E-Commerce: Tax Issue Begs for National Fix

If anything other than the deficit and the national debt is screaming for a national solution, traditional retailers believe it's having Internet-only retailers collect sales taxes on their online purchases. Virtually every state government in the United States was running a deficit at the start of the year, and uncollected taxes from Internet-only retailers such as Amazon.com can amount to hundreds of millions in lost revenue per year, per state. Cash-strapped state governments are attempting to require Internet retailers to collect sales taxes at the point of sale and remit them to the state where the customer resides – something consumers now are required to do – but they are being met with both constitutional and commercial resistance.

The issue is that online-only retailers that don't have a physical presence in a state are not required to collect sales taxes owed on purchases made by residents of that state. So at a time when online sales have steadily risen nationally – 12.6% in 2011 alone, according to Forrester Research – and are expected to reach $1.4 trillion globally by the middle of this decade, according to Cisco Systems, overall sales tax revenue declined in most states between 2007 and 2010. While that was partially due to a weak economy, closing the Internet sales tax loophole would have been a mitigating factor. A 2009 University of Tennessee study estimated that the state of Wisconsin, which generates 27.5% of its total revenue via the sales tax, will fail to collect $142 million in 2012 due to this loophole. Over two years, that would represent 36% of the $800 million in cuts to school districts in the 2011-13 state budget.

The financial condition of state governments is only part of the justification for having Internet retailers collect state sales taxes. State governments are also worried about the eventual impact on the competitiveness of their brick-and-mortar retailers if they continue to have this competitive disadvantage.

 

Taxing situation

The Internet Tax Freedom Act, enacted in October of 1998, does not prohibit states from taxing Internet sales, but there are limits due to the physical presence requirement, and states rely on the sales tax to varying degrees. Washington state and Florida, which have no individual income tax, derive 59.6% and 58.8%, respectively, of their tax collections from the sales tax, according to the Taxpayers Network. New York state, which gets most of its revenue from individual income tax collections, nets only 16.6% of its revenue from the sales tax.

In an attempt to collect more Internet sales taxes from online-only retailers – taxes that are legally owed – several states have enacted a broader definition of what constitutes a physical presence. That's the standard Internet retailers cite from the U.S. Supreme Court's 1992 Quill decision, which pitted the Illinois-based Quill Corp., a catalog retailer, versus the state of North Dakota. In that state, Quill did nearly $1 million in business with 3,000 customers to whom it delivered merchandise by mail or common carriers. The nation's high court ruled that states could require only companies that had a physical presence within the state to act as a tax collector, hence the state's interest in expanding the definition of physical presence.

While retailers like Amazon.com have not taken that lying down, the Quill decision did spell out a potential national solution. The Court noted that Congress has plenary power to regulate commerce among the states, and may authorize state actions that "burden interstate commerce." In other words, Quill left open the door for Congress to pass a standard law for sales tax collection under the Interstate Commerce Clause, which it has not yet done – perhaps due to the immediate need to address national fiscal issues.

Under Gov. Scott Walker, Wisconsin's approach has been to say it's an issue that ideally should be addressed at the federal level. In 2009, the Wisconsin Legislature passed the Main Street Equity Act, which signed Wisconsin onto a consortium of states that supports the Streamlined Sales Tax, which would establish uniform definitions for different categories of goods, with each state having one statewide sales tax rate and a limited number of local sales tax rates to prevent the overload of having Internet retailers collecting sales taxes for the full complement of more than 6,000 U.S. tax jurisdictions.

Beyond tax fairness, Rick Chandler, secretary of the Wisconsin Department of Revenue, considers Internet sales taxes to be a jobs issue for the state, especially when out-of-state sellers do not have to collect sales tax and in-state companies do. Chandler said that puts in-state companies at a competitive disadvantage, and it hurts Wisconsin in terms of retail jobs because some sales move from companies that do business here in Wisconsin to out-of-state companies.

Chandler noted that a number of companies already are collecting sales taxes on Internet sales. Lands' End, a Dodgeville- based catalog company that sells into all 50 states, has to collect sales tax on all of its sales because the company is part of Sears, which has a physical presence in all 50 states.

