Stop eCommerce Sales Tax Legislation!

April 24, 2013 by Paul Byrne

Business Environment

The eCommerce Sales Tax legislation needs to stop to protect online businesses. We are also merchants ourselves and operate stores on our own behalf and on behalf of clients. We also know how many families depend on the income from their online sales. Small online retailers are innovators and drive our economy into the future. In case you didn’t know, legislation exists before congress now, euphemistically entitled The Marketplace Fairnesses Act, which poses a serious threat to small businesses and employment. Really, the “Marketplace Fairnesses Act” is anything but fair. It will put a lot of people out of business and out of jobs if it goes into effect.

If you are not aware of the issue and points on both sides, USA Today has been following the story, as have other media outlets.

Proponents of the bill make several reasonable points:

  1. Local retailers collect sales tax. Because online retailers don’t collect sales tax, those companies have a cost advantage.
  2. Sales tax is technically due on those online purchases anyway, but it is up to the consumer to pay them. However, it is impossible for the states to pursue their own citizens for compliance and is rarely done.

The current legislation says that it will protect online merchants by requiring states to accept a simplified tax code and exempt companies that have less than $1M in sales. You can read the details about tax simplification in this pdf.

Though supporters of the act make some valid points, there are a lot of reasons NOT to enact this legislation. The most important one is that it is entirely unnecessary. Please join us in contacting your Senator or Representative in the House to defeat this ill-conceived legislation. eBay has also created a web page to make this easier for you!

Why it is not necessary and bad for business and employment

First of all, sales tax of small business is already a burdensome process. One small company that I run in Texas, which has one of the easiest regimes to apply to, sucks up about 20 hours per year in accounting and other administrative time for compliance. That costs about $400 per year for a business that collects less than $2000 in sales tax annually.

Many online businesses, especially small businesses, serve as niche businesses. That means their products appeal to a small slice of consumers. Many refer to it as ‘the long tail’ of eCommerce, and it offers one of the greatest opportunities of the Internet.

While most of these businesses earn less than $1,000,000 in revenue, let’s take the case of a business that earns that much in revenue and sells to customers in 40 of the 50 United States in a single year. This business, if the paperwork is as simple as in Texas will have 40 x $400 = $16,000 in additional overhead costs simply to comply with the tax code. You should note that some companies already provide online sales tax calculation and collection services for business required to pay sales tax because they have a presence in each state. The cheapest of these tools costs over $12,000 per year just for the software license. Fortunately, under current tax law, most small online merchants do not need them.

Most online businesses live on very thin margins because of the competitiveness of internet sales. Thus, a $1,000,000 business that is selling online would often have a net margin of $100,000 or less before income and other taxes. That additional $16,000 comes straight out of the business owner’s pocket. That’s simply an unnaceptable amount. In addition to that compliance cost, you have to consider the cost of an audit. A business that complies faces, in my estimation, at least $2,000 in additional costs due to increased workload and business disruption in the case of an audit. If each state only audits 1% of sales tax collectors, you can add that cost every other year.

Most people don’t understand that big businesses already pay these taxes. If you have employees or facilities within a given state, existing laws already require you to collect, file, and pay sales taxes. Online merchants who are building their sales typically either sell to distributors in a state, who, in turn, pay local sales taxes, or have their own retail location or local salespeople. They pay taxes on those sales.

What is most annoying to online merchants is that the states DO NOTHING to deserve the tax collected. In the case of a retailer, the state provides police, fire and other protection and services to physical facilities, education to store workers, clean air, roads to drive on and other services that benefit the local merchant. In the case of a package being shipped in from another state, does the state DESERVE the tax it receives when a package simply crosses the state line? Online merchants who have distribution centers, inventory and/or warehouses within a state, do pay taxes to that state.

Annoying Hubris of Supporters

Some amazing statements have been made by people who clearly don’t know what they are talking about:

Amanda Nicholson is professor of retail practice at the Whitman School of Management at Syracuse University. “The current situation is inherently unfair,” Nicholson wrote in an email. “It allows online-only retailers to frequently avoid charging and collecting sales taxes…while the brick-and-mortar stores (large or small) are compelled to do so.”

Where is the fairness in that? A small business that operates a single retail store collects taxes at a single local rate and pays that rate to one collection agency. Many of these small stores have more than $1,000,000 in revenue. An innovative business that sells online and ships throughout the country with the same level of sales must collect and pay taxes at 50 different rates. Is punishing innovation inherently fair?

