Magazine article Information Today

Taxation of Main Street versus Cyber Street

Magazine article Information Today

Taxation of Main Street versus Cyber Street

Article excerpt

Benjamin Franklin once said, "Nothing can be said to be certain, except death and taxes." However, taxes (at least state sales taxes) have been anything but certain in the development of ecommerce. In many respects, a major aspect supporting the development of ecommerce has been that many transactions have been free of a state sales tax. In reducing transaction costs by not collecting sales taxes, internet transactions can represent significant savings compared to brick-and-mortar sales.

With the tight budgets in which many states are operating and the need to locate additional revenues in any nook and cranny, both individual states and Congress are exploring new laws and mechanisms to let states collect taxes on internet-based sales transactions.

Taxing Internet Transactions

The internet has largely stayed a sales-tax-free environment because of a combination of unique legal principles that the U.S. Supreme Court has tested and the labyrinth of state, local, and other tax laws that could apply otherwise. Consequently, any change in the status quo would require legislation that is carefully crafted to avoid the legal restrictions that exist and make it a practical possibility for internet businesses to collect and redeem sales tax transactions.

Sales taxes are charged by state and local governments on retail purchases of tangible goods. Today, 45 of the 50 states charge some form of sales tax with a number of states permitting local governing authorities to add additional taxes. Many states also make various exemptions for their sales taxes, the most common of which are on food, prescription medications, and clothing (to a lesser degree).

Sales taxes are collected by the retailer from the consumer based on the amount of the transaction. A consumer may pay $7 to the retailer as the sales tax on a $100 transaction. The retailer then remits the taxes to the state or other taxing authority usually through regular tax filings outlining all of his or her sales and remitting the appropriate percentage(s).

Dealing in Different States

The challenge arises when the retailer and the customer are in different states. The tax is based on the retail sale of a tangible good and is assumed to take place in the location of the purchaser. In a face-to-face transaction, that location is obvious. However, in an online transaction, the tax is based on the purchaser's mailing address and not on the business' location. In a 1967 Supreme Court decision, the court found that when there are no minimum contacts between the retailer (generally defined as a physical presence in the state) and the customer's state, retailers are not required to collect that state's sales tax.

In response, several states enacted use taxes. Although not as widely known as sales taxes, they go hand in hand, so much so that retail sales transaction taxes are often labeled by their states as a sales and use tax. A use tax is charged by the states directly to the consumers for their use of a tangible good in their home states. So in theory, consumers would pay $7 in use tax directly to their home states on the $100 item they bought through Amazon.

No 'Substantial Nexus'

However, consumers rarely pay this tax (if they are even aware of it). In 1992, the Supreme Court addressed use taxes in a case involving mail order sales, which has since been extended to online sales. …

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