As the effects of the recession continue to unravel across the country, many states are struggling to secure funding for essential programs. One notable solution that is gaining momentum is broadening the sales tax by collecting taxes on remote sales and Internet sales.
Sales taxes are imposed on goods and services and are generally accepted by the public because they are paid in small increments at the time of purchases, so their cumulative value is not seen. Yet, a number of states, including Illinois, do not apply sales tax to movies, books, music or computer games that are purchased online, even though the tax would apply if the transaction took place in a brick-and-mortar store. Usually, a seller collects the tax at the time of purchase and remits it to the state. Even if the seller does not collect the tax, a purchaser is still legally obligated to pay it, though very few do.
One reason for states’ failure to collect Internet sales taxes is because until recently it has been unclear whether or not a state can legally require an Internet seller to collect the tax. A series of U.S. Supreme Court decisions starting in the late 1960s relating to catalog and mail orders--National Bellas Hess Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992)--appear to preclude states’ taxing authority.
According to these cases, understanding, administering, and collecting different state and local sales codes were too complex and placed an undue burden on catalog and mail order companies as well as an unreasonable restriction on interstate commerce in violation of the Commerce Clause. Instead, the Court held that only states in which a company has a nexus, through the presence of retail outlets or distribution centers, can be required to collect sales taxes.
Yet, technology has made computing sales tax less burdensome so the justification for the Court’s original ruling is gone. In fact, two other Supreme Court decisions--Scripto Inc. v. Carson, 362 U.S. 207 (1960) and Tyler Pipe v. Washington Department of Revenue, 438 U.S. 232 (1987)--seem to establish that an out-of-state seller is deemed to have a nexus through a physical presence in a state if it uses in-state third parties to help establish and maintain a market for its goods within the state.
The rapid increase in Internet sales has created a corresponding loss of state sales tax revenue. Illinois, for example, estimates it lost $150 million in sales tax due to online commerce and neighboring Michigan lost an estimated $414 million due to remote sales the state during fiscal year 2010.
The clearest guidance on the legality of taxing remote sales would be for Congress to mandate that companies must collect these taxes. The Main Street Fairness Act (H.R. 5660) was introduced in the 111th Congress in July 2010 to “require all remote sellers not qualifying for the small seller exception to collect and remit sales and use taxes on remote sales owed to each such member state.” Although the legislation did not pass it is likely to be reintroduced this year.
In the meantime, several state-based efforts are underway to address this issue. First, through the Streamlined Sales Tax Project, twenty-three states, including Illinois, are working together to standardize their sales tax codes to reduce the burden on sellers to collect sales taxes on Internet sales.
Second, states are adopting laws redefining “nexus.” In 2008, New York was the first state to enact an innovative law that relies on the fact that many out-of-state retailers enlist independent in-state websites known as affiliates to promote sales. At least 210 of the 250 largest Internet retailers operate affiliate programs. Affiliates place links on their websites to the retailer’s site and receive a commission when someone follows the link and buys something from the retailer. It has long been established that states can require out-of-state sellers to collect sales taxes if they use independent representatives paid on commission to solicit business within the state. New York’s new law effectively deems a retailer to have a physical presence, or nexus, within the state when it has independent affiliate websites promoting sales on its behalf within the state.
Legislators in at least seven other states introduced similar bills last year. Similar bills passed in North Carolina and Rhode Island, but California’s, Hawaii’s, Connecticut’s and Minnesota’s bills were vetoed by their governors. Additionally, states such as Arizona, Florida, Maryland, Mississippi, New Mexico, Tennessee, Texas, Vermont, Virginia and Wisconsin have either introduced or are considering legislation.
Illinois is the most recent state to pass an Internet tax law (H.B. 3659). The bill, which passed the General Assembly in early January, is awaiting Governor Pat Quinn’s approval and would become effective in July. In a sense, however, this tax is not new. The Illinois General Assembly passed the Use Tax Act in 1995, requiring a purchaser to pay taxes on items bought for use in Illinois since. In fact, Illinois recently implemented an amnesty program to allow customers to pay sales and use taxes on past online purchases, between June 30, 2004 and December 31, 2010, without penalty. Under the amnesty program, which lasts until October 15, consumers can pay this tax as part of their Illinois Form IL-1040 income tax.
This amnesty program and the new legislation will create new revenues to help decrease Illinois’ budget deficit, however, as Internet sales continue to grow and this revenue increases the extra revenue could be used to fund new and innovative programming in Illinois.
Ji Won Kim contributed to this blog post.