States Grab Taxes from Online Retailers

Companies that sell products online may face heavier burdens under a cluster of new state sales tax laws.
Marielle SegarraFebruary 16, 2012

Businesses that operate across state lines have long been responsible for complying with hundreds, even thousands, of diverging state and local tax laws. And for a long time, online retailers have not.

But times are changing. With coffers dwindling, a number of states have passed new laws or used their existing statutes to capture sales taxes from online purchases. More than a dozen states have such laws in place, and about as many more have similar legislation pending.

Some say that small and mid-size online businesses will be hit hard by the new laws, because they will not have the resources to comply with the many tax-reporting rules in the places they do business. “It’s an absolute nightmare from a small-business perspective,” says Marshal Kline, a member of  Dow Lohnes Price tax consulting group. “[The requirement] is a huge obligation and potentially a large barrier for growing companies.”

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Lawmakers, business groups, and states hope that one of several federal bills queued up in Congress will offer a compromise.

Locking Horns

There are 45 state tax systems and more than 7,000 local ones in the United States. (Five states don’t collect sales taxes.) Many of the laws differ on details and definitions. In New York, for instance, most food sold in grocery stores is exempt from taxation. But there are a number of exceptions. Supermarkets in the state must collect sales tax on chocolate candy, for example, but generally not on chocolate used for cooking.

But online retailers never had to pay too much attention to these details, because the Internet allows them to avoid collecting sales tax by doing business in states where they don’t own stores or factories. In 1992, the Supreme Court ruled in Quill Corp. v. North Dakota that businesses aren’t responsible for collecting sales tax from customers unless they have a physical presence (“nexus” in tax terminology) in the places their customers live or to which the companies ship purchases. 

The Supreme Court ruled this way because it believed complying with so many conflicting state laws would be a hardship for companies, says Susan Haffield, a partner at PwC. “[The Court felt] it would be very burdensome for businesses to have to know all of the laws in all of the states,” Haffield says.

Internet retailers like agree, saying their business model puts them in a unique position. Since they ship products across the country, it would be unreasonable to ask them to to comply with the thousands of applicable sales tax laws, they say.

But business groups like the National Retail Federation have long argued that allowing online retailers to skip out on collecting sales tax gives these retailers an unfair advantage over brick-and-mortar companies. The states agree, saying companies that operate online should have to collect sales tax like every other business.

The Push from the States

Hungry for revenue, the states are quickening their pace, passing new laws and finding other creative ways to collect sales tax from online purchases. Some of the laws include exemptions for companies on the smaller end, though each differs in approach.

Some states, such as New York, have introduced “click-through nexus” laws. Under these statutes, if an out-of-state online retailer asks an in-state company to solicit sales — perhaps paying the in-state company a commission for linking to its website — that retailer would then have to collect sales tax on purchases in the state.

Other states are applying statutes they already have to set up click-through nexus, says Kline. If a company has an agreement to link to, for instance, its state of residence may try to argue the company is an “agent” of Amazon and then require Amazon to collect sales tax on purchases sent to the state, he says.

States are also passing “affiliate nexus” laws that require each online retailer that has an affiliate with a store or other physical presence in a given state to collect sales tax from all customers in that state, even if a purchase is made on the online retailer’s website.

And some states, like California, are making one-time deals with, allowing the company to stay in the state tax-free for a period if the company stops fighting the new state sales-tax collection laws, for instance. 

The Federal Response

Companies like are criticizing the flurry of state laws and pushing for a federal law that would standardize the state tax systems. Amazon is not alone in this. Many states and brick-and-mortar business groups agree that a federal law could help fill state pocketbooks by making it easier and less costly for companies to collect sales tax.

With that in mind, legislators have introduced three bills in Congress that would do just that: the Mainstreet Fairness Act, the Marketplace Fairness Act, and the Marketplace Equity Act.

The first two bills allow states to demand sales tax on purchases from large online and mail-order retailers if those states join the Streamlined Sales and Use Tax Agreement (SSUTA), a project created by some of the states to standardize the tax system and try to “convince Congress to enact federal legislation that would overturn the Quill case,” says Haffield. 

Under the SSUTA, state and local jurisdictions each have one tax rate, or possibly two. All the states must define products, like candy, the same way. For instance, states that adhere to the SSUTA do not collect sales tax on cereal bars that contain flour, because they all define that product as “food.”

To lower business expenses, each state must offer one central database or location for companies to file their taxes. The agreement also offers an exemption for small retailers that make $500,000 or less in national remote sales per year.

As of 2012, only 24 states have signed onto the project. Absent are the largest states, including New York, California, Illinois, Texas, and Florida.

Under the Marketplace Fairness Act, states that decline to join the SSUTA can also require sales tax collection on remote purchases if they simplify their taxation policies according to the bill’s standards.

The third bill, the Marketplace Equity Act, also attempts to streamline sales-tax collection but remains independent of the SSUTA. Each of the proposed laws would make an exemption for small retailers, though the Mainstreet Fairness Act and the Marketplace Equity Act leave room for the states to define what’s “small.” The Marketplace Fairness Act requires companies to make $500,000 or less from remote sales to qualify as small.

Unlike Amazon, online retailers like eBay oppose the federal bills, saying that it would be too difficult for smaller companies that sell through their websites to comply.

Until Congress passes federal legislation or unless the Supreme Court takes up the issue again, the uncertainty over state tax collection will continue to escalate as states pass their own solutions to the problem. “I think the scary story right now is the fact that you’ve got every state dealing with it differently,” Kline says.