In contrast, L.L. Bean, an online retailer based in Maine, doesn't have stores in any other states. So when this company sells to somebody in another state, it is not collecting sales tax, which gives L.L. Bean an advantage, "even though they are selling the same types of goods under the same circumstances," Chandler said.

"From our point of view, it's an issue of making sure that we're doing everything we can to protect and promote job creation in Wisconsin," he added. "So there is a concern on behalf of Wisconsin retailers, who employ a lot of people here, and companies like Lands' End and Kohl's are examples, as are the Main Street hardware stores and the Main Street jewelry stores, who find they are competing with companies that are selling the same types of products from out of state. There is definitely a concern about making sure we are thinking about things that could be done to protect jobs here."

Several major national retailers, including Wal-Mart, have joined with smaller retailers to form an alliance to push for what they view as tax fairness. The Alliance for Main Street Fairness wants more states to expand the definition of physical presence. They too support the Main Street Equity Act because it would standardize sales tax collections for Internet retailers and reimburse companies for additional costs incurred in collecting the sales tax.

Ironically, Wal-Mart, the retail giant that receives so much criticism for harming Main Street businesses, is completely supportive. Lisa Nelson, director of public affairs for Wal-Mart, notes that Wal-Mart's online sales make it a sales tax collector in every state, including Wisconsin, where it has a store (physical presence).

On a recent In Business with Jody & Joan radio show, Nelson said Wal-Mart is working with other retailers and the coalition of Main Street businesses to educate policymakers "so they understand that we can't leave our state in the lurch." She noted that Wal-Mart and other retailers don't like taxes, but expect to pay sales taxes because they are legally owed, so it's not about creating a new tax, but enforcing the collection of a tax that is currently in place by changing the point of collection from consumers to online retailers.

"Every retailer that does business in the state of Wisconsin, that has a brick-and- mortar presence, does collect sales taxes and remits them to the state of Wisconsin," she noted. "From a state general purpose revenue perspective, sales taxes are a very important part of funding the programs and services that our state provides.

"We're happy to partner with the state of Wisconsin, so we collect those taxes and we remit them on behalf of the state. The issue that I think we're driving at here is the issue of e-fairness. This is an issue that retail organizations have been working on in recent times, in the past few months, particularly since so many states are faced with budget deficits and shortfalls."

Consumers are required to declare online purchases and report the tax, but they either ignore the law or are unaware of it. There is a line on income tax forms where Wisconsin residents can calculate the total amount of online purchases they make where they haven't paid sales tax, and multiply it by 5% if they reside in a county without a local sales tax, or 5.5% if they reside in a county with a county sales tax, and that number is added to their tax liability.

The same is true of businesses that make an online purchase from an online company. Businesses that make such a purchase have to declare it and pay the sales tax on that purchase in the state of Wisconsin, and private ventures are more likely than individual consumers to be audited to ensure compliance.

Beast of a burden?

Linda Remeschatis, president of Wisconsinmade.com, an online food, gift, and specialty retailer, knows that playing the role of sales tax collector would impact her business, especially if there is no limit on the number of taxing jurisdictions.

"When you look at the fact that each item is taxed differently in each state, as far as whether it's taxed or not, and they are going to ask us to collect taxes, then we would have to have a lot of information," said Remeschatis, who sells in all 50 states. "Each state would be different. Some states tax food and clothing and household goods. They all have different products that they tax or do not tax, so that would be kind of a nightmare with 50 states, and then you have the other problem with the amount of tax, not only from state to state but within each state with counties, townships, and other municipalities.

"Taking it a little further, with each jurisdiction, it would have to go down to the street level because you can't always go by zip code. Two places could have the same zip code, but they could be in two different townships, or two different taxing jurisdictions. That could be difficult because a lot of things are done by zip code."

To address these concerns, the Streamlined Sales Tax, billed as an attempt to simplify and modernize sales and use tax collection in the U.S., would set uniform standards for different categories of goods. For instance, if a state taxes food, it would have to follow the uniform definition of food. If a state taxes clothing purchases, it would have to follow the uniform definition of clothing.

