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The Senate could vote this week on legislation that would close the “Amazon Loophole,” a tax loophole that allows online retailers like Amazon and eBay to avoid collecting sales taxes on most purchases made through their sites. The loophole gives online retailers a major advantage over their offline competitors, since they only have to collect sales taxes in states where they have a physical presence.

This vote is particularly important for state governments whose budgets continue to come up short and could therefore use the huge sums that the failure to tax Internet sales has denied them. In 2012, Internet retailers earned $225.5 billion costing states millions of dollars—California (over $4 billion), Texas ($1.7 billion), Florida ($1.4 billion), Illinois ($1 billion), and New York ($1.7 billion). Cities, whose budgets are also in dire straits, are also taking a hit. Take for instance, Los Angeles, where the projected e-commerce tax revenue loss for 2013 is over $95 million. In Chicago, it tops out at more than $55 million.

Technically, online retailers should be collecting taxes, however, due a complicated history of Supreme Court cases, Internet-based retail stores have not had to comply with the same sales tax rules that brick-and-mortar stores had to comply with. Regardless of whether or not retailers collect the taxes, buyers are technically still required to pay such taxes—although few actually do. In recent years, a few states have begun enacting laws to require Internet companies to collect sales taxes. New York was the first state to enact a law defining “nexus” or presence more broadly in order to be able to require Internet sellers to collect sales taxes. Since then, six other states (Rhode Island, North Carolina, Illinois, Arkansas, Connecticut, and California) have adopted similar laws that require online retailers with sales affiliates based within their borders to collect sales tax, while other states (South Dakota and Colorado) have enacted laws that require online companies to at least notify customers that they owe the tax. California's law also extends the obligation to collect sales taxes to online retailers that have subsidiaries or affiliated companies in the state. While some of these laws have been upheld, others—such as Illinois’s—have been declared unconstitutional based on the previous Supreme Court cases.

States have also tried to collect the tax directly from consumers through amnesty programs. Illinois, for example, implemented an amnesty program to allow customers to pay sales and use taxes on past online purchases, made between June 30, 2004, and December 31, 2010, without penalty. North Carolina’s program, on the other hand, specified that if Internet retailers commenced collecting sales tax on products sold to North Carolina state residents, the state would, in turn, forgive taxes, penalties, and interest for certain periods, and it would not seek information about customers who bought from them. Such approaches have not been too successful. Illinois, for instance, collected only about $10 billion of the estimated $150 billion that should have been paid. 

As a result of state amnesty programs not working and laws being overturned, the pressure on Congress to pass federal legislation has been intense. The Marketplace Fairness Act of 2013 would give states the authority to levy sales taxes on online purchases even when the retailer isn’t based within a state’s borders. Passing the legislation would both remove an unfair advantage for online retailers and give cash-strapped states more authority to collect sales taxes. The bill states that the tax is only required for companies earning more than $1 million per year in sales, and states that do not currently have a sales tax would not be required to participate.   

The bill has caused a wide divide between supporters and opponents. Online companies like Amazon and brick-and-mortar giants like Wal-Mart and Target support the bill, while other online giants like eBay oppose it. It has also created a divide within the Republican party; many conservative Republican lawmakers who are anti-tax and pro-business are against the bill, while others are acknowledging their small business constituents’ desires and supporting it.

More important that the benefits to states are the effects such a law would have on low-income families. In general, poorer families pay a larger share of their income in sales taxes than better-off families do because they have to spend almost everything they earn. The Internet sales tax, though still regressive, might have less of an effect on low-income consumers since they are not heavy users of online shopping. Low-income families’ lack of home computers, high-speed Internet, and lack of credit cards relative to higher income families means that they are already paying state sales taxes when they shop in traditional stores. The bill, if passed, merely levels the playing field by ensuring that everyone else pays the tax too. Moreover, the increased revenues from sales taxes could help states fund the types of public programs that benefit these communities—job training, education, public health—which have been cut due to state budgets. 

Thus, the vote, which is scheduled for May 6^th , is an important one for states and low-income communities they are trying to serve.

