States Fight to Enforce Online Sales and Use Taxes

States are developing new ways to enforce sales and use taxes for online purchases.
William H. GorrodJuly 6, 2016

The explosive growth of online retailing over the last 20 years has increased the pressure on states to seek to enforce sales and use taxes on online purchases. This year, many states have taken significant steps to enhance their ability to enforce payment of the taxes, and to expand their taxing and enforcement jurisdictions. The outcome of the resulting disputes between online retailers and state taxing authorities will have significant ramifications for online retailers and consumers, as well as for brick and mortar stores who compete with online retailers.

William H. Gorrod, Greenberg Traurig

William H. Gorrod, Greenberg Traurig

Generally, states impose sales and use taxes on retail sales of taxable goods and services to end users. Sales tax applies to such in-state sales as a purchase of goods in a store, and state tax authorities typically do not have significant difficulty enforcing the sales tax collection obligation against in-state sellers.

Besides sales taxes on in-state sales, states impose use taxes on purchasers of goods from out of state that the purchaser will use within the state. While the use tax obligation is typically the purchaser’s responsibility, if the seller has enough connection with the state, called “nexus,” then the state has the authority to assert its jurisdiction to require the out-of-state seller to collect and remit the use tax to the state on behalf of the individual.

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If the out-of-state seller doesn’t have nexus, however, and doesn’t voluntarily collect and remit the use tax, then the state taxing authority may not receive the use tax. That’s because most individual purchasers do not report and pay use tax on their purchases if the seller does not collect it.Opinion_Bug7

Generally, an out-of-state seller has nexus in the destination state if it has a physical presence, consisting of employees or property, within the state. This physical presence standard was outlined by the U.S. Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In certain circumstances, states have extended the physical presence standard to include the presence of independent contractors, agents, or affiliates creating a market within the state (by soliciting sales within the state, for instance) for the out of state seller.

Historically, the use tax issue often arose with out-of-state mail order companies. But as internet commerce has increased, the use tax collection issue has become even more important because states have sought to enforce the use tax on online retailers’ sales to in-state purchasers.

In 2010, Colorado enacted a sales and use tax information-reporting law requiring retailers that make taxable sales to Colorado purchasers but do not collect and remit Colorado use tax to notify the customers about their obligation to pay Colorado use tax, provide an annual report to the customers detailing their purchases if the customers spent more than $500 with the retailer during the year, and provide a report to the Colorado Department of Revenue with the customers’ names and total purchases if the retailer made annual sales of $100,000 or more into Colorado.

The Direct Marketing Association (“DMA”) challenged the information reporting law as unconstitutional, and after several years of litigation, the Tenth Circuit Court of Appeals upheld the Colorado law. The DMA has until August 29 to file a petition with the U.S. Supreme Court requesting that the Court exercise its discretionary authority to review the case.

Following the Tenth Circuit’s decision in DMA, several states have enacted similar types of information-reporting requirements. Louisiana adopted a law similar to the Colorado statute that requires reporting both to the state and the consumer. Oklahoma and Vermont have enacted requirements for sellers to inform the consumers, but not the state, regarding the customers’ purchases and use tax obligation.

More states will likely follow the trend and continue to enact similar types of information-reporting legislation, and out-of-state retailers are likely to continue to fight the requirements in circuits outside the Tenth Circuit in the absence of a decision from the U.S. Supreme Court.

In the wake of DMA, besides these information-reporting requirements, several states, including Alabama, South Dakota, and Vermont, have adopted “economic nexus” standards for sales and use tax purposes, and Tennessee recently proposed similar legislation. These requirements seek to impose a use tax collection requirement on out- of-state sellers with no physical presence in the state. The tax would be based on satisfying a certain amount of sales to customers in the state.

These states have adopted the economic nexus standards, which directly conflict with the physical presence requirement provided by the U.S. Supreme Court in Quill, in order to try to have the U.S. Supreme Court revisit the sales and use tax nexus standard and overturn Quill’s physical presence nexus standard in favor of an economic nexus standard.

The South Dakota and Alabama economic nexus requirements are already being disputed in the courts. As is the case with the information-reporting requirements, other states may seek to adopt similar economic nexus requirements, and out-of-state retailers will likely argue that such requirements are unconstitutional based on Quill.

Online retailers and other out-of-state sellers should track the progress of the disputes involving the sales and use tax information-reporting and economic nexus requirements, which vary on a state-by-state basis. Further,  such vendors should monitor legislative and regulatory updates in other states where they have nexus, since those states may enact similar requirements in the near future. These disputes address the core constitutional requirements for a state to assert its taxing jurisdiction and will shape the sales and use tax landscape for online retailers and consumers for years to come.

William H. Gorrod is a shareholder at Greenberg Traurig, a law firm. He focuses his practice on state and local tax issues.