Sales Tax Loophole Means State Loses Revenue

Monday, November 29, 2010 at 7:15 PM by

Today is “Cyber Monday,” one of the biggest days of the year for making online purchases. Due to a loophole in sales tax regulations, the state misses out on revenue that would otherwise be generated by state residents making purchases on the Internet. The state of New York has won a court case against that will make it more likely that states can collect sales tax on online purchases, but Amazon is expected to continue to make colleting those taxes very difficult for most states, unless they work together.

Collecting sales tax on Internet purchases has long been a thorny issue. Sales tax is due on these purchases, but states can’t compel many Internet sellers to collect the tax. A Wisconsin Budget Project publication from earlier this year explains the whys and hows of this situation, and Michael Mazerov of the Center on Budget and Policy Priorities does a good job of summing up the dilemma:

“The U.S. Supreme Court has held that catalog (and, by extension, Internet) sellers don’t have to charge sales taxes to customers located in states in which the seller doesn’t have a ‘physical presence’ – such as a store. Purchasers in such states are legally obligated to pay an equivalent ‘use tax’ directly to their state, but very few do. This exemption costs state and local governments billions of dollars annually that they badly need to fund everything from education to public safety. It also kills local jobs by giving Internet and catalog merchants a 5 to 10 percent price advantage over Main Street businesses.”

But has facilities in Wisconsin (according to their annual report), so Amazon must be required to collect sales tax on purchases by Wisconsin residents, right? Unfortunately, no. Amazon and other Internet companies create subsidiary corporations to own these facilities and then successfully argue that the presence of the subsidiary corporation in a state doesn’t obligate the parent corporation to pay sales tax there.

These legal shell-games have a big-time effect. In 2011 alone, Wisconsin will lose an estimated $127 million in uncollected sales tax on purchases made online, according to a University of Tennessee study. To put this in perspective, that’s almost as much as the state spends on the entire technical college system in General Fund dollars each year. Steve Contorno explains additional effects of the sales tax loophole in an article for the Green Bay Press-Gazette.

The problem of uncollected sales tax could be easily solved at the federal level. The Supreme Court has said that Congress could enact legislation requiring all retailers to collect sales tax regardless of whether they have a physical presence in the state. But Congress has taken no action, and several states have taken matters into their own hands.

New York, along with a few other states, has taken action by enacting what is often referred to as an “Amazon law.” This legislation requires Internet retailers to collect sales tax if members of their “affiliate programs” are located in that state. (Affiliates are other businesses or nonprofits who post advertising for that retailer on their website and then get a commission when someone makes a purchase.)

In response, Amazon sued New York. The modest step forward that I referred to in the first paragraph is that New York won its case in the appellate court, confirming an earlier victory in the trial court.

Amazon, though, is playing hardball. When North Carolina and Rhode Island enacted legislation similar to New York’s, Amazon discontinued the affiliate programs there. When Colorado passed a law requiring Internet retailers to tell Colorado customers they may owe sales tax on their purchases, and also tell the state the total dollar value of items purchased by each purchaser, Amazon discontinued its affiliate program in Colorado.

The lesson here is that it’s difficult for states to act on their own and get the hoped-for results. There’s power in numbers, though, and if states work together to take action – especially states with a lot of economic clout like California and Illinois – then Internet retailers may show more of an interest in working with states to collect the sales tax due. There’s already a movement afoot to encourage voluntary compliance, of which Wisconsin is part.

This court victory has helped smooth the way for states to collect sales tax due. Internet retailers continue to fight any action taken by the states, so news of progress is welcome. Wisconsin is not likely to be able to collect that sales tax in the near future, but we should watch for opportunities to collaborate with other states on this issue.

Tamarine Cornelius

P.S. Don’t forget to check out the Wisconsin Budget Project publication for more information about the steps Wisconsin has taken to level the playing field between Internet and Main Street retailers.

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