To see an interactive chart showing how much each state is estimated to loss in Internet sales taxes, click here.  

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Illinois’s state budget deficit still stands at over $13 billion, including over $6 billion in unpaid bills. The state’s unpaid public worker pension liabilities exceed $83 billion and this could reach an estimated $140 billion by 2030 if nothing is done to close this deficit. 

In March 2011 Governor Quinn signed the Internet Tax Law, Public Act 096-1544, or so called “Amazon Tax Law”, which requires online retailers that work with affiliates in the state to collect sales tax on items purchased by Illinois residents and businesses. Before this the law was enacted, online companies only had to charge sales tax if they had a brick and mortar location within the state. For example, Sears was required to collect taxes because it is both headquartered and also has retail stores in Illinois. Amazon.com, on the other hand, did not have to collect sales taxes because it had no physical presence in the state.  By expanding the definition of “physical presence” beyond warehouses, factories and offices, and including affiliate companies (i.e., companies that are typically associated with coupon website generators), the state now has the authority to require online sellers to collect these sales taxes.  

Illinois was also one of the first states to offer an amnesty program to allow residents to retroactively pay sales taxes on items they had previously purchased online. However, the program only brought in $10 billion of the estimated $150 billion that potentially could have been paid. 

Illinois is not alone in its efforts to collect sales taxes on Internet sales. New York was the first state to pass legislation requiring online retailers to collect sales tax in 2008, and North Carolina and Rhode Island followed suit in 2009. States such as Iowa, Maryland, Mississippi, New Mexico, and Tennessee and many others have also introduced similar legislation. California even cut a deal with Amazon.com where the company agreed to drop a lawsuit challenging the pending legislation in return for the push back of the tax collection date by one year. 

Although the Illinois law could have brought in millions of dollars in tax revenue for the state, dramatically decreasing the budget deficit, it was recently ruled unconstitutional by Cook County Circuit Judge Robert Lopez Cepero. The complaint, which was filed by the Performance Marketing Association against the Illinois Department of Revenue, alleged that the law violated the Commerce Clause and the Federal Internet Tax Freedom Act (IFTA). The suit also claimed that the tax would be burdensome on Internet retailers, which was the defense for catalogue companies’ years ago, but thanks to technology is no longer a valid excuse. The judge held that the law was superseded by the Internet Tax Nondiscrimination Act, which prohibits taxes on electronic commerce until the end of 2014, and was therefore unconstitutional. 

When the law initially passed Amazon cut ties with all of its Illinois-based affiliates, and it is unclear whether or not it will enter into new contracts with such affiliates.  

While Internet retailers are applauding the ruling, the state is still reeling from the economic downturn and trying to climb out of a deepening budget deficit. In response to the ruling, the Department of Revenue said “We respectfully disagree with the court's ruling and are reviewing our appeal options with the Attorney General's office, and we need to protect ‘brick and mortar’ stores from an unlevel playing field and we need to recoup some of the estimated $153 million that was not paid by online merchants prior to the law being implemented.”

All over the country, legislators are taking steps to ensure that online consumers pay state sales taxes during these times of economic uncertainty. Illinois may have hit a roadblock, but advocates will not stop fighting big business to get the revenue that the state is entitled to.  

For more information on the “Amazon Tax Law” see our previous Shriver Brief posts here and here. 

This blog post was co-authored by Alison Terkel.

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That Illinois is experiencing a crippling budget crisis is old news. Illinois’s budget deficit has grown to $8.3 billion in the current fiscal year, including $5.5 billion in unpaid bills—a chronic problem for Illinois state government. In fact, of the five most populous states, Illinois, along with California, are facing the most immediate problems because the emerging gaps are opening in the current fiscal year.

One way that states have tried to plug these deficits is by cracking down on the collection of the sales tax on items bought on the Internet. It’s estimated that states will lose approximately $23.3 billion in 2012 from being prohibited from collecting sales tax from online and catalog purchases, and a six-year forecast puts this number at $52.1 billion lost. With nearly every state still facing budget shortfalls, this revenue could help fund police, school teachers, and other much-needed programs. The catch has been that several Supreme Court cases precluded states from requiring a retailer to collect the tax. These cases, which dealt with catalog companies, held that requiring out-of-state companies to collect different state and local sales codes was a violation of the Commerce Clause because it imposed unreasonable burdens on them. As a result, 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. Even though retailers were not required to collect the tax, purchasers were still required to pay it, however, few even knew of this obligation let alone paid it.

