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In Online Sales Tax Fight, States Adopt New Tactics

States are passing laws that -- they hope -- will lead to lawsuits that land the issue before the U.S. Supreme Court.

Tired of waiting for Congress to approve a tax on Internet sales, nearly two dozen states are moving to pass bills or change regulations in ways that deliberately invite lawsuits from Internet retailers. The goal? Landing the issue before the U.S. Supreme Court.

On May 1, South Dakota became the first state to implement new legislation allowing it to collect a sales tax from out-of-state retailers who sell products over the Internet to South Dakotans. Because the legislation calls for an expedited path for judicial challenges, experts believe the law will produce a crucial first test case that the nation’s top court could take up as soon as the end of this year.

Putting the issue of taxing online sales before the courts is part of a new coordinated effort by state legislators across the country. All told, 34 bills in 22 states have been introduced this year that would allow states to collect sales taxes from remote retailers, according to the National Conference of State Legislatures. About a half-dozen of those bills have moved forward in some fashion.

Other states, like Alabama, are revisiting their existing regulations. The state’s revenue department recently began enforcing an old law it says allows it to tax out-of-state sellers and then, possibly, audit for noncompliance.

The renewed push comes after more than a decade in which states have tried to get Congress to consider a national law that would require online retailers to remit a sales tax for purchases made in states where that retailer doesn’t have a physical presence. Proposed federal legislation has taken various forms over the years but has never gained much traction, despite having bipartisan support. In 2013, states got a huge victory when the U.S. Senate passed the so-called Marketplace Fairness Act. But since then, the bill has languished in the House. By some estimates, states are collectively missing out on more than $23 billion annually in potential online sales tax revenue.

Meanwhile, states have watched with great frustration as Congress has repeatedly extended -- and recently made permanent -- a law that bans states from collecting a tax on Internet service providers.

Online retailers and others argue that allowing Internet sales taxes wouldn’t level the playing field, as some hope. Large companies that have a presence in multiple states generally have the infrastructure in place to collect a sales tax. “But it’s more challenging for smaller retailers that don’t have the computer systems and accounting staff to ensure compliance with 10,000 nationwide tax jurisdictions and 46 state tax auditors,” argues NetChoice, a trade association promoting e-commerce.

If the issue does make it to the Supreme Court, it would challenge a 1992 decision, Quill Corp. v. North Dakota. Under that ruling, states can apply sales taxes only to companies with a physical presence in the state. But that decision, says the National Governors Association’s David Quam, is severely outdated because it revolved around the mail-order catalog industry. “Today the Internet has completely changed the economy,” says Quam. “It allows for a level of commerce across state lines that nobody anticipated back in 1992.” 

At least one U.S. Supreme Court justice agrees. Last year, Justice Anthony M. Kennedy invited a fresh challenge to the Quill decision. “A case questionable even when decided,” Kennedy wrote, “Quill now harms states to a degree far greater than could have been anticipated earlier.”

Liz Farmer is a former GOVERNING fiscal policy writer.
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