The Internet takes tax-free shopping to a new level. In fact, no-tax shopping has become a prime lure of online retailers looking to hook consumers on click-and-charge buying. Despite what you sometimes hear, however, some Internet sales are subject to sales tax, and even when a site doesn't collect sales tax, consumers are technically responsible for remitting any unpaid sales tax on online purchases directly to their state. For information on the Internet sales tax laws for each state, see Internet Sales Tax: A 50-State Guide to State Laws.
Collecting Sales Tax: Some Sites Have To, Some Don't
If an online retailer has a physical presence in a particular state, such as a store, business office, or warehouse, it must collect sales tax from customers in that state. If a business does not have a physical presence in a state, it is not required to collect sales tax for sales into that state. This rule is derived from a 1992 Supreme Court decision which held that mail-order merchants did not need to collect sales taxes for sales into states where they did not have a physical presence.
Margo is passionate about rare orchids but can't find them in Indiana, so she orders her supplies online from an orchid supplier with headquarters in Vermont. The supplier has all of its facilities in Vermont and collects payment in Vermont. Margo does not have to pay Indiana sales tax (or Vermont sales tax) on her orchids.
A few months later, the supplier opens a warehouse in Indiana to handle its online orders for the entire country. Margo continues to order her orchids from the headquarters in Vermont but she must now pay Indiana sales tax. Her ride on the tax-free train is over.
For a while, some big retailers with local stores sold their products tax-free over the Internet by creating separate legal subsidiaries to handle Internet business. However, lawsuits by several states and pressure from the Streamlined Sales Tax Project (a group created by states supporting the Streamlined Sales & Use Tax Agreement, discussed below) has ended that practice of avoiding sales taxes.
Consumers' Responsibility to Pay Sales or Use Taxes
Consumers who live in a state that collects sales tax are technically required to pay the tax to the state even when an Internet retailer doesn't collect it. When consumers are required to pay tax directly to the state, it is referred to as "use" tax rather than sales tax.
The only difference between sales and use tax is which person -- the seller or the buyer -- pays the state. Theoretically, use taxes are just a backup plan to make sure that the state collects revenue on every taxable item that is purchased within its borders. But because collecting use tax on smaller purchases is so much trouble, states have traditionally attempted to collect a use tax only on big-ticket items that require licenses, such as cars and boats.
That, however, may be changing. Many states have reevaluated their attitude towards collecting use taxes. For example, New York state has added a line to income tax returns requiring all residents to calculate how much they should pay on Internet, mail order, or out-of-state purchases. California has begun a campaign to educate taxpayers on what's owed, as well. Watch for more states to step up use tax collections.
The Internet's Future as a Tax-Free Zone
Will Internet purchases remain free from sales-tax? We'll find out in coming years as Congress and state legislatures wrestle with this issue. Naturally, there is a great deal of opposition to the current approach, and state governments and brick-and-mortar retailers are seeking legislation to overturn the 1992 Supreme Court ruling. A look at the numbers explains why -- sales tax revenues currently amount to about $150 billion annually and make up approximately one-third of all state revenues. These taxes pay for everything from schools and police to roads, parks, and other state services. California alone estimates losses of over a billion dollars per year in sales tax revenues.
States that don't have a personal income tax, like Texas, are even more dependent on sales tax revenue. (The five states that don't have a sales tax -- Alaska, Delaware, Montana, New Hampshire, and Oregon -- aren't hurt at all.)
Streamlined Sales & Use Tax Project
In 2002, state governments organized to fight back. Under a state-led initiative known as the Streamlined Sales & Use Tax Agreement (SSUTA), 40 states and the District of Columbia banded together to simplify their sales tax codes in order to make sales tax collection easier. Under SSUTA, the collection of sales tax still remains voluntary. However, it is considered a necessary stepping stone to federal legislation.
The SSUTA has gained traction. Several national retailers have negotiated with member states for amnesty deals in return for future collection of sales tax, and more are expected to follow. In addition, several states have already amended their tax laws to conform to the SSUTA. With all of this pressure from states, many expert believe that within the next few years you'll be throwing a few more dollars into your shopping cart for state sales taxes.
If you're thinking about setting up an online shop, learn more about how to minimize taxes in Running a Side Business: How to Create a Second Income by Richard Stim (Nolo).