With federal and state budgets still struggling, lawmakers are looking for ways to increase the money coming into their tills. Sales taxes are about a third of total state tax collections, second only to personal income taxes as the largest source of state revenue. But the Internet Tax Nondiscrimination Act (P.L. 108-435) means states don't collect taxes on any out-of-state online transactions.
If you have a business in California, your website's cash register is only required to collect taxes from Californians. Likewise, if you live in California and buy from an online retailer in Vermont, you don't have to pay sales tax on your purchase.
Technically, customers from other states are supposed to pay use taxes but trying to enforce this is complicated and virtually impossible. This is because of the "nexus," or physical presence, a concept that originated with the first use taxes implemented during the Depression.
New York State decided to apply this idea to the Internet with the Amazon Law. New York claimed that the commissions that Amazon paid to Empire State affiliates meant it had nexus in the state, and thus was required to collect sales tax. The state legislature passed a law supporting the claim. Amazon challenged in court and lost.
When North Carolina and Rhode Island passed laws similar to New York's Amazon law, Overstock.com and Amazon canceled affiliate programs in those states, putting some online retailers out of business. California, Hawaii, Colorado, and Virginia have defeated the proposals to tax Internet sales, while other states, like Oklahoma, are going ahead with Internet tax measures based on nexus.
Nevada, Florida and Washington, among others, rely on sales taxes in lieu of a state income tax, so they have a keen interest in the issue and are working to broaden the definition of "nexus."
Still, the lack of sales-tax and use-tax enforcement is attractive to online shoppers, proven by the 20 percent annual increase in online sales. With that kind of growth it's no surprise that there's a push for new tax legislation through the Main Street Fairness Act. The Act calls for an online sales tax to ensure online stores have the same tax regulations as retailers.
With around 7,500 unique tax jurisdictions in the United States, keeping track of changing tax rates will be a job that only a central service or software provider will be able to handle. But the problem is more complicated than that. Some states, for example, don't tax software and other digital products while others do, but they have lower tax rates for prescription drugs, clothing and food.
Unless special Internet sales exemptions are provided, a seller would have to register in every state where it sells its products or services. Sellers would have to register their businesses in every county, borough, parish, city or town where they have customers. They’ll have to keep tax records for every single jurisdiction too, and make them available in the event of an audit.
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Internet transactions aren’t the only ones under scrutiny. Catalog sales and interactive-TV sales raise nexus issues too. Even postcards inside magazines that a purchaser mails in to order a product raise nexus issues because the cards have codes that track sales back to the magazine.
Unless a solution is found, your business could find itself in the unfortunate position of selling competitive products that cost your customers as much 8.25 percent more than other online retailers, simply because you have to collect state tax and they don't. You can opt to reduce your price to balance the costs, but that means narrower margins.
One approach to solving this problem was the Streamlined Sales Tax Project (SSTP), created by the National Governor’s Association and the National Conference of State Legislatures in the fall of 1999 to simplify sales tax collection. The leaders of those two organizations were concerned that the 1930s sales-tax approach is not relevant to 21st century e-commerce. So far, 44 states and the District of Columbia have adopted the approach which encourages "remote sellers" selling over the Internet and by mail order to collect tax on sales to customers living in the streamlined states. It levels the playing field so that local "brick-and-mortar" stores and remote sellers operate under the same rules.
According to Scott Peterson, executive director of the Streamlined Sales Tax Governing Board, "people have lost their enthusiasm and patience for the Streamlined Sales Tax project." Why? George Isaacson, representing the Direct Marketing Association as senior partner at Brann & Isaacson, said at a recent conference that it was, at least in part, because SSTP had backed away from simplicity.
With states losing billions of dollars in revenue, it's a safe bet they’ll use whatever legal authority they have to chip away at the nexus issue.
Tom Harnish is a serial entrepreneur. Always on the bleeding edge of technology, he learned what works (and what doesn't) leading projects, products and companies to success (mostly). He can't play a lot of musical instruments.
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