Tax-free Internet shopping days could be numbered

Americans gather at the base of the Capitol building in Washington, D.C., to protest the income tax and federal government overreaching. Rep. Ron Paul spoke at the rally earlier in the day.

(Credit: Declan McCullagh/News.com)

If tax-hungry politicians get their way, the days of ordering items over the Internet and not paying sales tax may become just a fond memory.

Right now, if a California resident orders something from Seattle-based Amazon.com, for instance, he or she won't be charged sales tax at the time of purchase. That's because Amazon doesn't have offices in the state of California.

Pro-tax politicians want to change this by allowing California to force Amazon to collect and submit sales taxes--and they may have found an ally in a U.S. Congress that's controlled by Democrats. (Note: See our related story on new taxes on digital downloads.)

Two bills are pending in Congress that would allow tax collectors to target out-of-state Internet and mail-order retailers, and their supporters are optimistic about their political prospects.

"I certainly would love to see a floor vote," said Neal Osten, federal affairs counsel for the National Conference of State Legislatures (NCSL), a lobby group for state politicians. "We've heard encouraging words from the Democratic leadership in the House."

Meanwhile, pro-tax states are trying their own ways to circumvent a long-standing rule saying a retailer must have physical presence before it can be forced to collect taxes. One effort came from New York state, where legislators recently approved a measure requiring Amazon and other online retailers (that lack a physical presence in the state) to collect sales tax on New Yorkers' purchases.

That amounts to a declaration of war against Amazon, and a legal battle now seems all but inevitable.

This is not exactly a new debate. For years, politicians in state legislatures and the U.S. Congress have been arguing that the rise of e-commerce is causing them to miss out on potentially millions of taxpayer dollars. But now, with a Democratic Congress and a potentially Democratic administration next year, the arguments may gain more political traction.

Technically, of course, Americans in states with sales taxes are supposed to keep track of out-of-state purchases and cough up the necessary sales tax on April 15--the concept is known as a "use tax". But state tax collectors have long complained that in practice, that just doesn't happen, and that money has been unfairly left in taxpayers' pocketbooks.

Verenda Smith, government affairs associate for the Federation of Tax Administrators, framed the decision as a moral one of sorts: "Do you want to be a good American, or do you want to be an American who wants to cheat your government deliberately? It's a harsh way to look at it, but it's true."

Smith said she's also concerned that there's not a level playing field, which is potentially giving online retailers an advantage over their brick-and-mortar counterparts.

It's not exactly clear how much money states are losing to uncollected use taxes. Some politicians have thrown around claims in the past that state and local governments will have lost nearly half a trillion dollars in uncollected sales taxes by 2011.

More generally, total e-commerce sales were estimated at $136.4 billion in 2007, up about 19 percent from the year before, according to the latest U.S. Census statistics. That figure still accounted for only about 3.4 percent of total 2007 retail sales in the United States, however, as opposed to about 2.9 percent in 2006.

'Tyranny Response Team' clothing was popular among rally attendees. Speakers at the rally challenged the U.S. government to show them what section of federal law requires regular Americans to pay income taxes. Here's what the IRS has to say.

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The legal limits of sales-tax collection
States are currently limited in their sales tax collection authority because of a 1992 U.S. Supreme Court decision in the Quill v. North Dakota case. It says retailers aren't required to collect sales taxes from customers who live in states where they don't have a physical presence, or "nexus." The justices did, however, make it clear that Congress could step in and change the rules.

The ruling came out the way it did in part because tax codes tend to be quite complex and vary among states and localities, with bewilderingly different tax rates associated with the same kind of product. In response, some states have tried to smooth out their differences.

Over the past five years, 22 states have signed on, either wholly or partially, to a plan known as the Streamlined Sales Tax and Use Agreement, in which they agree to simplify their tax codes and make them uniform. About 20 more states are still considering whether to participate.

Steve Del Bianco, executive director of the NetChoice Coalition, whose members include eBay and Yahoo, said he doesn't think the plan has really simplified matters for retailers, nor has it produced the effects states were seeking.

"Fiscally strapped states thought that (the streamlined sales tax project) would bring a flood of new tax revenue, but they're seeing just a trickle, and that's coming from sellers who should have already been collecting under the old tax laws," he said.

That may be in part because adopting the streamlined sales tax system is voluntary to begin with. Participating states don't have the authority to require any retailers to collect those taxes from their residents, although if companies sign up to collect sales taxes under the regime, they must agree to do so in all participating states. (Some 1,000 companies have signed up so far, resulting in at least $150 million in newly collected taxes since the venture began, said NCSL's Osten.)

The push in Congress
Two bills introduced last spring in Congress, however, would change that. The Senate version is sponsored by Republican Michael Enzi of Wyoming and Democrat Daniel Inouye of Hawaii, and the House of Representatives version was introduced by Democrat Bill Delahunt of Massachusetts and is co-sponsored by Rep. John Conyers, chairman of the influential House Judiciary Committee.

In the past, similar proposals have stalled in part because of a disagreement over a section that attempts to exempt "small businesses" from the new tax-collection burden. Both pending bills stipulate that sellers who bring in less than $5 million in taxable sales per year don't have to collect taxes from their customers. eBay, for one, has argued that exemption is too high and could cause new administrative headaches for even small-time sellers.

The relevant congressional committees have already held hearings on the issue, with the latest one occurring last December in a House Judiciary subcommittee. The NCSL's Osten said he feels good about how that hearing went.

Elly Pickett, an Enzi spokeswoman, said the Wyoming Republican "continues work to secure additional co-sponsors and is hopeful it will be considered this year."

Aides to the committees controlling the bills' movement were less forthcoming about what happens next. An aide to Sen. Max Baucus, the Democratic chairman of the Senate Finance Committee, said the committee was aware of Enzi's bill but hasn't scheduled debate on it yet. House Judiciary Committee aides did not respond to requests for comment.

As for New York's recent move, it aims to circumvent the tax-collection restrictions that differ from the more common streamlined sales tax project. Instead, the state determined that any online retailer with "affiliates" located in its state would be required to collect sales taxes from purchases by New York-based customers.

Amazon, for example, has thousands of "affiliates" to whom it pays a commission for linking to products for sale on its Web site. Presumably some of them are located in New York, which would mean, under the state's interpretation, that it would have to collect sales tax from its residents. (Amazon.com did not respond to News.com's requests for comment on the New York law but has previously said it's still reviewing the language.)

Other states, including California, have considered such steps, but Osten said his group would actually discourage that method if they're really interested in increasing their tax revenues. "I think this option is one that is probably gong to be litigated and will therefore cause delay," he said.

News.com's Declan McCullagh contributed to this report.