Think Buying Online Is Tax-Free? Think Again

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The endless choices, the convenience of home delivery and the absence of sales tax draw many American shoppers online. But there's a wrinkle to that last benefit: Even if the site doesn't collect sales tax, those who live in the 45 states that charge sales tax are still liable for it.

It's called a use tax, and use-tax laws allow states to impose taxes on online and mail-order transactions from out-of-state retailers. A Supreme Court case in the early 1990s confirmed the longstanding requirement that in order for a state to collect sales tax from an out-of-state company, the company has to have a sufficient connection to justify the tax. In practice, that has meant Internet companies with distribution centers, corporate offices or other facilities within a certain state. But companies that only sell to residents without any additional activity aren't.

Because a state always has taxing power over its residents, use-tax laws are aimed at buyers. The use tax mirrors the sales tax rate, and it's designed only to take effect for items for which those purchasers didn't pay sales tax. Compared the infrastructure set up to collect taxes from businesses as they, well, do business, it's much harder to collect use taxes from people.

In addition, many people don't even know about use tax. According to a recent survey by Toluna QuickSurveys for TaxAudit.com, nearly half of Americans don't realize that they're responsible for use tax on online purchases, and three-quarters have no idea how to pay the tax. As a result, the survey found that 62 percent of Americans won't declare any use tax.

States Fight Back

The 45 states and the District of Columbia (which also has a sales tax) are fighting on several fronts:
  • They have lobbied hard for a federal law that would explicitly grant them the right to impose sales-tax collection responsibilities on out-of-state sellers. The Marketplace Fairness Act passed the Senate last year, but the House hasn't yet come up with its own version of the bill. Proponents argue that imposing sales tax levels the playing field level for brick-and-mortar and online retailers, while opponents say retailers would have to deal with thousands of combinations of state and local taxes.
  • They have negotiated with online retailers. Amazon (AMZN), for instance, has made agreements with 19 states to collect sales tax, with Indiana, Nevada, and Tennessee added to the list at the beginning of this year. Given the huge amount of business Amazon does, the moves could add more than $50 million to those three states' coffers. Yet even though Amazon supports a federal sales tax law, it has still fought sales taxes in certain states.
  • They have increased efforts to collect use tax. Some include use-tax items on state income tax returns, making filers state any untaxed purchases they made. Others provide safe-harbor use-tax amounts, letting taxpayers pay a fixed amount of use tax rather than having to record every untaxed purchase.
Given the pressure that state finances are in, shoppers should expect the battle for sales and use taxes to continue. Eventually, the tax-free status that many have believed online shopping gives them could well disappear for good.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google Plus. He doesn't own shares of the stocks mentioned in this article. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com.

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