Why localities may be unable to collect sales taxes from Internet sales

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WASHINGTON -- Some cities and counties could be shortchanged on local sales tax revenue, even if the Supreme Court rules in favor of South Dakota's effort to collect such taxes from e-commerce retailers, because not every jurisdiction has opted into a simplified system that would ensure collection and distribution.

That's the message local government officials received this week at a National League of Cities conference that highlighted the need for Congress to act on online sales taxes.

E-commerce retailers such as Amazon remit the sales taxes they collect to states rather than the thousands of jurisdictions with local sales taxes, Lisa Soronen, executive director of the State and Local Legal Center, said during a panel on court cases.

“But sometimes what the states do is they don’t turn the money over,” she said. “Sometimes they don’t turn any of that over. Sometimes they turn only some of it over or whatever they feel like turning over.”

The South Dakota case against Wayfair, Inc. and other e-commerce retailers seeks to enforce a state law that required collection of state sales tax by out-of-state companies with at least 200 transactions or $100,000 in sales to residents in the state. The state sued retailers that wouldn't comply. The state's courts sided with the retailers, saying they didn't have a "physical presence" in the state as required under the Supreme Court's 1992 decision in Quill Corp. vs. North Dakota.

South Dakota challenged Quill and the case is to be argued before the Supreme Court on April 17 with a ruling expected by late June. The high court is widely expected to overturn the "physical presence" limitation in Quill.

The 1992 ruling involved mail-order catalogs at a time when public usage of the internet was in its infancy.

“The question is what test will replace physical presence because that’s what the courts have relied on for all these years,” Sorenen said. “They could replace it with nothing. They could say if you do any amount of business in a state, you’ll have to collect. It’s very unlikely they will do that.”

Sorenen said local government advocates are hoping the court will select an “economic nexus test” such as South Dakota’s sales threshold, but that threshold may not work for a much larger state like California.

The issue of how the sales tax revenue should be distributed to cities and counties could be resolved by Congress, but so far opponents to e-commerce sales tax collection have blocked bills in the House and Senate that would do that.

Twenty-three states have adopted the Streamlined Sales Tax and Use Tax Agreement which minimizes the cost of compliance by out-of-state retailers by providing for administration of collection at the state level, simplification of tax rates and a uniform definition of the items that are taxable.

But only half of the states with sales taxes have conformed to the agreement.

In the states that haven’t adopted this simplified system, the local governments and state may have different definitions of what’s taxable, according to David Schmiedicke, finance director for the City of Madison, Wis. and chair of the Governmental Budget and Fiscal Policy Committee of the Government Finance Officers Association.

“States that collect sales taxes for local governments may not readily know where an online sale occurred so it can be remitted to the local government,” Schmiedicke said.

E-commerce retailers also face complexity over where to register if the Supreme Court rules in favor of South Dakota and there is no streamlined remittance process for paying all local sales tax through a central state collection system.

Emily Brock, director of GFOA’s federal liaison center, said that the collection of e-commerce sales tax could be simplified if Congress passes either the Senate’s Marketplace Fairness Act or the House’s Remote Transactions Parity Act.

“The legislation clarifies details for implementation,” Brock said. “The streamline sales tax agreement effort has succeeded in finding solutions for the complexity in state and local sales tax systems, and the legislation capitalizes on that.”

Mike Bailey, director of technology and information services for the City of Redmond, Wash., said states that are not part of the Simplified Sales Tax system – of which his state is a member – might have inconsistent laws and regulations for e-commerce firms to comply with.

“It would be chaos without any guidance,” Bailey said.

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Online sales tax Sales tax E-Commerce Government finance State and local finance NLC SCOTUS GFOA Washington DC