State Sales Tax on Internet Purchases

Overview
A state may tax a transaction if there is some connection (nexus) of the transaction to the state. Thus if the seller or the buyer is located in the state, the transaction may be subject to the sales tax. The important question in the out-of-state seller context is not the state’s power to tax the transaction, but rather whether the state can require the out-of-state seller to collect the tax from the purchaser.17

The Due process18 and Commerce clauses19 of the U.S. Constitution limit a state from imposing tax liability or collection responsibilities on a business concern unless there is a substantial nexus or in-state contact established with the state. There is currently no statutory authority and scant case law on the subject of nexus and the Internet, but the Supreme Court has given considerable guidance in the analogous area of taxation of mail order sales. The two major Supreme Court decisions in this area are National Bellas Hess, Inc. v. Illinois Department of Revenue,20 and Quill Corp. v. North Dakota.21

National Bellas Hess Case
In the 1967 National Bellas Hess decision, the Supreme Court held that the state of Illinois could not require an out-of-state mail order sales company to collect a use tax from Illinois customers. Bellas Hess’s only contact with the state was via the mails or common carriers. This contact was found to be insufficient to establish nexus under either the Due Process or Commerce Clause. The Court utilized a physical presence standard for nexus for both of these clauses.22 Ten years after Bellas Hess, the Supreme Court set out a four part test in Complete Auto Transit, Inc. v. Brady23 for determining whether a state tax is compatible with the Commerce Clause. For a state tax to be applied to an activity there must be substantial nexus with the taxing state. The tax must be fairly apportioned. It must not discriminate against interstate commerce. The tax must be fairly related to the services provided by the state.24

Quill Case
This clarification became more significant in the mail-order sales area after the 1992 Quill decision. In Quill, a case factually similar to Bellas Hess, the Court dropped the physical presence test for nexus under the Due process clause, requiring only that the seller’s efforts be “purposefully directed toward the residents of the taxing state.”25

Therefore the Due process clause was no longer an impediment to requiring tax collection by the out-of-state seller. However, the physical presence standard or substantial nexus requirement of the Commerce Clause was reaffirmed.26 Therefore the practical outcome of the case was the same as Bellas Hess. The state could not force the seller to collect the tax absent a substantial nexus.

The removal of the Due Process Clause as a road block did open a door for Congress, under its commerce powers, to legislatively empower the states to require the collection of these taxes. The Supreme Court, in Quill, specifically invited Congress to act in this area. To date, Congress has not enacted legislation in this area.

Streamlined Sales Tax Project
One of the objections to requiring out-of-state sellers to collect state sales tax is that there are many different sales tax rates (from state-to-state) as well as multiple sales tax rates within an individual state based on the type of good being sold or the locality where the tax is collected. The Streamlined Sales Tax Project (SSTP) is an effort now underway to address, at least in part, these concerns.

SSTP is comprised of thirty-nine states and the District of Columbia. According to the SSTP’s website,27 its goals are to establish uniform tax base definitions; simplify tax rates by allowing only one state rate (with limited exceptions); impose uniform sales and use tax exemptions; create uniform and limited audit procedures for sellers; and have states fund some of the required technology improvements. Many states currently employ a variety of sales tax rates, depending on what the type of purchase is (i.e. goods, food, prescription drugs, etc.). Local governments within states are also able to impose sales taxes, and often do so with a similar variety of rates. The SSTP would limit states to one sales tax rate per state, with the possibility of an exception (different rate) for food and drugs. Local jurisdictions would be allowed one local rate. Additionally, the SSTP would mandate that states and their local governments use a common tax base, and eliminate the widely imposed requirement that businesses file tax returns with local governments.

The coalition states working together are known as the Streamlined Sales Tax Implementing States (SSTIS). This group approved model legislation, the Streamlined Sales and Use Tax Agreement, on November 12, 2002. Ten states representing 20% of the population of sales tax states must conform for the agreement to come into effect (not clear whether states must actually be conforming in operation or just approve conforming).28 SSTP claims thirty-four states, and the District of Columbia, have approved the agreement and twenty have enacted some form of conforming legislation.29

The next step is for the participating states would be to ask Congress for the permission to compel out-of-state vendors to collect sales and use taxes once the states have implemented the simplified system by approving the agreement and enacting conforming legislation. Successful implementation of the SSTP will rely largely on technology to simplify the administration of sales and use taxes. It envisions providing sellers (retailers) the opportunity to employ one of three technology models to ease and modernize administration.

Model 1 consists of a Certified Service Provider, paid for by the states, which performs all of the seller’s sales tax functions. Model 2 is a Certified Automated System which provides only the tax calculation function. The third option would be for the seller (typically large nationwide retailers) to develop their own system and have it certified by the SSTP.