“What is status of taxation of Internet purchases?”

By September 13, 2010 Legislative, Retail

I was at a networking breakfast last week and was asked this question.  I’m sure this was intended as some form of icebreaker or as a way for questioner to show me that he was in tune with some of the sales tax current events.  About once a month, I get asked this question in one form or another so I thought it would be appropriate to post some sort of public response.

Even though it was not specifically stated, his underlying question was really “when will states be able to tax purchases of property made from Internet retailers?”  The answer to that question is quite easy.  Most states have had the ability to tax the purchases of property made from Internet retailers since the early 1960s when “use” tax was adopted by the states as a complement to the sales tax.   The taxation or taxability of the product purchase is not the issue.  The issue is how to collect that tax.

After explaining that all of the property they have purchased from Amazon and the myriad other e-retailers is taxable, I then ask when was the last time they filed a Georgia use tax return to pay the tax due?   This usually results in a blank stare.  And that’s the point.  Individual consumers don’t file use tax returns even though it is required.  Further, many, but not all, businesses file use tax returns but the accuracy of these reports is often suspect.

The “status of taxation of Internet purchases” is not much different than the “status of taxation of mail order catalog purchases”.  The product is taxable but until the retailer is required to collect the tax, only a small percent of the tax will ever be collected.  Some have estimated the lost revenue from this gap to be in excess of $10 Billion per year.

The next question is usually, “what is keeping the states from forcing the retailers to collect the tax?”  My response is simple: the U.S. Constitution!!  That’s all.  This is no place for a detailed analysis, but the U. S. Supreme Court has ruled that the Commerce Clause of the U.S. Constitution requires that the e-commerce retailer have some physical contact with the state before they are legally required to collect the tax.  This physical connection can take many forms.  Without some connection, the states can’t “force” the e-retailers to collect the tax and it cannot require the catalog companies to collect the tax.  Does that mean the property purchased is not taxable?  NO!!  It just means that the purchaser must file use tax returns with the state to pay the tax directly.

The state of Alabama recently reviewed is use tax filings and determined that less than 1% of Alabama taxpayers were filing use tax returns.  That seems about right!!  To raise this percent, the state is sending letters to taxpayers informing them of their use tax obligation.  Some states, like California, actually have a place on the individual income tax return for taxpayers to report their untaxed purchases.  I’d expect to see that in more states.

As states look for revenue, this is an easy target.  This is an enforcement issue not a tax policy issue. The question is not “whether” to tax purchases made from the Internet, but “how” to collect the tax that is due.

Ned Lenhart

President

Taxation of Internet Purchases