Yet, technology and the e-commerce boom have changed the landscape and the rationale behind the previous court decisions. As a result, New York enacted a law defining “nexus” or presence more broadly in order to be able to require internet sellers to collect sales taxes. Six other states—Rhode Island, North Carolina, Illinois, Arkansas, Connecticut and California—have followed New York's lead, adopting similar laws that require online retailers with sales affiliates based within their borders to collect sales tax. California's law also extends the obligation to collect sales taxes to online retailers that have subsidiaries or affiliated companies in the state. South Dakota and Colorado have also passed laws requiring online retailers to notify their customers that they owe the state's use tax on purchases in which sales tax is not collected.

Illinois and North Carolina were among the first states to enact an amnesty program. Illinois’s program allowed residents to pay sales taxes on items they purchased online from June 30^th, 2004 until December 31^st, 2010 without penalty, hoping to bring in some revenue. Unfortunately the program only brought in $10.2 million of the estimated $150 million lost in Internet sales tax revenue the state could have gained with a federal law mandating Internet companies pay a sales tax. North Carolina’s program, on the other hand, specified that if Internet retailers commenced collecting sales tax on products sold to North Carolina state residents the state would, in turn, forgive taxes, penalties and interest for periods, and it would not seek information about customers who bought from them.

Additionally, in March Illinois’s Governor, Pat Quinn, signed the Illinois Internet tax law (Public Act 096-1544), which requires online retailers that work with affiliates in the state to collect sales tax on purchases made by Illinois residents and businesses. By defining and expanding the meaning of “physical presence” beyond a warehouse, factory, or office, Illinois has basically said that, regardless of whether or not a company has a brick and mortar presence in the state, if the company uses websites (either their own or by contacting with affiliates in the state) to refer business to an online retailer, it is subject to the sales tax. This is equivalent to a call center or warehouse, both of which would be considered a sufficient “nexus” under the law.  

For years Internet companies like Amazon and Overstock.com vehemently opposed such laws. Not being required to collect sales taxes provided them with a business edge over brick and mortar stores. When New York passed its law, Amazon refused to collect sales tax and brought suit challenging it. It also cut its ties with its affiliates in New York and other states that had passed similar laws expanding the definition of “nexus.”

Yet, recently Amazon agreed to began collecting the tax in California. The reason for Amazon’s change of heart after battling so long against it appears to be two-fold. First, Amazon had more of a presence in that state that any other, and it had too much to lose to try to move its business operations. Amazon has a technology division in California that developed the Kindle. Second, there were simply too many jobs in California that it would have to move across state lines, like the company had been doing in the past to avoid such laws. Finally, the amount of revenue Amazon generated from California sales encouraged it to concede.

Amazon isn’t keen on cutting the same deal with other states—it maintains divisions in several other states where it currently does not collect sales tax, claiming that its e-commerce operations are a separate company. But now that it will be paying in one state it will be harder not to do it in others.

In the meantime, legislators are realizing that federal legislation on the issue should be passed. Such legislation, the Main Street Fairness Act, (S. 2701 and H.R. 2701), was introduced in 2011 by Illinois’s own Senator Dick Durbin, and similar legislation was introduced in 111^th, 110^th,  109^th, and 108^th Congresses.

Similarly, the  Streamlined Sales and Use Tax Agreement coalition is trying to create a model uniform Internet  sales tax law. Thus far, at least 24 states have signed on to it: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming.

Technology has discredited the ”burdensome” excuse, and with budget deficits increasing and potential revenue sources limited Internet companies will not have the ability to evade collecting sales taxes much longer. With Amazon opening the flood gates by making a deal to begin paying the tax in California in 2013, states are sure to increase their pressure on companies as well as the federal government to pass the Main Street Fairness Act. 

