As consumers we’re all familiar with the concept of paying sales tax for the goods we purchase. Forty-four states and the District of Columbia impose sales taxes on transactions, and retailers must charge the amount prescribed by the rules of their jurisdiction. Yet, for retailers, it’s not always so clear-cut.
Currently, online retailers are only required to collect sales tax in states where they have a physical presence of property or employees. As Internet sales through companies like Amazon and eBay continue to soar, this model is constantly under pressure resulting from the disparity in tax treatment between online sales and brick-and-mortar sales.
For years, states have pushed for legislation that clarifies how taxes should be collected on Internet purchases so they can get their fair share of the taxes owed on these transactions. In the last few years, two prominent proposals have emerged with differing consequences on business activities.
For purposes of our discussion, let’s use this example: You are Dell Corporation (headquartered in Texas), selling a laptop to a woman in Georgia who will give the laptop to her son who lives in Tennessee.
Marketplace Fairness and Destination Based Sourcing – The Standard
The Marketplace Fairness Act (MFA), as passed by the Senate in 2013, goes a long way toward addressing a number of Internet tax issues. In short, it grants states the authority to compel online retailers, no matter where they are located, to collect sales tax at the time of the transaction as long as the state agrees to simplify its sales tax laws. It also protects small businesses with less than $1 million in annual remote sales from having to collect the tax (for example a small Etsy seller).
The MFA bill, which awaits a vote in the House of Representatives, uses the traditional destination-based tax sourcing rules. This means that the tax rate for the item is determined according to the buyer’s location or “ship to” address. So in our example, Dell would charge the Georgia sales tax rate on the purchase of the laptop.
This approach is already enforced by 80% of taxing authorities in the U.S. and requires a unified tax base for use throughout the state in question. I believe this approach is very fair to current businesses, and moves all of the states closer to a standard approach to sales and use tax law. Furthermore, most retail groups are largely in favor of the measure due to the tax law simplification requirements.
Unfortunately, eBay and Overstock (and some others) oppose this bill because it creates a much smaller threshold in defining a “small business” than any other federal standard. They argue that the increased compliance burden, audit exposure and cost of potential litigation from remote sales activities for these businesses are too great and will inhibit their future growth. However, Amazon.com and other large retail groups are in full support of the measure and were actively involved in drafting the legislation to create an even playing field for all Internet-based business activity.
The MFA legislation was not brought to the floor of the House of Representatives before the end of 2014 for a vote. Although it seemed dead at one point, like many of its predecessors, there is now a renewed push for action on the legislation in the current session of Congress.
But, not so fast…
Origin-Based Taxation Proposal Bad for Business
Recently, a new proposal titled the “Online Sales Simplification Act of 2015,” was introduced by House Judiciary Chairman Robert Goodlatte (VA). The latest draft throws destination-based taxation to the curb and is a real cause for concern for Georgia businesses and others throughout the country.
In his draft, Rep. Goodlatte proposes to fundamentally change the way that sales tax is calculated in every jurisdiction. He is making a strong but misguided argument that since we don’t really know where products are being used, the tax should be based on the origin of the sale. Online retailers would calculate and then remit tax to their state of origination; it would then be the state’s responsibility to turn this tax over to the customer’s state of residence.
So in our previous example, Dell (Texas) would compute and remit the Texas combined state and local tax rate to a tax distribution clearinghouse maintained by the federal government. The clearinghouse would then direct the tax collected in Texas to Georgia based on the portion of Georgia sales collected versus other remote sales during the period.
Apparently, this “simplifies” the tax, as online retailers only would be required to charge one sales tax rate for all of their transactions. Sounds great in theory, right? Well, therein resides the major problem—it’s a great theory if all business transactions would be subject to origin-based sourcing, but they’re not. Can you imagine the reporting requirements that are generated by this proposal alone?
A Compliance Nightmare
Compliance in an origin-based tax environment would be a nightmare for businesses acting in multiple capacities with an online presence and brick-and-mortar outlets. A customer could potentially pick up an item at the Dell store in Georgia and pay one rate, and then pay a completely different rate by ordering the same product from the same retailer online (Dell is based in Texas). Think about the financial compliance and reporting requirements for that particular business, let alone the questions coming from consumers who don’t really understand why there is a difference in tax being applied to similar transactions.
Furthermore, what about the states that administer different tax rates from the jurisdiction of the transaction origin completed online (i.e., what if Texas’ tax rate is lower than Georgia’s)? Where is the shortfall in the tax rate made up? Some supporters of the Act say that some tax is better than no tax at all, but I find it hard to believe that all jurisdictions will agree to this method. Incremental taxes owed are levied extensively during current audits, and I can only imagine this becoming more cumbersome and complex given the outline of this proposal. Lastly, there may be more issues due to multiple customers transacting business in the same state and being taxed at different rates, potentially subject to tax from states that they have never been in contact with. This might be viewed as a direct violation of the Commerce Clause within the US Constitution. So in all its glory, the Simplification Act seems to be just complicating matters even more, which is something we don’t need in the sales tax arena.
We can all sense a bit of topic fatigue here – people are getting tired of hearing about the need to tax Internet sales. Often in this situation, we throw up our hands and tell legislators to “just do something.” However, it’s important that we don’t lose sight of the original need to clarify and streamline the way we tax internet transactions. We certainly need to find a way to tax sales in a fair and effective manner, but that doesn’t mean we should advance legislation that would unfairly punish businesses or consumers and create a compliance environment that is even more burdensome than the one we operate in today.
If you want to contact a member of Congress to express your views on Internet taxation, click here to find contact information. I strongly recommend you do so, before you find yourself paying Texas tax on a transaction shipped to Georgia that was eventually used in Tennessee. Makes perfect sense, right?
Tim Howe, CPA, is a Senior Manager in Smith & Howard’s Accounting, Advisory, and Assurance Services Group. He leads the firm’s Sales and Use Tax practice. If you have questions about this article, you may reach Tim at 404-879-3320 or thowe@SMITH&HOWARD.COM.