Sales and Use Tax Issue Has Potential to Get Messy

Oct 31, 2012 9:19 PM  By

For the first time since the Supreme Court’s landmark decision in in Quill Corp. v. North Dakota nearly a generation ago, there is significant momentum in Congress for legislation that may remove the constitutional obstacle to requiring remote merchants to collect sales and use tax.

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For those who have not followed the issue closely over the years, the U.S. Constitution has for decades been interpreted as prohibiting states from imposing a sales/use tax collection obligation on retailers who lack a physical presence in the state― “nexus” as it has been called. Only Congress may impose that burden on interstate commerce.

The policy arguments made on behalf of remote sellers against enactment of such a provision have been well-aired in the debate raging over federal legislation since at least early 2011, but little has been written about the potentially messy effort by states to implement the changes necessary actually to impose any such tax, even if the “Main Street Fairness Act,” “Marketplace Fairness Act,” or “Marketplace Equity Act” should happen to pass.

What happens then? To some degree, the answer to that question depends upon which bill, if any, is enacted. As an initial matter, in order for most states to impose an additional obligation on remote sellers as authorized by Congress, the state will need to amend its sales and use tax statute.

This is because every federal solution requires states to accept some degree of simplification in their sales and use tax systems, which means to take advantage of the federal authorization, a state must agree to part with some control over its own tax system.

The threshold policy issue is only the first question. The required changes to the tax scheme of some states could be quite significant and demand tough choices, if not entire tax code overhauls, from some state legislatures.

The Main Street Fairness Act, for example, only permits states who are members of the Streamlined Sales and Use Tax Agreement (SSUTA) to impose the additional tax. SSUTA is a multistate tax compact the purpose of which has been to attempt to simplify sales and use tax. Fewer than half the states, however, have become members, and its membership does not include the six most populous states in the country: California, Texas, New York, Florida, Illinois and Pennsylvania.

The SSUTA requires member states to adopt uniform sourcing rules, definitions, and administrative provisions for the calculation, collection and reporting of sales/use tax. In many instances, compliance by states would require changes in the sales tax base, adjustment in tax rates, and a surrender of autonomy by municipalities and other localities.

Some of these changes could produce losses in state or local revenue and it may be an open question whether collection of use tax on Internet and other direct to consumer sales would be enough to offset those losses.

The Main Street Fairness act also requires states to agree to cede control of aspects of its sales tax collection and administration process to federal courts―a significant advantage that states have enjoyed over the years in disputes over the interpretation of state tax rules. In short, there is at least the potential for a “be careful what you wish for” hangover as the various states begin the work of calculating the price of admission to the collection of tax on remote sellers.

There is no reliable method to predict the time frame required for states to examine the policy and practical questions surrounding the imposition of this new tax regime―it could easily be years. At the end of the day, in each state, implementation of federal authorization to collect tax on Internet and remote sales is likely to be perceived by voters as a tax increase, a politically charged issue under any circumstances.

The political and technical judgments involved in making the changes necessary to any particular state’s tax code are similarly complex. Many states may find them too daunting or expensive. For states that so not adopt the required measures to take advantage of Congressional authorization, the Quill “nexus” rule would continue to apply.

The only thing that is certain about the aftermath of the passage of one of these federal bills is that the uncertainty surrounding the obligations of remote sellers to collect and remit sales tax will linger for quite some time.

Kevin R. Haley is a partner with the law firm Brann and Isaacson.