This blog post was coauthored by Alison Terkel.

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On Thursday, March 10^th, Governor Pat Quinn signed the Illinois internet tax law (Public Act 096-1544) which will take effect immediately. This controversial law, which requires online retailers that work with affiliates in the state to collect sales tax on purchases made by Illinois residents and businesses, has been drawing heated debate across America.

A series of U.S. Supreme Court decisions starting in the late 1960s relating to catalog and mail order companies—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)—have precluded states’ internet taxing authority. According to these cases, collecting different state and local sales taxes was too complex, placed an undue burden on catalog and mail order companies, and was an unreasonable restriction on interstate commerce in violation of the Commerce Clause. The Supreme Court therefore held that only states in which a company has a nexus, i.e., the physical presence of retail outlets or distribution centers, can be required to collect sales taxes.

Technology has since made computing sales tax effortless, and 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)—have held 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 a market for its goods within the state.

Modeled after a 2008 New York law, the new Illinois law expands the meaning of “physical presence” beyond a warehouse, factory, or office to include marketing or affiliate companies and website operators who earn commissions for guiding consumers to online stores. Since it has long been established that states can require out-of-state sellers to collect sales taxes if they use independent, commission-based representatives to solicit business within the state, New York’s—and now Illinois’s—laws deem a retailer to have a physical presence within the state when it has independent affiliate websites promoting sales on its behalf within the state. Such 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.

As states continue to struggle with the effects of the recession, many are exploring options to increase revenue through internet sales tax laws. The Illinois Department of Revenue estimates that it loses between $153 and $170 million in revenue from uncollected internet sales tax. Nationwide, uncollected online sales taxes reached $8.6 billion in 2010. Legislators in at least seven other states introduced similar bills last year, and legislation passed in North Carolina and Rhode Island, but California’s, Hawaii’s, Connecticut’s and Minnesota’s bills were vetoed by their governors.

Amazon currently collects sales tax in New York—but has a lawsuit against the constitutionality of New York’s 2008 legislation—and in Washington, where it is headquartered, and Kansas, Kentucky, and North Dakota, where it has warehouses. Thus far, Amazon’s legal challenge has been unsuccessful, but regardless of its success Amazon may be on its way out of dominance as it continues to build warehouse and fulfillment centers in more locations. Texas’ Comptroller, for instance, recently sent Amazon a $269 million bill equal to four years of sales taxes to Amazon because it has a warehouse in Texas.

In response to the passage of the new Illinois legislation, Amazon notified its Illinois affiliates that it will terminate its contracts with them and stop paying advertising fees to Illinois residents who refer customers to Amazon.com, Endless.com, or SmallParts.com on April 15^th. Overstock also notified its Illinois affiliates that it will cut ties with them as of May 1^st unless the law is repealed or the affiliates move to another state without a similar law. Amazon has also threatened to cancel its 10,000 affiliate contracts in California if California’s third legislative effort in three years to pass legislation (AB 153) is successful. In the meantime, Wal-Mart, Sears, Best Buy and Barnes & Noble have issued public invitations to the any affected affiliates to join their affiliate programs instead, and the Alliance for Main Street Fairness, a brick-and-mortar retailers’ organization, has created a new website to connect terminated affiliates with retailers who already collect online sales taxes.

Amazon’s termination of its Illinois affiliates does not have much impact on Illinois consumers. They can continue to buy directly from Amazon or through affiliate websites despite the fact that Amazon will not be collecting the sales tax. Technically, however, under Illinois’s Use Tax Act customers have always been, and will continue to be, required to pay sales tax whether or not the retailer collects it. Moreover, Illinois recently implemented an amnesty program allowing customers to pay sales and use taxes on past online purchases, between June 30^th, 2004, and December 31^st, 2010, without penalty. Under the amnesty program, which lasts until October 15^th, consumers can pay this tax as part of their Illinois Form IL-1040 income tax.

Read the Shriver Center’s previous blog on the Amazon tax law for more information.

This blog post was coauthored by Ji Won Kim.

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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 111^th 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.

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