States, E-Tailers Clash Over Sales Tax

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Love to shop on the Internet? Maybe spend hundreds, possibly thousands of dollars a year? If you're like most Americans, you probably weren't aware -- or chose to ignore -- the sales tax owed to the state where you had your purchases shipped.

But the states aren't ignoring it. In fact, momentum is building to have out-of-state Internet retailers collect the sales tax, since it's difficult to force every online shopper to figure out and fork over the taxes owed to their respective states.

And the money left on the table is huge -- an estimated $23 billion in uncollected taxes will be owed to the states by 2012.

Since the start of the year, a number of states from California to Tennessee have introduced legislation to force out-of-state Internet retailers to collect sales tax from online shoppers. Illinois is the latest, with Gov. Pat Quinn signing HB 3569 into law on Thursday, a move that prompted e-commerce giant Amazon.com (AMZN) to terminate its relationship with 9,000 affiliates rather than collect the sales tax. California, meanwhile, held a revenue and taxation assembly committee hearing last Monday to address AB 153, authored by Rep. Nancy Skinner (D-Oakland). The committee is expected to take a vote on the measure in the coming weeks.

"If everybody paid the sales tax that's due, the states' budgets wouldn't be as bad as they are," says Diane Yetter, president of Yetter Consulting Services and the founder of the Sales Tax Institute.

Circumventing a Supreme Court Decision

New York was successful in passing legislation in 2008, when it found a way around the U.S. Supreme Court's Quill v. North Dakota decision. That 1992 ruling said retailers or sellers had to have a physical presence in the state, in order for the state to require them to collect sales tax on its behalf.

New York was like a number of other states that are watching their sales tax revenue come under pressure, as Internet shopping soared. But New York took a novel approach in addressing its dilemma, with the so-called "Amazon Law." The state deemed any New York-based affiliates used by out-of-state Internet retailers, like e-commerce giant Amazon.com, provided a physical presence to the out-of-towner. Affiliates run their own website but will post a retailer's advertisement or links on their site. In exchange, the affiliate gets a commission if a reader clicks on that ad or link and then continues to the retailer's site and makes a purchase. The law applies to retailers who receive a total of more than $10,000 in referrals within a 12-month period from New York affiliates.

Rhode Island and North Carolina quickly followed New York's lead with the passage of their own "Amazon" bills. But the e-commerce giant filed a lawsuit against New York shortly after the law passed, claiming affiliates should not be construed as a physical presence. A New York state appeals court ruled in November that the state's new law is constitutional and enforceable, unless a retailer can show on a case-by-case basis their own particular situation makes the law inapplicable.

In addition to its New York lawsuit, Amazon also terminated its relationship with North Carolina and Rhode Island affiliates, rather than collect and remit sales tax to those two states. But despite Amazon's actions -- and its threats to dump affiliates in other states that pass similar legislation -- a number of states have moved forward in introducing "Amazon" legislation.

States with "Amazon" Bills Pending

Here's a list of states with bills pending that would require out-of-state retailers to collect sales tax from online shoppers, if they use affiliates within that state: In California, opponents and proponents of AB 153 packed a hearing room last week. Supporters of the bill claim out-of-state retailers get an automatic price advantage, since they don't collect sales tax. Opponents, meanwhile, declared their livelihoods will be threatened if the bill passes, predicting the out-of-state advertisers they rely on for income will terminate their relationships, rather than collect the sales tax.

Rep. Skinner rounded up signatures of 103 supporters -- from big box national retailers like Home Depot (HD) to powerful organizations like the California Teachers Association, which relies on state coffers to fund education. She also received support from mom-and-pop businesses, like independent bookstore Moe's Books in Berkeley, Calif. Opponents, led by Performance Marketing Association, had 29 signatures from supporters -- ranging from the California Small Business Association to the Howard Jarvis Taxpayers Association, to a wide breadth of independent businesses such as Roy's Trains & Things in Clovis, Calif.

