Taxing Dilemma
It's Time for Congress to Kill Quill

By Bill Waltz

Nearly 20 years ago the U.S. Supreme Court issued its decision in the seminal case of Quill Corp. v. North Dakota 504 U.S. 298 (1992). Quill confirmed the standard that a retail business must have "physical presence" in a state before that state can require the retailer to collect and remit the state's sales tax from customers within that state.

Quill involved mail order purchases; the decision gives no mention or consideration to the just-developing online sales market of the time. The Court concluded that requiring an entity with no substantial nexus, or meaningful physical presence, in the state to collect and remit the state's tax constitutes an unjustified burden on and interference with interstate commerce in violation of our Constitution's Commerce Clause.

Quill remains the law and its restrictive rationale is considered fully applicable to online sales. But, neither Quill nor the Constitution prevents Congress from taking action to require online retailers to collect a state's sales tax. In fact, Quill was in large part based on the premise that it is up to Congress to make the determination as to "what extent the States may burden mail order (now read Internet) concerns to collect use taxes."

In 1992, online sales were a minuscule segment of the market. They now represent over 20% of all sales and that percentage is growing at an amazing rate of about 15% year over year. This phenomenon doesn't (and probably shouldn't) change the Court's test, but it should (and eventually probably will) change Congress's view. So, why should we burden the Amazons, eBays and Overstocks with the task of collecting sales tax? Isn't this still a burden on interstate commerce? Wouldn't this just amount to another tax, a tax on the Internet?

First, it is not a new tax. Sales taxes, in the form of use taxes, are currently owed on every retail purchase made over the Internet – they're just not being paid. How is that the Internet sellers' problem? It's not really, but then whether a purchaser pays the sales tax at the store wouldn't be the store's problem either but for the state law requiring them to collect it. The point is one retailer doing business in the state must collect it while the other doesn't. And it makes the Internet seller's product 7% cheaper. So the brick and mortar retail store (which pay property tax and employs state residents) has the additional burden of collecting and remitting the tax, and is put at a competitive disadvantage, while the Internet seller is free to market the same product to the same customer without the collection obligation and at a discounted price – all in the name of interstate commerce.

Second, this is not a tax on Internet use; it is a tax on purchases – the same tax you pay when you go into the store, and a tax that you are legally obligated to pay now under existing law. Opposition should not be based on the premise that this is a new tax or a tax on the Internet. Support should be based on free market equity, respect for the law and a desire to see everyone pay the taxes they owe.

To force those who sell exclusively over the Internet (let's call them "E-tailers") to collect sales tax for every state and locality where their customers reside will in fact be a burden. Administrative compliance issues will be abundant and there are very real complications, burdens and costs associated with trying to apply and comply with somewhere around 8,000 different taxing jurisdictions. But Internet sellers can cope and are not likely to suffer much.

For amounts far less than the windfall they currently reap from this situation (as a result of their competitive advantage), they could incorporate software to automatically apply local sales tax rates. These "burdens" are more appropriately considered part of the cost of doing business in those locales/jurisdictions – many as they may be. After all, their in-state, brick-and-mortar competitors must do the same; they may not operate in as many jurisdictions, but that is a matter of choice, and they have to manage the hassles of collecting and remitting the taxes wherever they choose to be. Principles of fairness, together with recognition of the modern realities, should control.

State revenue people of course care a lot about this issue because it means billions in lost tax collections. Estimates run as high as $25 billion nationwide each year. (Sales tax makes up around 30% of all state tax revenues). Consequently, states are doing all they can to push the envelope on the Quill restrictions. They are coming up with imaginative, liberal, expansive interpretations of what constitutes physical presence and legal nexus. States are going after the E-tailers through their business "affiliates" located in the state. But who and what is an "affiliate?" And when is that affiliation or business relationship so close that the presence of one can be imputed upon the other?

It is a complicated legal spectrum: On one hand, there is little dispute at this point that nexus can't be avoided by a practice called "entity isolation" (when XYZ company creates XYZ.com company to handle its Internet sales). Recent efforts, however, are at the other extreme; for example, states are attempting to establish nexus through truly independent companies which the E-tailer has no organizational relationship to except that it pays them a commission for referrals.

Many of the new laws go well beyond reasonable clarifications of the Quill test and essentially ignore the Court's holding, or at least blatantly refuse to apply it the way most legal scholars agree it should be. New York really got things started in 2008, when it passed legislation establishing nexus based on in-state online advertisers that provided a click-through link to the E-tailers' web site. This was just one of the approaches used as a basis for claiming a physical presence to exist through the connection with an affiliate. Others states soon followed suit: Rhode Island, North Carolina, Illinois, Arkansas and Connecticut all passed their own aggressive laws. Amazon and other companies have challenged the new laws, and fought back at every juncture. The New York case is still pending.

California just passed very broadly applying legislation (effective July 1). In response, Amazon, Overstock and other E-tailers immediately severed ties and cancelled contracts with their "affiliates." It is estimated that there are in the neighborhood of 25,000 affiliated companies (small businesses) that will be impacted by the new California law and 10,000 of those may just leave or go out of business. Massachusetts was considering a law similar to California's, but fear of this reaction (combined with the perception that it is a tax increase) has killed it for now. At least another half dozen states have such laws under consideration.

