The Main Street Fairness Act: Explaining Internet Sales Taxes

Legislative Update:   On July 1, 2010, House Bill (H 5660), was introduced in Congress by Massachusetts representative, William Delahunt. The Bill, named the “Main Street Fairness Act“ states that its purpose is to “promote simplification and fairness in the administration and collection of sales and use taxes, and for other purposes.”

My guess is by now, you’ve likely heard about the Main Street Fairness Act, as reporters, commentators, industry groups, legalists, retailers, bloggers, your mother, and just about everyone else, has an opinion on it. This isn’t surprising as a major focus of the Main Street Fairness Act is the hotly debated issue of internet sales taxes. This isn’t a new debate, as the issue of whether sales made over the internet should be subject to sales tax has been widely discussed for at least decade now, and it isn’t the first time similar legislation has been introduced. Proponents of an internet sales tax include brick-and-mortar retailers whose “physical presence” in their state requires them to charge sales tax, and who argue, therefore, that this puts them at a disadvantage against certain on-line retailers who are able to sell the same merchandise to the same customers “tax-free”. Also in support of this legislation are the state and local tax governments who lose billions in state revenue dollars each year to uncollected sales and use taxes. It should come as no surprise that opponents of the Act include the biggest of the big on-line retailers, such as Amazon.com and eBay. These and other on-line retailers have argued for years, that a 1992 U.S. Supreme Court decision, Quill Corp. v. North Dakota, does not require them to charge and collect tax on sales to customers in states in which the on-line retailers lack “substantial nexus” (more on this in a minute). These retailers have also long argued that imposing a sales tax collection responsibility on them would create a disproportionate administrative burden, especially on small on-line retailers who would need to navigate a complex system of tax rates in order to properly collect sales tax from customers located in thousands of different jurisdictions. (see eBay’s Policy Paper on this topic)

Brief Summary of the Main Street Fairness Bill

If you think the Bill is a way to “stick it to the big guys” and force them to pay more in taxes, you’re wrong. The internet sales tax isn’t a tax expense to the on-line retailer; it isn’t a means to force mega on-line retailers like Amazon.com to pay “their fair share” of taxes. The focus of the Bill is to require on-line retailers to charge and collect sales tax from you, the consumer, and remit the tax they collect to the state or local government to which that tax belongs.

So, here’s a brief overview of some of the key points of the Main Street Fairness Bill. The Bill, which states that its purpose is “to promote simplification and fairness in the administration and collection of sales and use taxes”, is based on several key findings, including that sales transactions should be taxed equally, regardless of how they are transacted (in person, over the phone, or on-line), that Congress has the power to facilitate equal taxation and make this law based on the 1992 Supreme Court decision, Quill Corp. v. North Dakota, and that states that voluntarily and adequately simplify their tax systems should have the authority to require sellers to collect sales tax regardless of where the seller is located. The Bill gives Streamlined Sales and Use Tax Act Agreement (“SSUTA”) member states, the authority to require sellers to charge and remit sales tax on sales to customers in those member states. In a nutshell, if this legislation passes, these particular states will have the legal right to require on-line retailers to charge sales tax on internet sales made to customers in their state. As of July 2010, full SSUTA members states include Arkansas, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Oklahoma, Rhode Island, South Dakota, Vermont, Washington, West Virginia, Wisconsin, and Wyoming. Although this sounds like a sweeping change, keep in mind the requirement to charge and remit sales tax would only apply to sales to customers in the SSUTA member states, only after specific events have occurred and only after several operational processes have been put into place. If you’d like to know more details about the Bill, click on this link to H. 5660.

Why Is It That On-Line Retailers Aren’t Required to Charge Sales Tax 

In order for a state to impose a sales tax collection requirement on an out-of-state retailer, the retailer must have a sufficiently significant “connection” or “tie” to the state, in other words, “substantial nexus” must exist.Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Briefly, Quill was a Delaware based seller of office equipment and supplies whose customers in North Dakota made purchases of Quill merchandise through the company’s catalog. Quill did not charge or collect a sales tax on sales made to its North Dakota customers. As a result the North Dakota Commissioner of Revenue attempted to assess Quill for the use tax (essentially the sales tax) due on purchases made by Quill’s North Dakota customers. Quill responded that since the company had no physical operations or employees in the state, it did not have that sufficient “connection” or “nexus” to North Dakota that would permit the State to require Quill to collect this tax. Ultimately, the case made its way all the way up to the U.S. Supreme Court which held in favor of Quill, stating that when a company participates in interstate commerce within the borders of a state, that company must have “substantial nexus” (achieved through physical presence, e.g., offices, employees) to the state in order for the state to require collection of sales or use tax for purchases made by in-state customers. Quill is still good law today, at least for now, and it is this holding that has allowed on-line (and catalog) retailers to avoid charging sales tax in states in which those retailers have no physical presence. Another significant statement the Supreme Court made in Quill is that Congress has the power to change the law. But states have long waited for Congress to act, and in the meantime, have enacted laws that go beyond the traditional physical nexus concept in an effort to bring more revenues into their state.

