Taxes and the Internet

Other posts about economic nexus and the use tax talked about how the Internet changed the way we interact and buy or sell goods and services. Electronic commerce is an emerging issue for states and local jurisdictions who deal with taxation of digital and out of state products. One of the main reasons governments haven’t had more dialogue on this issue is because of federal law.

The Internet Tax Freedom Act (IFTA) (Public Law105-277, Section 1100) was passed by Congress and signed by President Clinton in 1998. The purpose of the ITFA was to give the Internet some time to develop and to protect users from multiple and discriminatory taxation due to its decentralized architecture. The ITFA imposed a moratorium on state and local taxes for Internet access and banned multiple or discriminatory taxes on electronic commerce.  The law also created the Advisory Commission on Electronic Commerce, which analyzed Internet taxation and provided recommendations on dealing with this issue.

Two of these ideas included establishing “bright line” nexus standards for American businesses and placing the burden on states to simplify their own complicated telecommunications tax systems as well as sales and use tax systems to ease burdens on interstate commerce.  To address the issue of tax simplification, the National Governors’ Association and the National Conference of State Legislatures created the Streamlined Sales and Use Tax Agreement, which established a common set of definitions and tax laws regarding electronic commerce for government and businesses.  Currently, there are 24 states that have passed laws conforming to the agreement. Washington joined in July 2008 with the passage of Senate Bill 5089 - Conforming Washington's tax structure to the streamlined sales and use tax agreement.

Scott Peterson, Executive Director of the Streamlined Sales Tax Governing Board (Board), said that the consortium is recruiting mores states and seeking bill sponsors in Congress to create a national system for online sales tax collection and remittances. Remittance means sending the taxes collected to the jurisdiction of the buyer.  Businesses also like the agreement and 1,400 online retailers have volunteered to collect state sales tax. In return, Washington promises not to sue them for back taxes they might have owed.

While the Agreement is a step in the right direction, in order for there to be significant change the answer will need to come from the other Washington.  According to the Board, some studies estimate that states lose billions a year in uncollected sales tax and it could reach as much as $23 billion by this year.  Only Congress has the authority to let states require collection of this revenue.  The Agreement simplifies the complexity of this issue and as more states join, it applies pressure on Congress to act.

Unfortunately, in the current political climate in D.C. where lawmakers are willing to default on our nation’s debt for political purposes, change won’t come easy or quickly.  However, this change needs to happen. Even though the sales tax is regressive, it’s Washington’s primary source of revenue.  By fixing this issue it will help to modernize the state’s tax collection authority for a 21^st century economy.

What is a use tax? Is it effective?

According to the Department of Revenue (DOR), a use tax is a tax on the use of goods or certain services in Washington when sales tax has not been paid. Also, goods used in this state are subject to either sales or use tax, but not both. So the use tax compensates when sales tax has not been paid.

There are a few instances when you owe a use tax over a sales tax. If you buy something in another state that does not have a sales tax or a state with a sales tax lower than Washington’s, then you owe a use tax.  For example, if you buy something in Oregon that is used in Washington then you’re subject to the use tax.  The third option is if you buy something from someone who isn’t authorized to collect sales tax.  This happens if you buy something through a newspaper classified ad. Lastly, if goods are purchased by out of state by subscription, through the Internet, or from a mail order catalog company and they don’t collect Washington’s sales tax, you owe the use tax.

The use tax was created by the Revenue Act of 1935 (read Justin's entry about it here) along with a majority of Washington’s tax structure.   As we’ve discussed in other posts, this system reflects an economy from 80 years ago that doesn’t adequately collect taxes in today’s Washington.  According to the Economic and Revenue Forecast Council and DOR, about half of all online sales to Washington residents go untaxed. Rather, the tax isn’t collected although its payment is legally required in the form of an equivalent use tax.

A use tax is required when sales tax isn’t collected for online sales but it’s up to citizens to know when and how to pay.  How is this enforced? As we move to buying more goods online this gap will only continue to grow when there isn’t a sales tax being collected.  There’s an incentive for businesses to be on top of this due to DOR’s ability to audit them, but it’s highly unlikely DOR would audit citizens for online purchases from sites such as Craigslist. This would be expensive, hard to implement, and hard to enforce.

As it’s currently configured, the use tax isn’t an effective method for ensuring compliance when the sales tax isn’t collected.  However, the online sale of goods and services has changed the economy in a way that states can’t adequately adapt to.  A key reason for this is federal legislation about Internet taxation; we’ll talk about that next time.