Push for Sales Tax on Internet Orders

July 30, 2010

The idea has been out there for years, but a new push could turn it into a reality: companies selling over the Internet to individuals and businesses in states that impose sales tax could be required to collect and remit the tax. The days when you can avoid paying sales tax by ordering from Amazon or eBay could be numbered.

While you may not realize it, you’re already required to pay tax on purchases you make outside your state. Technically this not a sales tax. Your state has no jurisdiction to tax a sale occurring outside its borders, but the law says that if you buy an item outside your state without paying sales tax and bring it into your state you have to pay a tax on the privilege of using that item in your state — a use tax — that’s equal to the sales tax you would have paid if you bought the item locally. Each year you’re supposed to fill out a form and send in the tax you would have paid if you’d bought those attachments for your stand mixer at a local store.

Almost no one pays use tax on ordinary Internet or mail order purchases, however. Only a small percentage of the general public is even aware they owe the tax, and most of those who are aware ignore it. States are able to collect the tax on motor vehicles bought out of state because you’re required to register for license plates, and some states audit businesses to collect the tax on other purchases, but they have no realistic way of collecting the tax from individuals who don’t pony up.

To plug this leak, states would have to get Internet and mail order merchants to collect the tax at the time of the sale, the same way local merchants do. Yet the state of Illinois, for example, has no legal authority to tell a mail order merchant operating in Maine to collect its use tax when selling to Illinois residents. It would take a federal law to impose this requirement on merchants selling out of state. A bill pending in Congress would do just that.

Why would Congress take such an action? Most Americans live in states that impose sales tax. The opportunity to avoid that tax by ordering goods from out of state vendors is highly popular. And not just with the hoi polloi: a recent news story revealed that Senator John Kerry avoided close to half a million dollars in use tax by mooring his yacht in Rhode Island, which has no such tax on boats, rather than Massachusetts. (Kerry responded by ponying up the tax to Massachusetts even though he didn’t legally owe it.)

From the viewpoint of local storeowners, however, the situation creates unfair competition. And from the viewpoint of state and local governments, it results in tens of billions of dollars in lost revenue. The economic downturn has highlighted both of these concerns, as bricks-and-mortar merchants struggle to survive and states deal with unprecedented deficits. After languishing for years on the back burner, a proposal to require Internet and mail order merchants to collect sales tax when selling out of state may be an idea whose time has come.

Congress will have to iron out some important details, however. One is the small merchant exception. A website averaging $800 a month in sales of alpaca yarn can’t reasonably be expected to do all the paperwork to collect sales tax owed under varying state laws. It’s clear there will be an exception for small merchants, but so far no consensus on how small. There’s also a provision that will compensate merchants for collecting and remitting out-of-state taxes by allowing them to keep a tiny percentage of what they collect, with an unresolved issue of how tiny that percentage should be.

The legislation could still be brought down by haggling over these and other details or by opposition to the underlying concept. It has gained some momentum, though, and we should be prepared for the possibility that within a few years we’ll have to pay sales tax on most of these purchases.