What the end of tax-free online shopping means for small businesses

Mon Oct 8, 2012 1:51pm EDT

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In this season of non-stop mudslinging and campaign acrimony, there's a hot-button issue on which Republicans and Democrats actually agree. Stranger still, it involves taxes, and a set of bills in Congress that, though stagnant until post-Election Day at the earliest, could end tax-free shopping on the Internet as we know it.

At debate is a wrinkle online shoppers love, but brick-and-mortar small businesses loathe: the lack of state tax collection by online retailers. It's part of a long-broken system, and a set of three bills currently before Congress aims to fix the problem. In the process, it would also add a timely shot of much-needed revenue to state coffers, while clarifying tax collection for small business owners and consumers alike.

Currently, there are three online sales tax bills before Congress: the Marketplace Fairness Act in the Senate, the Marketplace Equity Act in the House of Representatives, and the Main Street Fairness Act in both chambers.

The bills all have similar aims, but some differences; the Main Street Fairness Act, introduced in July 2011, would provide authorization for states that have signed on to the Streamlined Sales and Use Tax Agreement. Currently, 24 states have passed legislation to conform to the SSUTA.

The bills are unique in that they have bipartisan support from politicians who rarely if ever agree on tax issues, including Sen. Dick Durbin (D-Illinois) and Sen. Lamar Alexander (R-Tennessee).

Taken as a whole, the bills before Congress would bring some sanity and order to a nationwide system of more than 9,600 state tax jurisdictions. Streamlined states have just one tax rate for most items (though they would still set individual rates apart from each other). So the new bills would not change states over to one universal state sales tax.

The five states with the highest average combined state sales tax rates are Tennessee (9.43 percent), Arizona (9.12 percent), Louisiana (8.86 percent), Washington (8.83 percent), and Oklahoma (8.68 percent), according to the Tax Foundation. The five states with the lowest average combined rates are Hawaii (4.35 percent), Maine (5 percent), Virginia (5 percent), Wyoming (5.18 percent), and Wisconsin (5.43 percent).

Five states have no sales tax: Delaware, Montana, Oregon, New Hampshire and Alaska.

Meanwhile, much confusion remains surrounding how and when Internet businesses will universally charge state sales tax. There's also some uncertainty as to what this will mean for small business owners, as much depends on how one does the bulk of their business.

Those with physical storefronts-the Main Street retailers who've long bemoaned the competitive advantage of tax-free shopping on sites such as Amazon.com-should see a more level playing field. Some, like Danny Givens, have been especially outspoken. He's the owner of Givens Books and Little Dickens toys, a 16,000-ft. emporium based in Lynchburg, Virginia. The business has been in his family since 1976, and Givens thinks that when huge online sellers move mountains of goods without any sales tax, they also bury homegrown retailers in the process.

"It only makes sense to force all online retailers to basically pay their share in the game," Givens says. "We sell goods online, too, and yet it's a disadvantage for brick-and-mortar stores like us when Amazon doesn't collect taxes. We pay sales tax, property taxes and other fees in terms of building our community. It's only fair that Amazon pay state taxes, too."

Amazon has voluntarily agreed to start collecting Virginia's sales tax, though it won't start doing so until September 2013; at least five more states will reap taxes on Amazon sales over the next four years, including New Jersey, Indiana, Nevada, Tennessee and South Carolina. California and Pennsylvania began collecting state taxes on Amazon sales this month.

In the meantime, if online state sales taxes are implemented nationwide, "This will remove the competitive advantage pure online retailers have held," says Scott Smith, a tax attorney with Baker Donelson in Nashville, Tennessee.

Further, the online sales tax collection bills before Congress have certain exemptions for small businesses, so shops need not worry about collecting sales tax if they make less than $500,000 in annual sales, says David Campbell, the CEO of TaxCloud, a free internet sales tax calculation service.

But if your annual sales surpass that $500,000 threshold, it's safe to assume you'll be liable for collecting sales and use taxes. Under those parameters, "Smaller operators are most likely to be hurt," says Bruce Clark, an associate professor of marketing at Northeastern University's College of Business Administration. "Large organizations have the resources to comply with regulatory burdens, even if they don't like them."

Yet Campbell stresses that collecting taxes isn't as burdensome as it might sound, even it removes some competitive advantage price-wise.

"It's no more complicated than calculating shipping costs," Campbell says. "Sales tax management software is available at every price point, including free. So collecting sales tax can be easy and cheap for anyone, including sole proprietorships." At the very least, it's a move towards collecting more taxes for strapped state treasuries without the appearance of raising taxes. That said, it would be a mistake to call online sales tax laws a cash grab, says Dennis Hoffman, director of the L. William Seidman Research Institute at Arizona State University's W. P. Carey School of Business.

"In Arizona, this issue was raised by retail businesses, not government bureaucrats," Hoffman says. "And legislators in Arizona are much more prone to cutting taxes than raising them. So it wouldn't be surprising to see overall sales tax rates decline once this broader uniform base is put in place."

Regardless, many experts see shoppers as having the most to lose. For them, tax-free online shopping has an obvious appeal: lower prices. But online shoppers have always been liable to pay state taxes for their purchases, even if merchants don't collect them.

This means consumers can be audited and charged penalties for failing to pay sales taxes. That's right: That tax-free bargain on a vacuum cleaner you just bought online could mean an audit from your state later on, at least in theory.

But this almost never happens, as states lack the resources to chase down taxes for every single web purchase. What's more, states are often unable to enforce their own laws because of a 1992 U.S. Supreme Court decision that some experts say no longer holds water in the Information Age. Back then the court recognized it was a record-keeping nightmare for retailers working across state lines to track every single tax rate and regulation, especially if businesses didn't have a physical office there.

But technology has come a long way since 1992. Now, state taxes can be calculated easily, and the Supreme Court decision left the door open for Congress to enact new laws as it saw fit.

While the sluggish pace of Congress on the three measures before it has frustrated some small business owners, new tax laws are all but inevitable. And that's a good thing, experts say, even if grumbling web shoppers might not think so at first.

"Everybody wins, even consumers," Campbell says. "We already owe sales tax when we make an online purchase, so if the store collects it, the shopper doesn't have to keep track of it. And more revenue means more funding for libraries, parks, police and fire departments, and services for children and the elderly. So their local communities win, too."

(The author is a Reuters contributor) (Editing by John Peabody and Brian Tracey)

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