Internet Sales Taxes

By a vote of 69-27 the U.S. Senate has passed a bill called the Marketplace Fairness Act which allows states to collect sales taxes from online sellers whose out of state sales are $1 million of more. Whether the House of Representatives also will pass it is yet to be determined. There are pros and cons about the bill.

Some Pros

It is indeed true that states have not been able to collect internet sales taxes on shipments into their states by out-of-state merchants unless the seller has nexus in the ship-to state. Nexus could be established by having a warehouse, office, or even an outside sales person. As an example, if a company in Georgia that does not have nexus in California sells and ships to a customer in California, they have not been required to collect and remit California sales taxes As internet sales grow this will increasingly have a negative impact on the states’ sales tax revenues. This has been a sore spot with local brick and mortar retailers who have to collect sales tax. Of course it they ship to a state where they do not have nexus they have gotten the same exemption. This bill may seem to level the playing field for local retailers versus online retailers. There is one other benefit to the bill in the bill that requires participating states to provide free software to calculate the sales taxes. There is certainly a case for this bill, but there are numerous reasons why it will tilt the balance in the other direction.

Jurisdictions, Jurisdictions.

There are around 9,600 sales tax jurisdictions in the U.S., comprised of states, counties, cities and local entities. Not all these taxing authorities go by the same rules. As an example, some tax food, some don’t, and others tax at a different rate than for other items. The sheer number of jurisdictions and the varying rules make this highly complex for the internet seller to implement and monitor. Even though the states are required to furnish free software to calculate internet sales taxes, there are potentially some major issues there, such as:

  • Will the sellers be able to integrate the software into their shopping cart system?
  • If each state furnishes its own software, will that mean that a seller may have to integrate 50 software programs with their shopping carts, and what will it cost them to do this?
  • If the software calculates the taxes incorrectly, who is held responsible – the state or the seller?
  • Will the software also file the returns or will the internet sellers have an extra burden preparing the returns for as many as 50 states including the one where they are located?
  • How will remittance occur? Will there be 50 different ways?
  • Will internet retailers have to deal with sales tax audits by 50 states and possibly individual jurisdictions?

Not Exactly Balanced

The diagram below shows how the balance may be skewed the other way.

scales

As you can see above, without internet sellers having to collect sales taxes for so many states there is still a competitive balance. Unlike local businesses, internet retailers pay shipping costs to customers. If this is not passed on to the customer then the seller sees their profit reduced. If they pass it on to the customer there may be resistance on the part of customers, particularly with low-cost items. People generally don’t want to pay $10 shipping for an item that cost $15. So, there really is more balance than you may have been led to believe. While the local retailer collects sales tax, the internet retailer pays incurs shipping costs. Both impact what the customer pays. The right side of the picture shows how the internet business is at a disadvantage if they have to collect sales tax.

Some Ideas

Because the push by states to be allowed to collect sales tax from internet retailers is unlikely to go away, here are some possible alternatives that are less complicated:

  1. Pay a national sales tax at some lower rate and have this allocated to states based on population. (I personally think this is not a great solution)
  2. Sellers furnish to states information on who they sold to in their state and how much. Then the states can make these individuals pay the use tax that were suppose to be paying all along. This is messy and creates too many returns.
  3. Let each state set a rate for their state. The internet merchant remits the sales taxes collected and the states allocate to the various jurisdictions. This could get a bit dicey if the states decide to set a high rate.
  4. Establish one rate nationwide for all states where a seller does not have nexus. Then remit to each state the sales tax collected and the states will allocate to the jurisdictions. Ideally this rate would be a little lower so as not to excessively distort the competitive advantage one way or the other. (This is my preferred method, but you may certainly disagree)

What are you thoughts? Do you think the bill should pass as written, be modified to one of the above methods, or is there another alternative that will work better?

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As always, your comments are welcomed.

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