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A Taxing Question: A Controversial New Law Attempts to Force Collection of Taxes on Internet Sales

One Illinois business intends to leave the state before a new plan to collect taxes on Internet sales takes effect in July. “I don’t have a choice,” says Tim Storm, chief executive officer of FatWallet, an Internet marketing company. “It’s a situation where I can’t take a hit on 40 percent of our revenue and continue to operate in the state of Illinois.”

FatWallet is a virtual sidewalk sale. The website recommends deals at other sites all over the Web. The company then earns a commission for referring paying customers to those retailers. A bill the General Assembly recently passed and Gov. Pat Quinn signed would base the collection of taxes on some Internet sales upon the marketing relationship that companies such as FatWallet and Chicago-based Coupon Cabin have with large Internet retailers like Amazon.com. Since the bill became law, Amazon.com and Overstock.com have announced they will cut ties to Illinois marketers such as Storm’s company.

Rep. Dave Winters, a Shirland Republican, says FatWallet, which is in his district, could easily move to Wisconsin, where lawmakers have not attempted to get online sellers to collect the tax. “We are so close; he’s like three miles from Wisconsin.” Winters says Storm’s 50 or so employees could commute, but the village of Rockton and the state would lose out on tax revenues and community investments from the business. 

Shopping on the Internet is no longer just for the tech savvy. In recent years stronger security measures, user-friendly websites and incentives such as free shipping have drawn everyone from teenagers to grandparents to shop online. The U.S. Commerce Department reported that online sales totaled $165 billion in 2010. Some retailers such as Amazon and the iTunes Store only exist, as far as customers are concerned, on the Web.

E-commerce has exploded in recent years, and sales tax collection has failed to keep up with new technology as cash-strapped municipal and state governments miss out on millions in revenues. The National Conference of State Legislatures estimated that $8.6 billion in taxes from goods sold on the Internet, as well as from catalogs, went uncollected last year. As states push for Internet retailers to pay the same sales tax as brick and mortar stores within their borders, the issue of what is fair when it comes to tax collection in the digital age is being debated in Illinois and nationwide. 

Online retailers are only required to collect sales tax if they have a physical presence in the state. For example, Walmart collects Illinois taxes on its online sales because it has stores in the state. 

Illinoisans who make purchases from companies that do not collect still owe tax equal to the state’s 6.25 sales tax. However, many people are not aware of the requirement or simply ignore it. According to the Illinois Department of Revenue, about 5,000 to 6,000 residents voluntarily pay the tax each year, which brings in $5 million to $6 million in revenue annually. The department estimates that if all who owed the tax sent their checks to the state, it would total about $153 million annually. In an effort to bring in more of that lost revenue, the state included a box in red type on this year’s income tax forms to remind people to pay. 

The question of whether states can require out-of-state businesses to collect taxes on sales has been around since the rise of mail order and catalog sales. In a 1992 ruling, the U.S. Supreme Court said that making businesses outside a state’s jurisdiction collect the tax, which can vary greatly from state to state, was too large a burden for states to impose. However, the ruling left the door open for Congress to present a national solution: “The underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve. No matter how we evaluate the burdens that use taxes impose on interstate commerce, Congress remains free to disagree with our conclusions. … Accordingly, Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes.” 

Some states, impatient with the progression of a national effort, are looking for ways to collect taxes on Internet retailers by focusing on links they have within the state’s borders. Illinois’ law will allow the state to require online retailers that do not have a physical location in the state but have marketing partnerships with Illinois businesses to collect tax on their sales. “It’s a growing concern as more and more people shop and spend online,” says Senate President John Cullerton, a sponsor of the bill.

New York, North Carolina and Rhode Island have all adopted similar legislation to varying degrees of success. According to Stateline.org, about 15 states across the country are considering some way to make retailers collect the tax. Neal Osten, director of the Washington office of the National Conference of State Legislatures, says large retailers such as Amazon and Overstock have ended relationships with sites like FatWallet in all the states except New York that are currently trying to collect the sales tax. He says the businesses maintained their marketing relationships in New York to file a lawsuit against the state. A New York judge tossed out Amazon’s and Overstock’s suits in January 2009, stating in her opinion that referrals from in-state Web companies that resulted in more than $10,000 in sales from New York residents is a large enough connection for the state to require the companies to collect sales tax. New York estimates the state brought in $70 million under the law last fiscal year. 

Arizona lawmakers passed a law requiring Amazon to notify its customers of the tax they owe as well as telling the state which residents owe the tax. Amazon cut off its relationships with Web marketers in the state. A judge put a hold on the law in January, and some Republican lawmakers in the state are calling for its repeal. 

North Carolina got into a legal fight with Amazon and some of its customers after it tried to get the company to give up records so the state could prove that Amazon owed taxes from the time the North Carolina passed its law until the time Amazon cut its ties with in-state entities. Amazon and the customers said the state’s request was an invasion of privacy. The state settled in February and agreed to pay $99,000 in legal fees but has reserved the right to continue to pursue collection of sales taxes from Amazon and its North?Carolina customers. 

