Part one of this article describes the current state of remote sales tax laws. Back in 1992 the Supreme Court in Quill explicitly invited Congress to simplify sales tax collection so that states could expand their tax collections and while legislation has been considered over the past few years, nothing has been enacted. Below I discuss one federal proposal to allow sales tax collections on remote sales.
This summer House Judiciary Committee Chairman Goodlatte released a discussion draft “Online Sales Simplification Act of 2016” that creates a framework for standardizing sales tax collection, and which contains some interesting features. In a nutshell, it will impose origin taxability at a single statewide rate selected by each destination state, and will only allow the origin state to audit sellers. The origin state would collect the tax and would then remit it to the destination state through a clearinghouse.
OSSA 2016 aims to simplify remote sales tax collection so significantly that physical presence would no longer be necessary to avoid violating the Commerce Clause. It addresses both identifying the applicable rate and ascertaining whether the transaction is taxable.
First, on the rate side, each state would be required to select a single statewide rate to be used by remote sellers. This would eliminate the seller’s need to know if the purchaser is inside city limits, part of the block-long business district, subject to the transit tax, etc.
Second, remote sellers would use their origin tax base, not destination taxability. Currently a remote seller has to be intimately familiar with the taxability rules of every destination locality to which they ship and where they have nexus. Even among Streamlined states, which have all adopted the same definitions, taxability differs. For example, look at the food section of several states’ matrices and you will find that one state taxes all food, another generally exempts food but taxes candy and soft drinks, and a third exempts food including candy but taxes soft drinks. States have different definitions for many items and a company like Amazon, for example, with a very broad selection of merchandise, has to know both which products are included in each definition and how they are taxed, for every sale they make. For example, both New York and New Jersey exempt most food and tax candy, but they use different definitions of candy. Chocolate chips are exempt in New York but taxable in New Jersey (and yes, I have bought chocolate chips on Amazon!) while cotton candy is taxable in New York but exempt in New Jersey. Under OSSA 2016, sellers would only have to know their origin state’s taxability rules.
OSSA 2016’s hybrid sourcing is an interesting attempt to minimize the complexities of destination sourcing while still adhering to the philosophy that sales tax properly applies where the item is used. This approach raises both practical and policy questions, though.
One area that is unclear is how transactions that are partially taxable will be treated, either when a low rate applies to the entire selling price or when the sale is only taxable above a certain threshold. For example, Illinois taxes food at a lower rate than most retail sales, while Michigan exempts food. Will a bag of pretzels sold from Illinois to Michigan be taxable at Michigan’s full rate because it is not fully exempt in Illinois, or will it be considered exempt because it’s not subject to Illinois’ regular rate? A similar situation would arise with clothing in a threshold state like New York, where state tax only applies only to clothing sold for $110 or more and local tax either applies over the threshold or applies completely, depending on the jurisdiction. How will clothes sold from New York to another state be taxed? (There will be a special clothing amendment but even so, the partial taxation issue will remain, and adding a clothing amendment just complicates the law. Once you start adding exceptions, why stop at clothing?)
The above examples also illustrate one policy question raised by the Act: If you believe that the elected officials in a state ought to determine how purchases in their state are taxed, how does allowing the seller’s state to set taxability make sense?
Is it a violation of Equal Protection if two taxpayers in the same location are taxed differently just because the remote sellers from whom they purchased are in different states, one of which taxes the item and the other of which exempts it? If the purchaser’s state taxes an item that is exempt in the seller’s state, under OSSA 2016 the purchaser’s state would not be allowed to asses use tax. A buyer can work the system to legally buy things tax free online, even though the products would be taxable at a local bricks and mortar actual store. If the purchaser’s state exempts the item that the seller’s state taxes, isn’t that taxation without representation? And speaking of similar transactions with different tax implications, why should a purchase be subject to one rate if an item is bought from a remote seller but a different rate if it is bought from a seller within the purchaser’s state? That’s what will happen in states with local taxes. There will be a single averaged remote rate but all local taxes will continue to apply to in-state sales.
Another policy question is whether the origin state has enough of a connection with the transaction to tax it. OSSA 2016 requires the seller to remit tax to the origin state, and obviously the origin state has a connection with the seller. (Actually it’s not so obvious under some of the quirkier definitions of origin, but let’s stick with the most straightforward possibility.) If the purchaser is in another state, though, the origin state may not have any connection to the purchaser. Under OSSA 2016, sales tax could be viewed as a tax on the seller that the seller is allowed to pass through to the buyer, rather than a tax on the buyer that is collected by the seller. But if the tax is on the seller, not the buyer, then what is the rationale for transferring the funds to the destination state?
What about states that don’t participate in the clearinghouse?
If the seller is in a participating state but the purchaser is not, the sale is taxable at the origin rate and tax base. No distributions may be made to non-participating states so that means that the purchaser pays what is called sales tax, at the seller’s rate and taxability rules, but the purchaser’s state doesn’t get the money. Being in a state with no sales tax would not protect the purchaser from having to pay sales tax if the no-sales-tax state has not joined the clearinghouse. If the purchaser is in a state with a sales tax they would owe use tax on top of having been forced to pay the origin sales tax!
Remote sellers in non-participating states that impose their own sales taxes are subject to the reporting requirements listed below, but they don’t have to actually collect another state’s tax.
If a seller is in a state that does not have a sales tax and does not participate in the clearinghouse, the seller will be required to report the purchaser’s name and address to the clearinghouse, along with the amount of the sale. What’s more, the seller would be required to “determine the applicable tax on each remote sale using the alternate base and destination rate for each state that participates in the clearinghouse, and remit such tax to the clearinghouse with sufficient information to identify the destination state.”
A seller who presumably has no contact with a state other than making an online sale into that state is being forced to collect and remit the foreign state’s tax. The seller would have to use the tax base of the state in which the seller had the highest gross receipts the previous year, so the seller (and remember, this is a seller in a state that does not have a sales tax!) has to identify the state to which it made the most sales the prior year (being required to recalculate every year) and has to know what is taxable in this state (which might be different than last year’s alternate base state.)
In short, a seller in a state without a sales tax doesn’t avoid having to collect sales tax (as the local elected officials prefer) but has to use some other state’s tax base to calculate and collect sales tax on a sale to what could be a third state. The only improvement over current attempts to force remote sellers to collect sales tax is that there would be just one rate per state, but there’s the added complexity of using a different state’s taxability rules. This sounds worse than what the Court struck down in Quill!
So what’s next? My crystal ball says … crackle … squawk … beeeeeep. Oops, it just died. Going back to old-fashioned analysis … On one hand, there is support for “leveling the playing field” between online and bricks-and-mortar sellers and for “not cheating states out of their revenue.” But maybe we’ve gotten there, or at least made progress. While e-commerce has absolutely exploded in the years since Quill, the tax landscape has been changing, too. About half the states with sales taxes have gone Streamlined, which to some extent treats them as a single state vis-a-vis remote sellers, and a significant number of online businesses currently collect sales taxes in many states. To a very large degree it is no longer accurate to say that consumers who buy online are not paying sales tax. There is also a certain amount of backlash among consumers who feel that this would be “taxation without representation” or “a tax hike” (which is kind of funny since so many online sales are already taxed) and politicians who are sensitive to these concerns may not vote for a remote seller sales tax bill. We’re also still stuck with what may be insurmountable policy reasons this particular proposal is not the vehicle for addressing remote sales taxes. Other simplification bills have also been proposed but none of them are fully satisfactory.
Bottom line? The federal government is not likely to resolve remote sales tax collection in the near future. You still need to know where you have nexus and you need to keep up with changing state laws.