Internet Affiliate Sales Tax: “No Pot of Gold” For States

Jan 13, 2011 4:17 AM  By

States hoping to reap a windfall in taxes via legislation that enables them to tax online affiliates may be disappointed, says Jerry Cerasale, senior vice president of government affairs for the Direct Marketing Association. Rather than deal with the taxes, the legislation is prompting large marketers in the state to cancel all affiliate contracts.

This will eliminate any increased tax revenue, and the loss of affiliate income will reduce income tax revenue. And it’s already happening, Cerasale notes.

Illinois recently became the fourth state to pass legislation that requires out-of-state online retailers to collect state and local sales taxes. New York was the first to do so in 2008, followed by North Carolina and Rhode Island.

The legislation contradicts a 1992 Supreme Court Decision, Quill Corp. v. North Dakota, which said states are not allowed to require out-of-state companies to collect sales taxes unless that company has a physical presence, such as a store or warehouse, in the state.

With the so-called ”Amazon tax,” states are now going after marketers using the affiliate technique: when a website (an affiliate) has a link to a marketer’s website (for example, Amazon.com) and the website receives a commission for every sale made by Amazon when the customer comes through the link. The affiliate tax laws state that if the affiliate is located within the state, then that creates nexus (a physical presence) in the state, which requires a remote or out-of-state marketer to collect sales and use tax for all sales the marketer makes to that state’s residents, regardless of channel.

“So affiliate tax laws extend the reach of the tax collector by redefining physical nexus,” Cerasale says. “States are hurting, and they will be pressing hard to increase revenue.”

But Cerasale doesn’t think this legislation will gain traction nationwide. The large marketers in North Carolina and Rhode Island using the affiliate technique have responded by cancelling all affiliate contracts, he says.

“I have heard that the N.C. Commissioner of Revenue says the taxes collected under the program are very small,” Cerasale says. “I don’t know if the commissioner included the loss of income tax from canceled affiliates in the calculation.”

Cerasale says he also heard that in Rhode Island, “the net effect of the law was a decrease in tax revenue from the loss of income tax from affiliates and the lack of any collection from former affiliate marketers.”

Illinois, too, will see marketers cancel affiliate contracts, he says, which will eliminate any increased tax revenue, and the loss of affiliate income will reduce income tax revenue. “There are also reports that companies plan to relocate from Illinois, which will have job and tax revenue implications,” Cerasale adds.

Will states stop trying to tax direct sales and affiliate marketers? A lot depends on the outcome of a lawsuit filed in May 2008 by Amazon.com challenging the New York law.

Amazon.com officials claim that New York’s law violates the equal protection clause of the constitution because it specifically took aim at Amazon. (The American Booksellers Association and other independent retailers and their trade associations lobbied hard for the tax legislation to level the playing field in competing with Amazon.com.)

If New York wins the court cases over Amazon, “I expect a new push for the affiliate tax,” Cerasale says. “However, if the Illinois tax becomes a bust, other states may rethink.”

Bottom line: “There are consequences to state tax revenues as a result of affiliate tax bills that are contrary to the promise of greater tax revenue for cash-strapped states,” Cerasale says.

“There is no pot of gold at the end of the affiliate tax rainbow for any state,” he notes. “Once all these facts are known by the legislators, several states won’t pass similar legislation.”