Some states may be emboldened to tax all internet purchases but online retailers are likely to rein in those states in through legal action…
By overturning a ruling that had made much of the internet a tax-free zone, the court delivered a victory to South Dakota and effectively blessed its model of collecting sales tax from online retailers. Justice Anthony Kennedy defended the state’s measures as preventing “discrimination against or undue burdens upon interstate commerce.”
South Dakota taxes most products at a single rate, exempts small sellers and doesn’t allow retroactive collection. New York and California’s rules are more complex, and those states have sought to increase sales tax collection by using broader definitions of what it means to do business within their borders. Both states already require retailers to collect tax if they have digital ties to the states.
“New York and California would likely have to make some pretty big changes,” said John Buhl of the Tax Foundation. “South Dakota has a uniquely simple law since it generally taxes all consumer purchases instead of carving out a bunch of exceptions, and online sellers can remit their taxes to the state instead of each and every locality.”
The decision reverses a 26-year-old standard that allowed states to levy sales taxes on e-commerce sales only if the sellers had physical locations in the state. Among the biggest winners are small or less populous states where retailers are not as likely to have stores or employees. While states like New York may be emboldened to test the bounds of what’s now possible, retailers are likely to rein in those states in through legal action.
The New York State Department of Taxation and Finance didn’t respond to a request for comment.
“This decision is not the end of the days for this case,” said Jamie Yesnowitz, a National Tax Office leader at accounting firm Grant Thornton.
Rep. Tom Reed, R-N.Y., said he supported the ruling’s creation of a level playing field between online sellers and physical retailers. But he said he’s concerned that it will create a complex web of online sales rules that could prompt some businesses to move.
“When you are dealing with the virtual cloud, it gets complicated,” Reed said. “This is an area that’s very much in a state of disruption.”
Online retailers will have to deal with a hodgepodge system until Congress enacts a federal standard, which is unlikely this year given the midterm elections in November. Amazon.com and Overstock.com are among the companies that say they support a nationwide law that would relieve retailers from dealing with a patchwork of state tax laws.
Lawmakers have tried unsuccessfully to pass online sales tax legislation for years, with the most recent attempt failing after several conservatives called the provision a tax increase on online shoppers. Some Democrats also opposed the measure.
Broader taxing power will let state and local governments collect an extra $8 billion to $23 billion a year, according to various estimates. Thirty-one of the 45 states that collect sales taxes have allowing them to expand their tax collection beyond the physical-presence standard vacated in the Supreme Court ruling, according to an analysis from the Tax Foundation.
The 16 states with laws similar to South Dakota’s, including Indiana and Maine, are less likely to be challenged. States that don’t have laws governing online sales tax are likely to move quickly to follow South Dakota’s approach, including its threshold of $100,000 in sales, said Gary Botwinick, a lawyer at Einhorn, Harris, Ascher, Barbarito and Frost in New Jersey.
“The South Dakota model is a safe bet for states, so it’s reasonable for them to start there” said Max Behlke, who directs budget and tax issues at the National Conference of State Legislatures.
The ruling means some states can expand their tax collection systems, but it will take months to get systems up and running, Behlke said.
Another question for states to consider will be whether to push to collect tax on previous transactions. Kennedy didn’t directly weigh in on retroactivity, but he said the issue wasn’t a reason to keep the physical-presence rule. He said the court had other legal tools to ensure that sales taxes don’t become an “undue burden” on small businesses and startups.
Tax lawyers including Richard Jones, a tax partner at Sullivan and Worcester in Boston, said they interpreted the decision as meaning sales tax could be applied retroactively –– perhaps on sales as far back as 10 years.
But taxpayers could raise challenges, including the argument that collecting sales tax for previous sales could subject the seller to double taxation if the customer had already paid sales tax. Congress could also step in and block retroactivity, Jones said.
The Supreme Court decision “will certainly change how states look at these laws but we may see states trying to see if their versions could survive even if they are less simplified and direct than South Dakota’s law,” Joseph Bishop-Henchman, an executive vice president at the Tax Foundation, said in a blog post. “This ruling is not a blank check for states.”
(Greg Stohr contributed to this report.)
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