TAX NEWS - June 2010

Collecting tax on Internet buys stymies local officials

For government tax collectors, getting sales tax money owed on out-of-state Internet purchases can be a task as complex as computer code and as fleeting as a message on Twitter, say experts.

These difficulties can contribute to the kind of mistake such as the one this week when Suffolk officials learned that the state Department of Taxation and Finance had erroneously credited the county with $5 million in sales tax, because a taxpayer by mistake said $10 million in sales tax was owed on out-of-state Internet purchases. The taxpayer meant only $1,000, it turned out.

"This happens all the time," said Art Rosen, a former deputy counsel for the state tax department and now an attorney for non-profit Tax Foundation supporting a legal challenge by Amazon.com. He noted, however, that the undetected amounts aren't usually as large and often remain uncorrected. Rosen said studies show as much as $20 billion a year goes uncollected on sales tax from Internet purchases nationwide.

But in a world where more and more customers are doing business with Amazon.com and other out-of-state vendors, state and local officials -- already hard-pressed for revenue because of the recession -- say they are determined to collect the same amount of money as they get from sales tax in brick-and-mortar stores.

New York "believes that states must be innovative and proactive to increase sales tax collection by remote sellers," said Brad Maione, spokesman for the state tax agency. According to the most recent statistics, 515,000 state taxpayers listed owing $42 million in sales tax on their returns in 2008, though the agency doesn't break down how much comes directly from Internet sales.

"Our focus on requiring remote sellers, primarily retail websites, to collect sales tax from their customers at the time of the sale has proven to be an effective way to ensure that sales tax is collected up front," said Maione.

New York is in the thick of a large and controversial national debate about getting sales tax revenues from Internet vendors. Based on a 1992 U.S. Supreme Court ruling, out-of-state retailers were exempted from rules requiring them to collect sale taxes if they had no "physical presence" such as a store, office or warehouse in the state where the customer bought their goods. Many states still follow that rule of thumb.

But as part of the 2008 state budget, New York officials passed a new tax law requiring out-of-state Internet retailers to collect sales tax on sales of $10,000 or more from New York residents, claiming that Internet links to online stores qualified as a physical presence. Amazon filed a lawsuit challenging the law, but it was upheld by a state judge and is now on appeal.

"Historically, you have to have a brick-and-mortar presence to collect sales tax, but this law seeks to expand that definition," said Robert Willens, an adjunct professor of taxation at Columbia University's business school who runs his own private tax firm.

But many smaller vendors don't collect sales tax, and many purchasers also don't fork over the taxes when filing their annual income taxes, said Willens and other experts.

Ironically, the Suffolk County case arose because the taxpayer -- who remains unidentified because of privacy concerns -- did report sales tax on out-of-state Internet purchases, but apparently typed that he owed $10 million instead of the correct amount of $1,000. The glitch forced Suffolk officials to have to give up $5 million in anticipated revenues.

"There's no doubt this [glitch] is part of the confusion, and we'll have a lot more glitches in the future because people are not sure what to do under the law," said Willens.