A Fine Mess

by Mark Battersby

You can’t tax the internet, right? Not quite. When Congress enacted the Internet Tax Freedom Act in 1998, it merely prohibited any new laws taxing Internet sales. States can still collect tax on in-state, online sales, and customers who purchase from out-of-state vendors may owe money to their own state without even realizing it. Thus a confusing web of federal and state laws govern online sales.

Congress acted in 1998 to prevent discriminating taxes that would tax specific products on line that are not taxed off line, but the debate over how to handle Internet taxation in the long-term still rages. In February, U.S. Senator Ron Wyden, D-Ore., and Representative Christopher Cox, R-Calif., co-authored a new Internet tax proposal. Wyden and Cox’s proposal extends the current moratorium on new, “discriminatory” Internet taxes by five years.

According to Wyden, the proposal aims to protect consumers by giving states and localities a blueprint of “fair, Constitutional ways” to simplify tax collection. “This is about fairness,” Wyden said. “Chris and I want to continue the e-commerce boom we’ve gotten from our ban on discriminatory taxes.”

But many say that the status quo itself is discriminatory. “It gives [online vendors] a preferential tax position compared to brick and mortar competitors,” explains Rep. Bob Goodlatte, R-Va. Sorting out how and when taxes need to be collected costs money and takes time, even with software designed to negotiate the labyrinthine rules.

Politicians at both the state and federal level are looking for ways to create some order out of this chaos, but don’t get your hopes up. “Any legislation in this area faces a perception problem,” Goodlatte says. “Last year Congress was in no mood to pass legislation that would address the collection problem because to consumers who were used to getting their purchases [tax]free over the Internet, it would have seemed like the imposition of a new tax.”

The Current Tax Chaos
Currently, Internet commerce is governed by a mishmash of laws. Sales taxes must still be paid when purchases are made from in-state vendors or those with an in-state nexus. Purchasers who patronize out-of-state vendors also, technically, are obligated to pay an equivalent “use” tax to their home taxing jurisdictions. Because Congress’ moratorium only affected new taxes, it did not change existing tax laws. Therefore, buyers who weren’t charged sales tax are supposed to voluntarily hand it over to their home state on their own. Few appear to be complying.

Many e-commerce businesses have also argued that software doesn’t exist that can handle complicated tax collection scenarios, but such software does exist and is already used by businesses across the country. Taxware International (www.taxware.com), which is considered the market leader, integrates with Netscape’s CommerceXpert software to provide accurate sales tax calculations. IBM and Open Market have similar systems, as well as DPC Computers’ Zipsales (salestax.com) and Vertex’s Quantum (vertexinc.com). Most of this software can handle the 7,000 taxing jurisdictions found in the U.S. Since tax laws are always changing, several of the commercial software companies are providing the most complex level of tax compliance by continuously expanding and updating their products.

Admittedly, collecting sales taxes adds to any business’ costs (much of this software sells for around $1,000). However, many states allow vendors to retain a portion of the sales taxes that they collect. The portions retained by vendors across the nation can range from one percent of total sales tax revenue collected in Indiana to a high of four percent of total sales tax revenue collected by small vendors in Virginia.

The States Take Action
If the Federal government doesn’t step in to sort out the mess, the states may decide to do it themselves. North Carolina is working with three other states and nine private-sector companies to launch a pilot study that will encourage companies to voluntarily collect out-of-state sales taxes.

“We are in the proof-of-concept stage right now,” says Charles Collins, director of the state’s Sales and Use Tax Division. “States are expected to be certifying the software soon.” If the program works, companies will add software to their order processing systems that will determine the tax application, the residence of the buyer, and will add the appropriate sales tax to the order. Because companies aren’t currently required to collect taxes on out-of-state purchases, Collins says North Carolina state and local governments lose an estimated $110 million to $140 million annually. That amount is expected to grow to $400 million by 2003.

“From the perspective of any business,” said Brett Smith, president and CEO of Durham-based Bargain Builder, “any time you get more requirements, more paperwork, and more bureaucracy, then you are adding more steps to the sales process and making it more costly.”

Some lawmakers want to standardize Internet tax codes nationwide. The National Governors Association (NGA), along with state lawmakers and others, is pushing legislation to make it easier for states to capture such taxes. The Streamlined Sales Tax Project (SSTP) has adopted rules to simplify collection of state sales taxes. These rules are intended to serve as models for new tax laws in states that wish to participate.

“The mantra of the 21st century has to be local control but central coordination,” said Mike Leavitt, Governor of Utah, a strong advocate of collecting sales taxes on online purchases. Another goal is to build an automated system of sales tax, where all states operate under a constant set of rules and the compliance burden on remote and online sellers is substantially lessened. Bargain Builder’s Smith says that projects like North Carolina’s have some merit. “Any program that would simplify requirements would be viable to companies of any size,” he says.

The Crystal Ball
“We were heartened last year,” said National Retail Federation senior vice president for Government Relations, Steve Phister, “when the Senate overrode efforts to get an extension on the moratorium. We are also encouraged as we see some Democrats previously labeled as liberal who appear ready to support legislation that will help level the playing field between our members and Internet businesses.”

The National Retail Federation, like many organizations, takes a multi-pronged approach. Pressing for legislative relief for their members while actively lobbying on both the state and federal levels, they also belong to and support the E-Fairness Coalition. This Coalition represents a total of more than 1.5 million retail stores and real estate-related businesses. Its members include The International Council of Shopping Centers and the American Booksellers Association, among others.

“We feel that the best scenario is a comprehensive solution,” says Lisa Cowell, executive director of the E-Fairness Coalition. “We hope for federal legislation that would extend the moratorium and encourage states to simplify their sales tax systems.”

Small Business Computing Staff
Small Business Computing Staff
Small Business Computing addresses the technology needs of small businesses, which are defined as businesses with fewer than 500 employees and/or less than $7 million in annual sales.
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