Barnes & Noble (BKS), which employs more than 4,100 workers and operates nearly 110 stores in California, paid approximately $45 million in sales tax last year, according to Gene DeFelice, the book giant's general counsel, who spoke at the hearing.

Taxes Ignored with a 'Wink and a Nod'

"This has become a serious competitive issue," DeFelice said. "Those of us who pay taxes and employ California workers and operate stores in communities across the Golden State are in a serious competitive disadvantage that is not sustainable. This pricing advantage is approximately 10% and the ironic thing is that the sales tax is still due. It's just not being paid. It's just receiving a wink and a nod. There is an irony here where we're putting California businesses out of business."

According to report last year by San Diego State University professor Richard Parker, California-based businesses lose an estimated $4.1 billion annually to online retailers. Those losses are expected to rise to $7.7 billion in 2015 and $14.3 billion 2020, Parker's report estimates the equivalent of 18,300 full-time jobs are lost to out-of-state online sales -- with that figure projected to increase to 34,100 in 2015 and 63,400 in 2020.

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The state's Board of Equalization (BOE), meanwhile, estimates $1.1 billion is lost annually in uncollected sales and use taxes. But opponents say Amazon and other out-of-state retailers will drop their affiliates if pressured, resulting in no new sales tax collected. And the in-state website operators will have to leave the state to maintain their livelihoods.

Online shoppers, meanwhile, would still be able to circumvent paying sales tax even if any of these bills pass by going directly to the out-of-state retailer's website, or an out-of-state affiliate's website, to make their purchases.

Currently, California has an estimated 25,000 affiliates -- and Amazon told the BOE it would drop its 10,000 affiliates in the state if AB 153 goes through. Amazon declined to comment for this story and did not appear at the hearing.

The BOE estimates state and local revenues would rise $317 million in the fiscal 2011-to-2012 if everything stays the same with the number of affiliates. But factoring in an Amazon pullout, that anticipated gain would shrink to $114 million in the same period. California jobs at affiliates are also expected to be hurt by the bill, the BOE says, as well as revenues from personal income tax and corporation tax, but the scope of that shrinkage is unknown.

Of the 25,000 California affiliates, 25% operate their businesses full time and 4% have more than five employees, says Rebecca Madigan, executive director of Performance Marketing Association. She says California affiliates generated $1.6 billion in revenues in 2009 and paid $124 million in state income taxes.

Surfmyads.com, which has relationships with 15,000 retailers for its discount coupons, says its business has grown to 20 full-time employees since it formed in 2006 in Santa Barbara, Calif. And the company is on tap to hire an additional 10 more employees this year.

"We continue to grow and continue to contribute back to California," says Alexis Caldwell, its director of affiliate and strategic partnerships. "We're proud to be from California. We're proud to be a California business. I was raised in Sacramento. We don't want to go anywhere. We want to stay here, so please, please, please, I urge you to say 'no' to AB 153."

The Tip of the Iceberg

And collecting state sales tax in the Internet era, says Diane Yetter, is only going to get more complicated.

Some states, for example, have finally figured out how they each want to treat downloaded software. California considers such software an intangible product that is not taxed, while Illinois assesses a sales tax on it. But as cloud computing, and streaming audio and video, ramp up in demand among businesses and consumers, the sales tax conundrum is once again rearing its ugly head -- as purchases are made over the Internet.

"Some states tax access services, so streaming software will likely be taxed," Yetter says. "In many states, you're taxed on software downloads because you acquire it and take possession, but with streaming software you never take possession."

Virtual currency is also another taxing affair that some states will need to tackle in the future, Yetter predicts. Virtual currency is frequently used in online games to buy points -- and those points can be used, in some cases, to buy tangible products, like a pizza that's delivered to your door.

"I'm not aware of any states that are addressing this right now, but this will be one of the next big challenges," Yetter says. "Technology moves very fast and there's a lot of confusion on how you tax it."

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