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In South Dakota, a Test Case for Online Sales Taxes

Provoked by legislators, online retailers have filed a lawsuit against the state that could have taxing consequences nationwide.

In a lawsuit that could have taxing consequences nationwide, online retailers are suing South Dakota for trying to collect a sales tax from them. If the suit makes it to the U.S. Supreme Court -- as many believe it will -- governments would finally get an answer to their long-awaited question of whether they can collect a sales tax from online purchases.

South Dakota lawmakers essentially provoked the suit by passing a law they knew would be challenged by retailers. The law allows the state to collect a sales tax on Internet purchases from remote retailers who have a so-called “economic presence” in the state. Retailers had to start complying with the law by May 1. It challenges a 1992 Supreme Court case that ruled states can only tax retailers who have a physical presence there.

“[Lawmakers] were intent on getting this to the U.S. Supreme Court, and we are obliging that intent,” said Steve DelBianco, executive director of NetChoice, a trade association promoting e-commerce and one of the plaintiffs in the lawsuit against South Dakota.

NetChoice and the American Catalog Mailers Association filed their lawsuit against the state two days before the law officially went into effect but after South Dakota had started issuing demand notices to retailers regarding tax collections. The day before the retailers filed suit, South Dakota itself announced it was suing four online retailers, including, to collect sales taxes from them.

South Dakota may not be the only state that sees litigation on this issue. 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 let states collect sales taxes from remote retailers, according to the National Conference of State Legislatures (NCSL). About a half-dozen of those bills have moved forward in some fashion.

The lawsuit shouldn’t have a chilling effect on other states considering similar legislation, said NCSL analyst Max Behlke. In fact, he expects it will encourage others to move forward. But given that South Dakota’s legislation actually calls for an expedited process through the state courts, many expect it will provide a crucial first test case for the nation on the issue. Behlke said it's likely that the U.S. Supreme Court will take up the case this year or next.

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.

NetChoice's DelBianco argues that requiring retailers to remit a sales tax wherever they make a sale would be overly cumbersome given that more than 10,000 jurisdictions across the country levy a sales tax. But NCSL's Behlke said that doesn’t mean a retailer will have to comply with thousands of different taxing regulations. The real total is more like 22 different regulations. That’s because localities generally streamline their taxing definitions with their state, and about two dozen states have also streamlined their sales tax codes with each other. On top of that, he added, software is available to businesses to automate the sales tax collection process.

“It’s a really hollow argument,” said Behlke. “It’s a good tag line, but it’s just not true.”

If the Supreme Court does take up the case, there might already be one justice on the states’ side. Last year, Justice Anthony M. Kennedy invited a fresh challenge to the court’s 1992 decision, Quill Corp. v. North Dakota. That decision revolved around the mail-order catalogue industry and was made years before e-commerce took off.

“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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