Navigating Sales Taxes in Online Markets

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States reconsider traditional sales tax requirements for e-commerce retailers.

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Benjamin Franklin said that nothing could be as certain as death and taxes. In today’s booming online marketplace, however, taxes have been anything but certain.

Traditionally, only business with a “physical presence” within a state –such as a store or a factory—could collect and remit sales taxes on consumer purchases. Online retailers, including eBay, Etsy, and Amazon, have been able to avoid many of these sales taxes by minimizing their physical presence within states.

The tax-free status of Internet sales, however, may quickly change. As of April of this year, Amazon.com—one of the largest worldwide online stores, with sales reaching $136 billion in 2016—started collecting sales taxes nationwide in all U.S. states that currently impose a tax.

In a 1992 case called Quill Corporation v. North Dakota, the U.S. Supreme Court held that, under the U.S. Constitution’s Commerce Clause, a taxpaying vendor must have a “substantial nexus” to a state before that state could impose a sales and use tax requirement on the vendor. The Court clarified that, in order to fulfill the substantial nexus requirement and to “further the ends of the . . . Commerce Clause,” the vendor must maintain a physical presence in that state. The primary purpose of the physical presence requirement, according to the Court, was to ensure that taxpayers engaged in interstate commerce were not “unduly burdened” by compliance costs. The physical presence test would act as a bright-line rule to avoid a “case by case evaluation of the actual burdens imposed by particular regulations or taxes.”

But what qualifies as having a physical presence in a state? The Supreme Court did not say what, exactly, constitutes physical presence. In subsequent cases, the Court did, however, leave some clues. For example, delivering shipments in the state through common carriers, such as the United States Postal Service, was not a physical presence; but operating two stores through an unrelated sister corporation marked a sufficient physical presence.

Under traditional “brick-and-mortar” retail sales, the physical presence test is relatively straightforward. The advent and subsequent boom of online sales, though, has been harder to fit squarely into this regulatory tax scheme.

Online retailers, like Etsy and eBay, typically operate and advertise their businesses online, avoiding the physical presence requirements for state sales taxes. Consumers who buy online goods “sales tax-free” are technically required to make sales tax payments on their own to their home states; however, because these buyer compliance laws are generally unenforced, the sales tax payments slip through the cracks. It is estimated that states lost approximately $23.3 billion in revenue in 2012 from online purchases.

Even with Amazon’s changing the lay of the land for the collection of e-commerce use taxes, some scholars are still skeptical that the online vendor’s actions will be enough to convince the Supreme Court to reexamine its Quill ruling and allow states to tax sales transactions even without the seller’s physical presence in the state.

Hayes Holderness, a professor at the University of Illinois College of Law, argues that the Quill Court never explained the basis for its required substantial nexus between the taxpayer and the taxing state. The shift to Internet-based selling may make the physical presence test an “awkward jurisdictional rule,” Holderness argues.

Referring to the “Kill Quill” movement—a legal strategy adopted by several states seeking to strike down Quill’s physical presence test and collect use taxes on online purchases—Holderness argues that technological and economic circumstances have not changed enough to “merit reconsideration of the rule”—just yet. Still, states have already started changing local tax laws and regulations to be able to collect on these lost Internet sales.

For example, in 2009, the New York State legislature amended the definition of “vendor” in its sales tax statutes to include online vendors. The amendment required large Internet retailers –with sales to New York customers exceeding $10,000—to collect sales tax from New York customers if the retailers maintained a “click through arrangement” with a New York seller.

More recently, the Massachusetts Department of Revenue released a directive requiring sales tax collection from out-of-state Internet vendors with over $500,000 in annual in-state sales. To meet the Quill standard, the directive explicitly mentions that the use of in-state software and “cookies”—text data files stored in the user’s computers—qualifies as a physical presence in the state. In July 2017, the Massachusetts Department of Revenue reportedly issued a proposed regulation that would implement the directive’s obligations.

Despite Holderness’s skepticism over the possibility of fast-paced change, challenges to Quill’s foundation are even being pursued at the federal level. Earlier this spring, a team of senators introduced the Marketplace Fairness Act of 2017, which would allow states to collect taxes on Internet sales. The proposal would require states that are members of the Streamlined Sales and Use Tax Agreement—an agreement to improve the efficacy of interstate sales and use tax administration systems—to collect and remit sales and use taxes on out-of-state online sales made within each state. The bill, S. 976, notes that although “collecting sales taxes in multiple states was once difficult, technology has eliminated historic burdens and costs.”

The photograph of an Amazon, Inc. warehouse is used unaltered under a Creative Commons license.