No Longer A Tax-Free Zone
Get ready to pay taxes on online purchases
The free ride for shoppers used to avoiding sales tax on Internet purchases is coming to an end. Cash-hungry states are aggressively going after the billions of uncollected revenue, and many big merchants are deciding that there are fewer reasons to help customers avoid the levy. In addition, Congress is considering legislation that would allow states to compel all but the smallest retailers to collect sales tax from more customers.
Paving the way for broader collection is a new multistate pact now being finalized that simplifies sales tax rules and offers merchants amnesty for uncollected past taxes. "The states are going to get their money one way or another," says Maureen Riehl, a government affairs official at the National Retail Federation.
When Maine-based L. L. Bean sells a $59 flannel-lined shirt to a local Down Easter, it collects $2.95 in sales tax. But when it sells the shirt to a chilled customer in Ohio, where Bean has no warehouse, store, or other facility, it doesn't collect Maine tax and isn't obligated to collect Ohio tax, either. Years of legal wrangling over such situations led to a Supreme Court ruling in 1992 that blocked states from requiring out-of-state merchants or subsidiaries to collect sales tax on phone, mail, or online orders shipped into the state. (This issue is separate from the congressional debate over extension of a moratorium prohibiting states from taxing access to the Internet.)
Part of the problem is the array of rates and rules among the 7,500-plus state and local jurisdictions that impose a tax--ranging from roughly 4 percent to 9 percent. Cough drops, for example, are taxable in Massachusetts but not in Maryland, while in Ohio a gift basket of fruit is not taxed though a crystal dish filled with candy is, according to a compilation by Velosant LP, which assists merchants. Cloth diapers in Wisconsin? Tax exempt. Disposable ones? Taxable.
State deficits and growing untaxed sales are fueling the push in Congress to overturn the high court's barrier. Estimates of the revenue lost are as high as $26 billion this year and more than $55 billion by 2011. But the Direct Marketing Association, which opposes new collection efforts as overly burdensome, says most estimates are grossly overstated. "There may be some dough out there, but it isn't the pot of gold states think it is," says spokesman Louis Mastria.
Uniformity. States say new, streamlined rules will reduce burdens. Rates will be set by ZIP codes for easy calculation, and definitions of products will be standardized nationwide. Fruit drinks with over 50 percent juice, for example, will be universally classified as food, which is often untaxed. "Every business will benefit, not just Internet and mail-order merchants," says Diane Hardt, Wisconsin's tax chief.
The 45 states and the District of Columbia that levy sales tax already have the power to collect an equivalent "use" tax from Internet and mail-order shoppers. But the levy is rarely enforced, and few individuals pay it voluntarily. That puts tax-collecting local retailers at a disadvantage, says Riehl of the Retail Federation. "This is about an uncollected tax, not a new one," she says.
Ironically, many retailers are voluntarily collecting more sales tax as they move toward letting customers return online or mail-order purchases at a store or order goods online for store pickup--services that mandate tax collection. Until earlier this year, Wal-Mart.com collected sales tax in only nine states where it had facilities. But now as part of a plan to link promotions and sales with its stores, the online division collects tax everywhere. Toys "R" Us and Target are now also collecting sales tax widely.
Consumers, meanwhile, say they worry more about shipping fees, easy returns, and user-friendly Web sites than about taxes, says retail analyst Patti Freeman Evans of Jupiter Research. "Consumers are used to paying tax," she says. Which is good, because it's getting harder and harder to avoid.
This story appears in the November 3, 2003 print edition of U.S. News & World Report.