States and small businesses have been battling to close a gaping sales tax loophole that has created an unfair playing field in the retail industry.  For years, online retailers like Amazon and eBay have avoided collecting and paying over state sales taxes.  This has given them a substantial tax advantage over brick-and-mortar retailers that allows them to present customers with lower bills at checkout, despite charging the same amount for goods.

Under federal law, states cannot compel a business to collect sales taxes unless the business has a “physical presence” within the state.  In Quill Corp. v. North Dakota, the U.S. Supreme Court reasoned that existing sales tax collection systems were too complex to impose on businesses that did not have a physical presence in the state.  It also established that Congress has the authority to allow states to force businesses without a physical presence to collect. Amazon, which is based in Washington and has been at the center of an escalating war on sales tax collection, has contended that its advertisers, warehouses, and subsidiaries in neighboring states were not enough to constitute a physical presence.

In an effort to raise revenues, California passed legislation that expanded the definition of “physical presence” and would have forced Amazon to collect and remit the taxes; however, a couple of months ago, Governor Jerry Brown delayed (PDF) the enactment of that law until September 15, 2012.  This move was part of a compromise with Amazon, which had campaigned for a ballot referendum asking voters to overturn the law.  Amazon agreed to drop the referendum in return for the delay.  Also, Amazon agreed to reach out to its affiliates in California that it dropped when the legislation was first passed.  The bill turned on the idea that Amazon’s affiliates were the source of its physical presence within the state.

In all, a costly election contest was avoided, more jobs will be coming to California, and Amazon was given time to lobby federal lawmakers for a national scheme addressing the issue.  Amazon was interested in lobbying for a uniform federal scheme because it feared that other states would follow California’s example, resulting in a myriad of complex collection standards with which it would have to comply.

On November 9, 2011, U.S. Senators Lamar Alexander, Dick Durbin, and Michael Enzi introduced the Marketplace Fairness Act, a bill that could give state governments several ways to collect sales taxes.  Under one approach, states would sign an agreement altering their sales tax codes so they are all uniform.  Then, they would be able to force online retailers to charge a sales taxes.  Any state that did not sign the agreement could still force the collection of taxes if they adopt minimum standards that simplify their collection process.  The provisions of the Streamlined Sales and Use Tax Agreement provide one example of the ways states would have to simplify their sales tax system.  Twenty four states have already adopted the agreement, which was authored by the Streamlined Sales Tax Governing Board, a group established in 2000 to create simplified means of reporting and paying sales taxes.  To avoid burdening smaller companies and create incentives for entrepreneurs, all retailers with less than $500,000 in sales per year would be exempt from sales tax collection.

Considering state budget deficits, bipartisan support for tax reform, and the growing desire for a sense of fairness in the marketplace, the Marketplace Fairness Act was inevitable.  It could finally level the playing field between Amazon and sellers on Main Street.  Supporters also note that the bill is not creating a new tax, but merely closing a tax loophole created years ago.  Amazon will be forced to innovate if it wants to continue offering customers discounts, but it most likely still holds an enormous advantage by virtue of being the one-stop shopping center accessible to anyone with a computer.  Hopefully this bill passes so that states can enjoy the revenue they always deserved.

— Andrew Farrell

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5 Responses to The Marketplace Fairness Act: Leveling the Playing Field for Brick-and-Mortar Retailers

  1. Brandon Trout says:

    I like the ideas that are presented here, and I agree that we should close the tax loophole that allows online retailers to get out of paying sales taxes. However, as a functional matter, it will be interesting to see how the ‘uniform tax’ will be applied. If I place an order, does the sales tax go to my state of residence? The state that I am in when I place the order, if I am away on vacation? The state where the product is delivered, if I order something in TN and have it shipped to CA? Or is it based on the origination of the product that I order, or the headquarters of the business I order from? There are so many different scenarios that affect which state will end up receiving the tax revenues, it will be interesting to see how it is resolved.

  2. Andrew Farrell says:

    I think you are both right, and one of the most interesting issues is whether or not the task of paying sales taxes in a variety of states really is too complex for businesses.

    On the one hand, the “it’s too complex” argument likely applies to many international businesses. The idea of making international sellers who operate across the United States interpret 50 state tax returns and calculate the amount they owe every year isn’t too attractive. It may deter some market players who are capable of selling products in many states, but don’t have the software necessary to do it in-house or the funds to outsource the duty.

    On the other hand, the complexity argument is severely dated. Technology now exists that could handle the separate calculations and organize the collection of funds. Paypal could EASILY implement a nationwide tax payment mechanism that would calculate and collect state sales taxes from multiple states. What’s more, this payment system would be highly coveted and capable of providing such an essential service that other market players would be incentivized to come up with similar products. If a market for such a service was created, it would drive down the costs of utilizing it. The money is there to be made.

    • Nick B. says:

      I like the idea that a new marketplace can be created to make it less expensive for online retailers to track and pay sales tax to the appropriate states. That’s a great idea.

      But I don’t see how the Federal government is going to step in and force states to simplify their sales tax? What happens if a few states like their complicated schemes, they can’t collect sales tax from online retailers? A clear power of a sovereign state is the power to tax. The federal government stepping in and requiring States to follow certain protocols to be able to tax online retailers raises separation of power questions. Does the federal government have the power to tell states how to implement their state sales tax schemes?

      What if a state wanted to create its own simplified sales tax for online sales only? Any online sale in the state is taxed at 10% of sale price, no matter what. But sales tax for everything else in the state stayed the same (Say 5% with exceptions). Would the feds allow a disparity? Maybe the state is attempting to protect its domestic retailers, which seems to raise more separation of powers questions. (Is that a tariff?) Tough area of law and I’m curious to see how the states solve it to get their tax dollars.

  3. Paul Russell says:

    Like Kevin, I love my no tax shopping on the internet. However, there is no reason that Amazon cannot comply with every state’s state sales tax.

    Undoubtedly, complying with every state’s sales tax would be a huge burden on Amazon. For example, some states do not charge any sales tax on groceries (Kentucky) whereas some states charge a reduced sales tax (Tennessee). Additionally, the definition of “groceries” and other relevant terms likely changes from state to state.

    That said, if stores like Target and Wal-Mart are able to comply with this law, I see no reason why Amazon cannot as well. With the $500K threshold and the fact that few other online retailers are “full-service” like Amazon, most websites will face a much more limited regulatory burden in complying with the law.

  4. Kevin Lumpkin says:

    Putting aside the fact that I love not having to pay taxes on online purchases, I agree that it’s not a great idea to have the loophole in place. Government needs all the tax revenue it can get these days.

    As far as the legal aspect, I wonder whether the “physical presence” test is just too anteqauted for the state of today’s marketplace. For to be arguing that only a few states should be empowered to collect sales tax from online purchases seems completely ridiculous to me. It seems equally ridiculous that California should have to rest its laws on affiliates’ physical presence in the state.

    While Amazon may not have boots on the ground in every state, it has an indisputable and massive presence in every single one. When a physical presence isn’t required to do tremendous business and make tremendous profit in a state, why should physical presence play any part in the legal analysis as to whether tax can be collected?