Small Business, The Internet, and Sales Tax: Avoid the Impending Disaster
Sales tax on the internet has been a big issue over the past couple of years, especially with some big companies with big opinions like Amazon, eBay, and Best Buy. However, no one seems to be looking at it from the perspective of the small internet only business.
It’s best to start with some background to make the issue clear. Total Home Supply is a small business started in 2010, selling air conditioners, heaters, appliances, and more on the internet. We do not have a retail location and only exist online. Almost all of our business comes from our own website. We also have an eBay store, but this is not our primary sales venue. We are a New Jersey based company and our only location is in New Jersey. This means that we are only legally required to collect New Jersey sales tax. At this point, an accepted fact is that a company is only required to collect sales tax where it has nexus (a physical presence). Although this is still challenged by some states (and a surprising number of our vendors), this is the law which currently exists.
A Supreme Court decision, Quill Corp. v. North Dakota, 504 U.S. 298 (1992) clarified that a state cannot require a business outside of its borders to collect and remit sales tax. This decision also pointed out that only congress has the right to govern interstate trade, and therefore is the only legislative body which can pass any law concerning sales tax across state borders.
In order to make up for lost revenue from out of state internet or catalog purchases, included on most state’s tax returns is a Use Tax line, where the taxpayer is required to declare out of state purchases and pay their tax share on them. According to a survey conducted by the Minnesota House of Representatives Research Department in 2007, a mere 1.6% of taxpayers paid any use tax.
The states are correct regarding missing out on sales tax revenue. We don’t deny that. Unlike many other online businesses, we refuse to advertise that we do not collect sales tax. When asked, we simply say we do not collect sales tax outside of New Jersey. Most of our customers are still liable for the Use Tax in their state, but it is not our obligation to see that they pay it.
Clearly, we need reform. Many states have passed laws requiring payment from out of state companies, but these laws are not legal nor can they be enforced.
Seeing that the current system is not working, Congress has begun to take action; attempting to come up with a solution which will appease states and their constituents, or at least the constituents with a voice in Washington. Amazon seems to be the biggest, if not the only target of most of the proposed legislation. After many years of trying to avoid sales tax, Amazon has started accepting the inevitable and thrown their support behind S.1832 The Marketplace Fairness Act. This act is an ill-conceived attempt to quickly fix the sales tax problem. It is currently in the Senate Committee on Finance, and if passed… would essentially force us, as well as thousands of other small businesses across the country to shut down.
The Marketplace Fairness Act would require businesses to collect sales tax based on the destination of the shipment. With over 7,000 different tax jurisdictions in the United States, it would be nearly impossible for a small business to know the rules in each one. The act attempts to help with this problem requiring states to either agree to the Streamlined Sales Tax Agreement or follow some guidelines stated in the bill.
However, the Streamlined Sales Tax Agreement isn’t streamlined, nor is it easily implemented. For example, our home state of New Jersey, one of 24 full participants in the Streamlined Sales Tax Agreement, has Urban Enterprise Zones with reduced sales tax, as well as special rules regarding sales tax on items such as clothing. How can a small business be expected to not only be cognizant of all of these rules, but to also have the staff to implement them?
New Jersey is probably one of the easier states, there are only two tax levels: 7%, and 3.5% for Urban Enterprise Zones. In other states, tax rates can vary for every county, and even for specific cities. To make it easier on small businesses, the creators of the bill have proposed having one organization responsible for the collection of these taxes. These legislators assume because this can be computerized, it would be a viable option for a small business. However, they do not take into consideration the need for an employees (or several), to collect and program that information. Nor do they realize checks will need to be distributed to fifty separate entities.
A small business exception was put into the bill stating that any company doing less than $500,000 per year would be exempt from the program. However, the Small Business Administration (which is a part of the federal government used to help small companies), a company such as ours, is still considered a small business until sales reach $30 million per year, 60 times larger than what this bill considers a small business. This discrepancy between the two governing agencies is beyond belief.
Better solutions can be put into place; solutions which would solve the problems of states, brick and mortar stores, small companies, and large corporations.
One option would be to allow businesses to charge sales tax based on their location. For example, New Jersey based businesses would collect and remit New Jersey sales tax on every order. This makes the payments from the business to the state simple, and requires a small business to only follow the sales tax laws now implemented in their state. A side benefit of this would be the creation of competition in tax rates among the states.
If states begin to compete for lower tax rates, it would provide incentives for internet companies to locate their business in the state with the most favorable tax rate. For example, if New Jersey extended the Urban Enterprise Zone rate of 3.5% statewide, there would be more incentive to buy from a New Jersey based company than say, New York with its 8.875% tax rate. As a result, New Jersey would create more jobs, ensuring larger tax revenues for the state. This would benefit the consumers, the state and the small businesses.
The only other realistic option; a nationwide internet flat tax rate. One tax code and tax rate for all states would simplify the entire process. A business would be only required to have knowledge of one set of simplified tax codes. Payments would be made to only one governing board.
Of course it’s not as simple as just saying this should be done. States without a sales tax would certainly not be onboard, and states with higher than the flat tax rate would be similarly dissatisfied. Clearly, this is not an easy problem to solve, and is the reason no legislation has been passed since the Supreme Court decision in 1992.
However, it remains clear to me none of the proposed plans will work. No business large or small should be expected to implement 7,000 different tax rates and regulations. Even with modern software, this proposed legislation is simply ridiculous.
Passing the Marketplace Fairness Act would not create a fair marketplace. It would however, destroy years of growth for small businesses, make selling online unfeasible and would eliminate virtually all small companies from the equation.
Want to read more? Check out some of my sources for more details.