State governments are applying pressure on Congress to restructure online sales tax. Currently, online sales tax follows the same guidelines as mail, catalog, and phone retail orders. In 1992, almost 25 years ago, the U.S. Supreme Court ruled in Quill v. North Dakota that states are not required to collect taxes from remote retailers who do not have a physical presence in that state. In legal terms, a physical presence is referred to as a “nexus,” and can be anything from a storefront, an office, or warehouse.
States and local governments are in favor of a more structured online tax system because it would result in more funding. Under the current law, since retailers are only required to collect taxes where they have a physical presence, they are not required to collect tax from customers who live in other states. If tax is not collected at the time of purchase, but a consumer lives in a state that has sales tax, the consumer is responsible for reporting and paying that sales tax. Obviously, this almost never happens. Internet Retailer estimates state and local governments would receive $15 billion in additional sales tax if all online orders were subject to tax. For brick and mortar stores, local and state taxes are charged and collected onsite, and turned over to the government immediately. For online retailers who deal with customers across the country, the issue is more complex.
In 1992, when the original ruling was passed, there were very few computers in every day retail use. Having mail or phone order retailers handle taxes for all 50 states would have been an arduous task. However, the technology landscape has changed with computers and ecommerce. Over time, the technological changes have led to an increase in sales, but not taxes, which many states view as lost revenue. Proponents argue that software and technological advances will make it easy for online retailers to recalculate their tax system, and that the current ruling does not accurately reflect today’s reality.
Online retailing is a huge industry, generating at least $4 trillion annually. This number is significantly larger than the sales from remote phone and mail orders from back in 1992. According to Forbes, “U.S. retail e-commerce sales for the second quarter of 2016, adjusted for seasonal variation, hit a whopping $97.3 billion. Since many online retailers aren’t collecting sales tax – either because they’re not required to or they choose not to – states are losing millions of dollars in sales tax revenue each year.”
What’s at Stake?
There are several moving parts to this issue. However, any changes in the law would result in some legwork for online retailers. There are literally thousands of different tax codes and rates for different towns across the country. It is a possibility that online sellers will need to be equipped to handle and charge for those rates appropriately. The most commonly suggested solution is a software system that will handle this automatically. This system may or may not be partially or fully subsidized for retailers. There is also a learning curve for the software on the retailer’s side. Not to mention the learning curve for consumers who are used to paying, or not paying, certain tax rates with individual stores.
If online retailers are obligated to collect sales tax for each area to which they send product, e-retailers will also be open to auditing by every one of those individual local governments. The likelihood of independent retailers actually being audited may be small, but it would still be a possibility for which online retailers would need to be ready.
Marketplace Fairness Act
The Marketplace Fairness Act is the proposed legislation that is currently pending in the U.S. Congress. This legislation would allow state governments to collect sales and use tax from remote retailers who do not have a physical presence, or “nexus,” in that state, providing that the state has simplified their tax laws according to the guidelines outlined in the Marketplace Fairness Act. Small businesses with less than $1 million in annual remote sales would be exempt from collecting taxes.
Similar bills have been presented before, and have expired before they were voted upon, or have lost traction while in congress. It is uncertain whether or not anything will be decided with the current pending legislation, but mounting pressure from local governments indicates a decision is likely in 2017. Stay tuned.