes his sales in his home state of New York are lower because he has to charge tax to New York consumers. “Jewelry customers in New York prefer buying from companies not in New York to avoid paying sales tax,” he says. “And my conversion rate in New York is lower than in other states.” He could not provide details.

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