According to Chandler, the belief of supporters of the Streamlined Sales Tax was that if a sufficient number of states adopted it, then that would be an incentive for Congress to establish its provisions as the national standard for remote sellers. Thus far, more than 20 other states have adopted it, and enabling legislation has been introduced, but not passed, in Congress, even though the concept has bipartisan support at the federal and state levels. "We think having the federal government act, so that it's resolved on a national level, is probably the best way to go," Chandler said.

No technical difficulties

For Internet retailers, computer programmers should be able to architect a system that alleviates much of the administrative burden of collecting and remitting sales taxes. There are a number of programs that perform the calculations for people and tell them that if they are selling into a particular zip code, what the applicable sales tax rate is in that zip code, and what categories of goods are taxable in different states.

Some zip codes fall in multiple communities with different taxing jurisdictions with different sales taxes, but retailers have programs to overcome that, Chandler said. "Lands' End has to collect sales taxes on all those sales," he noted, "and they've got their programming all set up to figure that out fairly easily."

Chandler said Wisconsin should not try to pass legislation to get around the Quill standard, which a number states, including Illinois, have done. This legislation, known as the "Amazon Law," says that if online retailers like Amazon.com, which owns the Madison-based Shop Bop (arguably establishing a physical presence in the state), have an "affiliate relationship" with a company in their state, meaning they either sell coupons or furnish coupons that allow consumers to get dollars off on Amazon purchases, that constitutes a physical presence in the state, requiring Amazon to collect sales tax in those states.

Amazon's reaction to those laws has been to cut off business relationships with those affiliates, which is why governors in states like Wisconsin and Texas, where Gov. Rick Perry vetoed such a bill, favor a national standard.

The lack of a national standard has led to business relocations, including one that benefitted Wisconsin. After Illinois Gov. Pat Quinn signed legislation making his state the seventh to enact the Amazon Law, the Internet company FatWallet announced plans to move from Rockton, Ill., near Rockford, to downtown Beloit. FatWallet owner Jim Storm explained the company, which employed 54 people, generated roughly $13 million in commission revenue by sending shoppers to the websites of retailers like Amazon.com, and that under the new law, the state of Illinois would claim about 30% of its business.

At the moment, 45 states and the District of Columbia have a sales tax. Asked if she could handle that many, Remeschatis answered in the affirmative but indicated that elected leaders would have to take some of the administrative hassle away. "Sure we could, but it's going to cost us," she acknowledged. "You hate to use the money that way – collecting money for the states that can't collect the money themselves."

From her vantage point, the more help that could be provided, the better, whether it comes in the form of government reimbursement for administrative costs, which could be part of the congressional legislation, or to purchase software designed to apply the right tax on the right products based on the jurisdiction, or more precisely, the zip code of the purchaser.

Even with a streamlined approach, Remeschatis indicated that she would have to invest in the necessary software and have an employee, either an existing one or a new hire, remit it to the correct state and do the tax returns, and that might also require the company to provide benefits. While that would create a job, it's also money that would not be used for more marketing or promotion of Wisconsin products, helping artisans, or opening a store. "Obviously it would be a burden," she said. "If it can be totally streamlined so there is not any extra cost to us, that would be great. I don't mind doing this because I know with the states, everyone is hurting and they are trying to collect more taxes, but it would have to be extremely streamlined.

"It certainly would be quicker if they could set something up nationally," she added, "but they'd really have to give some of us a lot of help in doing it because it could be a real nightmare."

The way we do commerce

For Nelson, resolving the issue is a matter of establishing tax equity and ensuring that tax systems and processes reflect the way commerce is done today. She agreed with Chandler that the issue is ultimately about job retention and went one further, stating that Wisconsin's "Main Street business culture" could be impacted because such businesses are put at a competitive disadvantage when the government essentially picks winners and losers.

"What we're saying is we need tax fairness," Nelson said. "We need to look at equity. We need to look at how sales tax revenue declines are impacting our states, and does our tax code really reflect the way that we conduct commerce?"

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