Executive officers in Texas cannot agree whether Amazon has a responsibility to collect the tax. Texas Comptroller Susan Combs sent the company a bill for $269 million in sales taxes she says the company should have collected because it has warehousing operations in the state. However, Texas Gov. Rick Perry disagrees with fellow Republican Combs because he says Amazon does not actually make sales at its warehouses. Amazon announced it plans to close its distribution center in Irving, Texas, on April 12 and canceled plans to expand operations in the state. 

The threat of lost jobs is a big stick for those opposed to efforts to make Web retailers collect the tax. Republicans in Congress have introduced a resolution in opposition to any potential changes on the federal level. “The most effective thing we can do to help our economy recover is to remove the roadblocks standing in the way of our nation’s job creators. At a time when we are trying to foster a sustained economic recovery, it doesn’t make sense to saddle entrepreneurs with tax requirements that stifle growth,” U.S. Rep. Dan Lungren, a California Republican, said in a written statement. 

However, proponents say big retailers’ ability to duck the issue by moving their business out of states trying to collect sales tax gives them an unfair advantage over local businesses that have to collect it. If buyers do not voluntarily pay the tax, in essence, they receive a discount on purchases from out-of-state Internet retailers. 

“It’s not good for state government; it’s not good for local government; it’s not good for brick and mortar retailers. … Maybe it’s time that people stood up to the bullies like Amazon and say we’re not going to take it anymore,” says David Vite, president of the Illinois Retail Merchants Association. Vite, a proponent of the Illinois law, says that the decline of local book, music, hardware and other stores is evidence that online sellers do not need any help being competitive. He says while the state could use the revenues, the issue is really about treating all businesses equally. He says states are not trying to impose a new tax but simply trying to get retailers to collect a tax that is already owed. “This is a fairness issue. It’s a parity issue.”

Attempts to address the issue on the federal level have been more than a decade in the making. “It’s hard to get one level of government to take a step on tax revenue when the revenue is not for that level of government,” says Stacy Mitchell, a senior researcher for the New Rules Project, an organization that advocates for local communities.

The Streamlined Sales Tax Governing Board has been working with the NCSL to urge states to simplify their tax codes so collecting the sales tax across multiple jurisdictions would be easier for online retailers. Scott Peterson, executive director of the board, says that states do not have to change their codes for Congress to pass legislation, but the hope is that an effort from the states would compel action on the federal level. So far, 24 states representing about 115 million Americans have signed on to bring their tax codes in line with the group’s so-called Streamlined Sales Tax Agreement. Peterson says many retailers, including Amazon, are cooperating with the group’s work. “Amazon.com has been working with us. …What they’ve always said [was] they will collect when everybody has got to collect.”

Osten says while bills like the one in Illinois draw attention to the issue, they are not a solution. “The goal should be passing streamlined sales tax. In the end, that is the only thing that is going to work.”

Former Illinois Republican state Sen. Steve Rauschenberger says one of the biggest challenges is deciding how to classify products. Something such as a candy bar might be considered food and taxed accordingly in one state, while it is categorized as candy and taxed that way in another state. If the item in question is considered food in Illinois, it would be exempt from a sales tax. He says that before technology made selling across state lines such big business, states would write tax codes unique to their own needs and quirks. “States grew up and were able to do these individual things when people were born, lived … and died within 50 miles, and every transaction took place across a counter.”

But efforts to bring Illinois in line with the agreement fell flat because it would mean an almost $120 million revenue hit for the city of Chicago, according to Republican Sen. Pamela Althoff, who has been working on the issue with Cullerton. The city currently collects all the sales tax for the lease of a vehicle upfront instead of over the life of the contract, and streamlining would put an end to the practice. Althoff says the state would have to demonstrate other revenue options to Chicago. She says one option might be to show the city how much money it could bring in through the collection of sales taxes on Internet purchases. The fact that Illinois has a tax code that is, according to Peterson, “rather antiquated and a little bit cumbersome” when compared with other states, especially the states that have complied with the agreement, has also complicated things.

Many working on the streamlining project say if Congress would pass a bill allowing states to force collection of the tax on the condition that they sign on to the agreement, the movement would gain steam instantly. 

“I would think that within a matter of probably one [legislative] session and most states would fall in place,” Osten says. In past incarnations of the bill, states have been required to meet the agreement to force retailers to collect the tax. U.S. Sen. Dick Durbin plans to introduce a version of the bill this year, but a spokeswoman for Durbin says she could not comment on the bill’s content because as of press time, it had not been introduced. 

Peterson says the move would be a relatively easy way for Congress to help states get more revenue without having to pass something unpopular, such as a second stimulus package. “Our message to Congress is: ‘You’re not going to give us any more money, and you are very likely not going to eliminate any of the mandates you put on us. … Give us the authority to collect our own sales tax.’” 

Illinois Issues, April 2011

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