The Leaflet: Should States Tax the Internet?

Published July 11, 2018

On June 21, in South Dakota v. Wayfair, Inc., the U.S. Supreme Court upheld South Dakota’s internet sales tax law, effectively overturning the 25-year-old “physical presence” standard set in Quill Corp. v. North Dakota. Up until now, the Quill decision prevented states from collecting sales taxes on purchases made from out-of-state vendors, unless the vendor has a physical presence such as property or employees located in the taxing state.

Many states have passed “Amazon tax” laws, some of which have been struck down, that required out-of-state businesses to collect sales taxes if the businesses had commissioned affiliates in the taxing state. A few other states established a “cookie nexus” standard, which considered internet cookies on customers’ computers a physical presence of businesses.

In South Dakota v. Wayfair, Inc., the Supreme Court ruled in favor of South Dakota, citing the ubiquity of e-commerce and the necessity of having a uniform tax structure that better suits the modern economy. In particular, the justices favored the state’s internet sales tax because of its minimalist structure. For example, the South Dakota tax bars retroactive collection, minimizes the number of local sales tax rates, requires uniformity between state and local sales tax bases, and excludes businesses with very low sales and/or transactions from tax collection, among other aspects.

The Supreme Court recommended other states follow the Mount Rushmore State in implementing an internet sales tax that does not “impose undue burdens” on interstate commerce. For the five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) that currently exempt sales tax on e-commerce purchases, you should keep it that way.

Small businesses and entrepreneurs already face a mounting pile of regulation, fees, and licenses just to get their enterprise up and running. The collection of online sales taxes can be burdensome for businesses, but especially small businesses, which have to dedicate additional resources to comply with state and local jurisdictions. How many resources? Well, enough to be in full compliance with the more than 10,800 distinct state, county, city, and district sales tax jurisdictions nationally. Currently, Iowa, Missouri, and Texas each have more than 1,000 such jurisdictions within their borders.

Making compliance even more frustrating is the fact that sales and use tax rates change 609 times each year, on average. To avoid or lessen the likelihood of an IRS audit, many businesses rely on tax software services to collect and remit taxes quarterly to the various taxing jurisdictions.

In general, sales taxes also burden lower-income consumers disproportionally because they spend a larger percentage of their household income on goods and services, such as groceries, food, and clothing. Thus, a larger share of their limited income goes to sales taxes. Internet sales taxes may also threaten the growth of the e-commerce industry, one of the key future growth sectors of the U.S. economy.

Fourteen states and the District of Columbia maintain a physical presence rule, meaning sales taxes are not collected on internet purchases unless the online retailer has property or employees located in the state. This was the standard preserved under Quill. These states should resist the temptation to levy sales taxes on out-of-state sellers in the wake of the Supreme Court’s latest decision.


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