If anything, the $1 million threshold is too high, David French (head of the organization trying to railroad this legislation through congress) says, countering that brick and mortar retailers collect sales tax “on the very first dollar of sales.” “Why should (online retailers) get special rules?” he says.

Why should online retailers get special treatment? They shouldn’t. However, the sales tax system was created in a world without small online businesses. It places the burden of handling taxes on the business owner rather than on the citizen and the government. Brick and mortar retailers pay sales tax based on where the product is sold, not its end destination. This holds true even if they take a credit card over the phone and ship the purchase elsewhere. You are asking online retailers to face a level of complexity that local retailers don’t face. If you want the law to be fair, allow the online retailer to pay a single rate to a single state (say the state they are incorporated in).

Point by Point

States can comply with the law in two ways. First of all, they have the option of joining the so-called ‘streamlined sales tax’ regime mentioned above. However, the document is anything but streamlined. This ‘simple’ set of rules covers over 200 pages of vaguely-worded rules, exceptions and examples. While 200 pages may be simple by government standards, for a business it represents another risk factor and compliance cost.

In the second option, they can comply by observing the following rules:
  1. Notify retailers in advance of any rate changes within the state
    • While this is well and good. There is no clear standard or mode of notification. If each state notifies businesses in a different way, businesses will have to deal with the complexity of different states notification systems. We will need a whole class of experts to simply understand notification.
  2. Designate a single state organization to handle sales tax registrations, filings, and audits
    • Most states already have this. However, the merchant still has to deal with 50 organizations with different rules, procedures, filing requirements and so forth. Again, this adds a great amount of complexity to business.
  3. Establish a uniform sales tax base for use throughout the state
    • This is helpful, but, you will notice that it says ‘uniform sales tax base,’ it does NOT state a single sales tax rate. States could easily implement tax codes that will make this very complex. For example, some items, like most food items, are not subject to sales tax in some states. Understanding tax requirements is complex enough for doing business in a single state. Imagine keeping track of that for 50 states.
  4. Use destination sourcing to determine sales tax rates for out-of-state purchases (a purchase made by a consumer in California from a retailer in Ohio is taxed at the California rate, and the sales tax collected is remitted to California to fund projects and services there).
    • This seems to be the only simple rule. However, you can bet that we will soon have exceptions for things like gifts where a purchaser in New York orders a gift, coming from Ohio, for shipment to California.
  5. Provide free software for managing sales tax compliance. Also, do not fault retailers for any errors that result from relying on state-provided systems and data.
    • Software to do what? Will the state software integrate with every existing eCommerce platform (there are 100s in use) to accurately quote taxes for each purchase (based on type of item and rate)? No definition of the software’s required features exists. Additionally, simply stating this requirement in these words shows how woefully out of touch the proponents of this bill are. Clearly, they understand nothing of software and eCommerce. Even if software is made available, are the states going to absorb the cost of integrating it with eCommerce software? Many types of online store software platforms currently don’t even allow for integrations of this kind.

Unintended Consequences

1) We do not ship to ND, SD, MT, WY, AK, HI and other low-population states

Due to varying costs, online retailers will have to decide whether or not shipping to a particular state is worth it. Ironically, people in states with small populations tend to rely on online purchases more simply because the items they seek are less likely to appear in a local store. Because of the long tail issue, a boot maker in Texas might not sell his boots to North Dakota.

2) A gift to Canada and Mexico

Many online retailers based in Canada and Mexico ship to the United States. Those companies pay NO taxes to any state regardless of the size of their sales. They exist outside the jurisdiction of the states. That said, even if the law were to address that, the states would not be able to enforce compliance. Passing this law will be a gift to those foreign companies who employ NO U.S. nationals.

3) A big hit to small manufacturing

Many small online retailers are companies that manufacture their product and ship directly to customers. Most have less than $5,000,000 per year in sales and manufacture or create products with their own hands. Compliance with this law will make them less competitive with the big-box retailers buying from China and Mexico.

The Supreme Court, in Hess vs. Illinois, wisely recognized that the states were placing an undo burden on companies engaging in interstate commerce by forcing them to comply with the rules in all 50 states. We should take their advice.

If the sales tax system is breaking down because it is unmanageable, maybe states should find other ways of taxing their populations rather than pushing the burden of tax collection onto small businesses. Okay, we know that isn’t going to happen. However, they should at least make the changes suggested by eBay CEO, John Donahoe and other small business advocates.

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