The Internet Tax Freedom Act of 1998 Does NOT Prohibit the Taxation of On-line Purchases

I believe many people are under the false impression that the 1998 Internet Tax Freedom Act is the reason why purchases made over the internet aren’t always subject to sales tax. I believe this since I am very often asked this very question, which goes something like this, “Isn’t there some type of internet law that prevents internet sales from being subject to sales tax?” No! This is not what the Internet Tax Freedom Act is about. To clarify, the 1998 Internet Freedom Act was passed in order to promote and preserve the commercial, educational and information potential of the Internet. Under this Act, federal, state and local governments are prohibited from imposing a tax on internet access, imposing discriminatory internet only taxes (e.g., a tax on e-mail), and imposing multiple taxes on electronic commerce. The Internet Tax Freedom Act specifically does not exempt sales made over the internet from sales tax, nor does is repeal any state sales or use tax. It only mentions that sales made over the internet are to be taxed (if they are taxable) at the same rate as non-internet sales. The provisions of the Internet Tax Freedom Act have been extended several times since the Act’s original enactment, and will remain in effect until at least November of 2014.

Purchases Made Through the Internet are NOT Tax Free

Perhaps one of the biggest misconceptions regarding internet purchases is that these purchases are being made “tax free”. Here’s a statement we’ve all heard (and maybe have even made ourselves), “I’ll just buy it on the internet and save on sales tax”. The reality is, if you’ve purchased merchandise on-line which is considered taxable in the state in which you reside, and the on-line retailer did not charge a sales tax on the transaction, a tax is still owed to the state, and you, the purchaser, the ultimate consumer, are now the party that is are responsible for the remitting use tax (i.e., sales tax) to your state. The only consumers who truly are able to make purchases over the internet “tax free” are those that are residents of, or businesses that are located in, one of the four states that do not impose a sales tax; New Hampshire, Montana, Oregon and Alaska.

I’m Supposed to a Pay a “Use” Tax? I’ve Never Heard This Before! Tell Me More

Perhaps you’ve heard the term “use tax”, and wondered what this refers to. The sales tax and the use tax are analogous, essentially the same tax. When the tax is charged by a retailer at the time of sale, it is referred to as a sales tax. The sales tax is a “trustee tax”, which means that the retailer is merely collecting it on behalf of the state, but it is not a liability of the retailer. When the tax is not charged on the actual sales transaction, the tax that is due is referred to as a use tax, which is an actual liability of the final user or consumer. Generally, a purchaser will pay the same exact amount of tax whether it’s charged as a sales tax, or paid directly to the state as a use tax. Now that you realize that you may owe a use tax on all the “tax free” purchases you’ve made, here are some general guidelines on where to report the use tax. If you’re a resident of a state that imposes a personal income tax, your annual use tax is most likely reported on and paid with your state personal income tax return. (See line 33 of Mass. Form 1) States without a personal income tax will generally have a separate form for reporting a personal use tax liability. (See Florida Form DR-15MO) If your businesses is registered for sales tax purposes in a state (i.e., you’re already charging and collecting sales tax), any business use tax owed (on purchases made by the businesses) is reported on that state’s sales & use tax return. (See line 5 of Mass. Form ST-9) Most states also have a separate form for businesses that do not have a sales tax collection responsibility, but make purchases on which use tax is owed. (See Mass. Form ST-10)

I Keep Hearing About these “Amazon Laws”. Is the Main Street Fairness Act Just Another “Amazon Law?”

The short answer is “no”, the Main Street Fairness Act is not just another “Amazon Law”, even though both the proposed Main Street legislation and the state “Amazon Laws” have a similar goal: to require the collection of sales tax by on-line vendors who do not have a physical presence in a state. The so called “Amazon Laws” (nicknamed after their most visible target and also because Amazon challenged this law in the New York State court system) are an example of how states are becoming more aggressive in their interpretation and administration of the state tax laws and are enacting laws which stretch the concept of nexus. These “Amazon Laws”, which exist in some variation in New York, Rhode Island, North Carolina and Colorado, are primarily directed at on-line retailers who contract with and compensate “affiliates” (residents or businesses which are not necessarily a part of their own company or organization) for customer referrals back to their website. Using New York’s law as an example, a typical scenario would involve an out-of-state retailer contracting with a New York based “affiliate” who posts a link to the out-of-state seller’s website and who receives a commission whenever its customers link from the New York company’s website to the out-of-state retailer’s website in order to make purchases. Now, assume you’re a retailer based in Oklahoma, who just so happens to have several customers in New York who purchase your product on-line through your company’s website. All your business is transacted over the internet, you have no physical presence in New York, you never send your employees to New York for business reasons, and you don’t contract with New York “affiliates” in an effort to secure more sales. The New York Amazon law would not apply to your on-line business, and you would not be required to charge sales tax on sales to your New York customers. But under a law such as the Main Street Fairness act, this same on-line retailer could ultimately be required to charge sales tax on its internet sales to customers in SSUTA member states.

Sylvia’s Summation 

So, there you have it, almost everything you’d want to know about the taxation of internet sales. Whether the Main Street Fairness Act passes remains to be seen, and if it does, it will be interesting to see what the final form of the law looks like. Keep in mind, that the Bill in only in proposed form, and needs to move through the entire legislative process before becoming final law. Even if the Main Street Fairness Act ultimately passes, It will take some time before all the processes are in place and before every internet sale is subject to sales tax.