In a discussion taking place over on Jon Henke’s “The Internet Has Not Changed Everything” post, the topic of sales and use taxes has come up.  Based on the discussion, it’s clear that there is a misconception of what exactly the issues are in an online context.  So I thought I’d provide this short, but hopefully handy guide to sort it out.  I will use Amazon in a lot of examples below.  I’m not picking on them, there is just a reason this thing has been nicknamed “The Amazon Tax” and it will quickly become apparent.

The Situation (and not the one from Jersey Shore)

States typically have two kinds of taxes that apply to retail sales – sales taxes and use taxes.

Sales taxes are the easiest to understand.  When you walk into a store and buy just about anything from a pack of gum to new tires for your car, the state and local governments take their share in the form of a direct tax on your purchase.  Purchases at online retailers are exempt from the collection of sales taxes because of a 1992 Supreme Court ruling (Quill v. North Dakota) that held that companies do not have to collect sales taxes in states where they do not have a physical location (or nexus, in the court’s terms). This ruling has also been applied to collection of taxes via Internet orders.

Use taxes are a bit more complicated.  When you buy something from an out-of-state vendor (formerly through mail or phone orders, but more commonly now through teh Interwebs) you are actually required to report the value of that transaction to your state and pay a tax on it.

States are watching sales taxes dry up as consumers are increasingly turning to online retailers.  They’re no longer getting their vig, and just like the mob would be if they stopped getting their cut, the states are very upset about it.  So they are getting creative and looking for ways to get their money back.  These generally fall into three approaches:

• Laws that would force Amazon to charge and collect use taxes (since they can’t be force to collect sales taxes.)
• Laws that declare Amazon affiliates or eBay sellers to be functionally equivalent to storefronts, and therefore require collection of sales taxes.
• Laws that would require online retailers to hand your transaction history over to the state so they could assess use taxes on your purchases.

Rarely are these efforts “new” taxes, but rather they are new ways to collect taxes that are already on the books.

The Players

Against
Amazon, and companies like it.  Since they do not have to collect sales taxes, and the obligation is on you to report use taxes (which almost nobody does), it appears that your Amazon purchase is tax free.  It’s not.  Use taxes still apply, we just haven’t been paying them.  If you have filed taxes recently, you have no doubt seen a new question that asks how much stuff you bought online last year.  You likely said “none” and went about your business.  Had you actually entered a number, the form will help you figure your use tax.

Online retailers like Amazon, eBay and others without physical stores are opposed to efforts that would force them to levy taxes on purchases.  Laws that assume affiliates are equivalent to store fronts would require assessment of use taxes.  If you live in New Mexico, and make a purchase through the affiliate account of a friend in New York, Amazon could be required to collect the use tax for New Mexico and/or the sales tax for New York.

For
Traditional retailers (like Best Buy, Target, etc) who have physical locations are forced to compete with Amazon on price and convenience.  Now they face several big disadvantages.  First, they have massive overhead that come with the stores, and they also have to tack on 5-10% for sales tax.  When Amazon throws in free shipping, not to mention their low cost “Prime’ option shipping and new same day delivery, the retailers are at a significant disadvantage. On cost, convenience, and taxes, brick and mortar companies are taking it in the shorts.

They have been active in pursuing the collection of taxes by the online guys because it is a way to increase their costs (hiring accountants, lawyers and programmers to deal with the increased complexity of transactions would drive up Amazon’s costs.)

Where Things Stand

Many states are pursuing their own options to get a handle on the situation.  Those laws are being fought hard in state legislatures nationwide, and in courts.  The Appellate Division of New York’s Supreme Court is currently deciding on a law passed there, and challenged by Amazon.  Depending on the outcome, that case could get kicked up into Federal court and, some suspect, all the way to the US Supreme Court.

Within the past few weeks Bill Delahunt (D-MA) introduced a bill in Congress that would eliminate the mail/phone/Internet sales tax loophole and require state sales taxes to be collected.  This would please state governements to no end since estimates of tax that would be collected top out in the $20 billion range.

Something is very likely to happen in the near future, it’s just not clear what.

This may seem to be yet another case of large companies on either side of an issue attempting to use government policy to their own advantage.  It seems that way because it pretty much is that way.  That’s not to undervalue the argument that states are losing money, but states were pushing for Internet sales tax long before their shortfalls began.

Ultimately, it’s likely that the consumer will lose.  You’ll notice that nowhere in the argument does “just don’t charge sales taxes to offline retailers, either” appear as an option.  States rely on them.  One way or another, be it through Congressional action or court challenge, it’s likely that you will end up paying taxes of some sort on your Internet purchases.

IMHO, I just hope that the option of handing our transaction history over to the state is avoided at all cost. That would be an egregious violation of our rights – even by the standards of a government that has already shown willful and reckless disregard for protecting our privacy.