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February
2003

ONLINE SALES: NEW URGENCY IN EFFORTS TO COLLECT TAXES

A nasty fiscal morass in state budgets nationwide has helped turn up the heat on the numbingly complex subject of Internet sales tax. Once deemed too troublesome or too minor for state tax collectors to pursue, the collection of sales tax from online transactions has taken on a new urgency in an era of tumbling government revenues and record-setting budget gaps.

Despite a temporary Congressional moratorium on taxing Internet access services, some Internet sales are already subject to a special form of sales taxes at the state level known as Ďuse taxes.í Consumers who live in states that collect sales taxes and purchase merchandise on the Internet tax-free are, technically, required to pay the uncollected tax directly to their state. Not surprisingly, few consumers ever do so, leaving very little of these tax dollars collected. Use taxes apply not only to the Internet, but to any taxable transaction, and states have traditionally reserved collection efforts for big ticket items, such as cars or boats. But with legislatures desperate for money, collecting tax on smaller purchases is looking much more appealing, despite the complexities.

With Internet commerce continuing to show significant growth even in a down economy, the tax loss to states is substantial. California officials estimate the state has lost $13 million in uncollected cigarette taxes sold online between May 1999 through September 2001. Floridaís estimated share of sales tax lost to the Internet in 1999 stood at $30 million; a University of Tennessee study projected that figure would hit $900 million in 2001, and soar to $3 billion by 2006.

Some major national retailers, who originally set up separate companies for their online stores to bypass sales tax liability for customers located in states where they also have a physical presence, have now started to voluntarily collect taxes. Web operations are increasingly integrated with the physical stores, rendering companies liable. Rather than waiting for trouble, these retailers are collecting taxes now.

But if tax-free shopping online has been a general hit among consumers, it has been even more so among tobacco consumers, since tobacco excise taxes - incredibly hefty in some states - are levied in addition to any general sales tax. The savings for consumers can be enormous, and the uncollected revenue particularly enticing. Plus, separate laws govern interstate tobacco sales.

Attempting to collect unpaid taxes, one consumer at a time, may be cumbersome, but it isnít impossible. Anyone selling cigarettes across state lines to an individual is required to report the transaction to state tobacco tax administrators, a provision of the 1949 federal Jenkins Act. For decades, states have exchanged such information, but collection efforts have been erratic. According to the General Accounting Office, state tax collectors in Rhode Island and Massachusetts have contacted residents seeking payment for cigarettes bought over the Internet, and New Jersey has even sought unpaid taxes on Internet cigar sales.

New York City - which hopes to collect $15 million in unpaid taxes - sued a group of web site owners in January for evading the nationís highest local cigarette tax, allegedly defying the notification requirements of the Jenkinís Act and misleading consumers by claiming the sales are legally tax-free. Last year, Washington state sued one website to force it to turn over its list of cigarette customers.

For brick-and-mortar tobacco retailers frustrated by the unfair price advantage that online retailers enjoy, the possibility of a uniform Internet tax is appealing. For those who also sell online themselves, a uniform national standard would be preferable. A simple answer is probably a long way down the road.

E. Edward "Ted" Hoyt III
Editor