Stateline Story

This Holiday, 21 States Reaping Tax Rewards From Online Shopping

  • November 18, 2005
  • By William T. Pound

Americans have become quite predictable when it comes to the year-end holidays. Family and friends gather together, children write letters to Santa, menorahs are lit and placed in the window sills, and bargain hunters flock to the malls in search of that hard-to-find gift.

Over the past several years, however, more and more holiday shoppers have decided to stay home and do their shopping online, through catalogues and television shopping networks. In fact, Forrester Research says holiday shoppers will spend an estimated $18 billion online this holiday season, an increase of 25 percent over last year.

Perhaps the allure of shopping in your pajamas is too great for shoppers to resist? Or maybe having your purchases arrive on your doorstep instead of schlepping them through the mall is appealing? Perhaps, items are cheaper because many retailers do not collect state and local sales taxes? Whatever the attraction, holiday shoppers are turning to the Internet in droves.

This trend, which has grown exponentially over the past 10 years, has created several policy issues with which state legislators and tax administrators have had to wrestle.

The growth in Internet, television and catalog sales has serious budget implications for state and local governments. Because of two U.S. Supreme Court decisions, there is no requirement for a retailer who does not have a physical presence in a state to collect that state's sales tax. Most online retailers only collect sales taxes for one or two states.

For example, if has a headquarters in West Virginia and a distribution center in North Dakota, the high court holds that the nation's more than 7,500 sales tax codes are too onerous to require to collect sales taxes on purchases that are being shipped to states other than West Virginia or North Dakota.

The problem is that state governments rely on sales and use taxes to provide essential government services such as K - 12 education, public safety and health care services to the elderly.

In fact, researchers at the University of Tennessee estimate that state and local governments will lose more than $60 billion in sales and use tax revenue between 2003 and 2008.  That's $60 billion less to spend on textbooks, school lunch programs, terrorism and emergency preparedness, and prescription drugs.

It also creates a competitive inequity between online retailers who do not collect sales and use taxes and the "brick and mortar" retailers who do.

State legislators and tax administrators from 41 states have been working together over the past five years to create a voluntary program that provides retailers with compensation and a certain level of immunity from liability for any mistakes in exchange for collecting sales taxes in states where they do not have a physical presence.

This voluntary system—called the Streamlined Sales and Use Tax Agreement—has created a series of common definitions and rules that states can apply to their sales- and use-tax codes. States still, however, maintain sovereignty over what items and services are taxed and at what rate (if any).  To date, 21 states have decided to conform their sales and use tax laws to the common definitions and rules created by the agreement.

The way it works is simple. A retailer signs up to participate and contracts with a certified service provider who can easily determine what is taxed and at what rate in each of the 21 states that participate. The certified service provider collects the sales tax on the consumer's purchase and remits it to the consumer's state. The certified service provider is then compensated for the transaction and is held harmless in the event that the software made a mistake. Companies that voluntarily participate in the program are also given amnesty from penalty for any previous times in which they did not collect sales taxes but should have.

But just because more online retailers are collecting sales taxes, that doesn't mean holiday shoppers will not find bargains on the Internet.  In fact, because of the Streamlined Sales and use Tax Agreement, a participating retailer's costs are likely to go down due to a simpler tax system, better compensation for collecting taxes and a reduced level of liability.

So as the holiday rituals begin to unfold for the 2005 season, those who relish the after-Thanksgiving sales need not leave their living rooms. As the Internet retail industry likes to say, "Just click and save."