In Texas, the Department of Revenue sent Amazon a tax bill for $269 million based on the presence of distribution warehouses operated by related companies. Amazon decided to pull up stakes and leave the state. (In contrast, Indiana has embraced Amazon; favorable "affiliate" laws and policy positions have resulted in Amazon's building three new distribution facilities here in the last few years with announced plans for a fourth.) Some states (e.g. Colorado, North Carolina and South Dakota) have tried different tactics, like requiring E-tailers to provide lists of their resident customers and/or forcing them to notify their customers that they must pay the state use tax. Obviously, they think they can scare the customers into compliance, knowing their state's revenue department has been notified of their online purchases. These laws are also being challenged and so far have not fared well in court.

Long before the recent rash of Statehouse legislative activity prompted by tough fiscal times and dropping state revenues, there was already a quite involved and organized effort under way to prompt Congress to take action in response to Quill. In the fall of 1999, the National Governor's Association (NGA) and the National Conference of State Legislatures (NCSL) teamed up to seek out a way to deal with the Quill related issues. State tax administrators, other interested parties and organizations began working on an initiative to streamline, simplify and make uniform the various state sales and use tax laws (not the rates, but the administrative procedures).

The Streamlined Sales and Use Tax project was born and led to the Streamlined Sales and Use Tax Agreement (SSUTA), first adopted in 2002. By its own terms, the SSUTA became effective in 2005 when 20% percent of the total population of states with a sales tax had fully approved the Agreement (it took 12 states to reach the threshold). Currently, every state that has a sales tax, except Colorado, participates in the effort in some fashion.

But only 24 of the states are "full members," meaning they have passed conforming laws in full compliance with the Agreement and must regularly amend their statutes to maintain compliance with the administrative procedures, definitions, etc., established by the SSUTA Governing Board, on which our own Sen. Luke Kenley (R-Noblesville) has been active for several years and currently serves as the president. The full member states are: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming.

These states represent 33% of the U.S. population. Unfortunately, the largest, most populated states have not yet signed on to the Agreement (e.g. California, New York, Texas, Florida and Illinois.) These and other states participate in the SSUTA discussions but as either associate members, advisory states or project states, rather than full members. Full members are already reaping modest benefit via voluntary sales tax collection by some E-tailers on purchases from customers in full member states. But most E-tailers are waiting for Congress to act, so the problem persists.

Outside the 24 full member states, there is little uniformity. And with the flux of new nexus stretching laws and state revenue generating efforts, the situation is getting worse all the time. As is simply put by Scott Peterson, SSUTA executive director, the present hodge-podge of laws and the whole situation is "a real mess.' State procedures need to be much more "harmonized" and that remains elusive without federal legislation.

This is where the Main Street Fairness Act comes in. This proposed legislation was first introduced in 2009 and was just reintroduced on July 1 in the 111^th Congress as H.R. 5660 by Rep. Delahunt (D-Massachusetts). A little inconsistent with the name, the major proponents of the Main Street Fairness Act include most of the big name national retailers: Target, Wal-Mart, Sears, Best Buy and the like). The Act would give SSUTA members federal authority to force the E-tailers to collect sales tax in their states (consistent terms of the Agreement.) Passage of the Main Street legislation would surely induce non-SSUTA states to quickly join in so they too could require collection, alleviating the need for them to attempt more stretching of the Quill nexus standard. Quill would be dead for SSUTA-compliant states.

Can Main Street get passed by our present, seemingly "can't agree on anything" Congress? Well, maybe. The issue is a tax issue, making it volatile and potentially subjecting it to opposition from the "no tax of any form" groups. But to repeat, this is not a new tax – just one that isn't being paid. Perhaps more importantly, the issue is not a partisan issue. This is evidenced here in Indiana by the strong support of both Sen. Kenley and Rep. Ed DeLaney (D-Indianapolis).

Federal lawmakers will, of course, bring some different perspectives, but even those with the most adamant views on taxes will face conflicting loyalties – to their local retailers and state colleagues on the one hand, and the big E-tailers who actively lobby (and contribute to) them on the other. The debate also presents conflicting principles: states' rights vs. federalism. It raises the questions of: What is government's role in fostering equity among competitors? Who is paying the price of a wholly ineffective system for collecting a tax? What is that price? Legislators will have to determine for themselves what principles, philosophies and obligations they find most compelling and controlling.

My suggestion, and the position of the Indiana Chamber, is that the present state of the law is serving citizens and businesses alike inadequately and that maintaining the status quo is irresponsible. This is a federal issue and deserves a federal resolution. Although too many people would like to consider the Internet a "tax-free" zone, it should not be when it comes to sales transactions on which taxes are due. The time has come for Congress to step up and do something positive for their local businesses, their states and their constituents: pass the Main Street Act, kill Quill, and move state taxation into the 21^st century in the name of fairness to all involved.

Author: Bill Waltz is vice president of taxation and public finance for the Indiana Chamber of Commerce. He can be contacted at (317) 264-6887 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it

More information on the Main Street Fairness Act:
www.opencongress.org/bill/111-h5660/show

About the Streamlined Sales and Use Tax Agreement:
www.streamlinedsalestax.org/

Background perspective from the Tax Foundation:
www.taxfoundation.org/publications/show/27416.html