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Annette Nellen
Annette Nellen
Marketplace fairness realities

Will the touted benefits of the Marketplace Fairness Act materialize?

May 16, 2013
by Annette Nellen, Esq., CPA

The Marketplace Fairness Act of 2013 (S. 743) was passed by a vote of 69–27 in the Senate on May 6. This bill is similar to versions that date back to the early 1990s, following the U.S. Supreme Court’s decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In that case, the Court ruled that a vendor must have a physical presence in a state before the state can require the vendor to collect sales tax. The Court also noted that since this nexus issue involves the Commerce Clause, it was one that Congress could address through legislation. Perhaps 2013 will be the year this finally happens.

As its title suggests, the Marketplace Fairness Act is intended to level the playing field for in-state and remote vendors so that both are required to collect sales tax from customers in the state. States are eager for such legislation in the hopes it helps bring in some of the $23 billion of sales and use tax currently uncollected each year, according to a National Conference of State Legislatures estimate for 2012. Main street retailers hope the bill will prevent a loss of sales that can occur when customers find the same product “tax free” on the internet (but only because most customers do not know they owe use tax).

If enacted, will the touted benefits of the legislation materialize? This article briefly describes the legislation and explains some implementation and operational challenges for sellers and states that indicate a different reality may result from this legislation.

Basics of the bill

The bill allows states that meet specified requirements to collect sales tax from vendors with “remote sales.” A “remote sale” is one where the vendor “would not legally be required to pay, collect, or remit State or local sales and use taxes unless provided by this Act.” A small-seller exception applies for vendors with remote sales of $1 million or less (throughout the United States) in the prior calendar year.

States need to take action before they can implement expanded sales tax collection activity. If the state is a member of the Streamlined Sales and Use Tax Agreement (SSUTA) and the agreement includes the “minimum simplification requirements” spelled out in the bill, the member state is eligible to expand collection efforts. Each member state, however, must publish a notice of its intent to collect and wait 180 days after publication. In any case, no state can begin collecting any earlier than the first day of the calendar quarter that is at least 180 days after enactment.

States that are not members of the SSUTA would need to be sure their sales tax laws include the specified “minimum simplification requirements” in the legislation. Once the requirements are in place, the state may start to collect sales taxes, but no sooner than the first day of the calendar quarter that is at least six months following enactment of its legislation.

A state is required to have a single entity in the state administer the tax, including return processing and audits. There must also be just one sales and use tax return for remote vendors. Also, the tax base must be the same for the state and local governments, and the bill’s sourcing rule must be followed (generally, sales are taxed at their destination). The state must also provide information on the tax base, free software for calculating the tax and filing the return, and procedures to approve “certified software providers.”

The bill provides that it is not to be interpreted as creating nexus between a taxpayer and state or local government that does not otherwise exist.

Challenges

The challenges noted here may diminish the ability of the bill and similar legislation to yield a better sales and use tax collection system and be fair to all vendors.

State action needed for implementation: Enactment of the bill (should that happen) is not enough by itself to expand sales tax collection. States must take legislative action on their own. For states that are members of the SSUTA (22 states as of 10/1/12), the process should be fairly simple. The SSUTA governing board will need to be sure the SSUTA includes the simplifications specified in the bill. Then states must publish notice of intent to start collecting.

States that are not members of the SSUTA need to decide whether to modify their sales tax law to conform to the SSUTA and join that group, or make the required simplifications on their own. Advantages of SSUTA membership include that legislative language is available, the SSUTA website provides helpful information to vendors (such as taxability matrices for each state), and the SSUTA project includes software and certified software providers. Possible disadvantages of joining the SSUTA are the need to conform to the definitions in the SSUTA and being part of a one-vote-per-state governing mechanism, regardless of the size of the state.

States that need to enact legislation to fall within the bill may face challenges in enacting the required simplifications and meeting supermajority vote requirements in states that require them for tax increases. Resolving the issue of whether this change is a tax increase necessitating a supermajority vote (such as two-thirds), might also be a challenge. On the one hand, the bill should not be considered tax increase legislation because any sales tax not collected by a remote vendor resulted in use tax owed by the buyer. However, changing the legal incidence of the tax from the customer to the remote vendor may be enough in some states to require a supermajority vote.

Need to educate buyers: Sales transacted via the internet have often been improperly labeled or perceived as tax free. For example, a recent article stated that the bill “would end tax-free online shopping” (Hughes and McKinnon, “Hurdles in House for Web-Sales Bill,” The Wall Street Journal A2 (May 6, 2013)). When buyers start to see sales tax showing up on more of their online purchases, there might be public outcry about a new tax. States can help themselves and remote vendors by engaging in a public awareness campaign of how sales and use taxes work.

In addition, the small-seller exception means that many vendors will not be required to collect sales tax. Buyers must be reminded that they owe use tax on those purchases.

Need to educate vendors: The increased compliance burden that online and catalog vendors will face in states that become authorized to impose sales tax collection obligations on them will be significant. States should be prepared to educate vendors about the tax base and filing procedures. States should also consider additional simplification measures, vendor compensation, and amnesty measures to address likely initial mistakes vendors may make. States that take action to be able to start collecting from remote vendors should also authorize additional funding for the state tax agency so it can help vendors with compliance challenges that will likely arise.

Administrative issues: States that become authorized to collect from remote vendors will still have the challenge of finding them. Even vendors who are careful in determining where they must collect sales tax may make mistakes. They may not be aware that they actually have nexus (and are thus not a remote vendor in the state) or that the state has conformed to the requirements of the bill. Should states want to pursue non-U.S. vendors, additional enforcement efforts will be needed (challenges posed by trying to collect from vendors without a physical presence in the state).

States will also likely find that with more possible tax collectors, there are more questions to answer. A few questions that might arise are: How does the drop-shipping rule work in the state, and are there any special rules such as for attending trade shows?

Nexus issues: The bill does not eliminate the long-standing, difficult issues of determining whether a vendor has sales tax nexus in a state. For example, if an employee is in the state for two days to help a customer, is nexus created? If yes, the vendor has sales tax collection obligations even without the bill. If nexus is not created, sales into that state are used to determine if the vendor meets the small-seller exception. Errors in knowing if a vendor has nexus may become more significant with the new bill.

Example: In 2013, I-Vendor, located in State X, has $2 million of sales to customers in X. I-Vendor also has $900,000 of sales to customers in six states in which it does not have nexus. Under the bill, I-Vendor is a small seller that needs to collect sales tax only in State X. In 2014, I-Vendor obtains new customers in State Y with total sales of $200,000. Other sales remain the same as for 2013. I-Vendor is not sure if it has nexus in Y. If it does have nexus in Y, it must collect from customers in X and Y and will remain a small seller in 2015 (because remote sales do not include sales in any state where the vendor has nexus). If it does not have nexus with Y, its sales into Y will count as remote sales, and I-Vendor will no longer be a small seller and must collect sales tax in all authorized states, starting in 2015.

Looking forward

The Senate’s passage of the Marketplace Fairness Act was a milestone in the decades-long challenge of collecting sales tax on remote sales, but its chances of passage in the House of Representatives are unknown. As noted in this article, there are some challenges that exist with this type of legislation. Perhaps further discussions in Congress will result in improvements in the final legislation. In the meantime, states need to continue to simplify their sales tax laws and educate buyers about use tax obligations.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. Nellen is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is the immediate past chair of the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax policy and reform and a blog.