During a recent meeting in Chicago, representatives of the 18 states in the Streamlined Sales Tax Project reached agreement on how items are to be classified across the board for purposes of assessing sales tax.
The uniform definitions for taxable items are a key element of the SSTP. Until states can agree on what exactly an item is, they can't agree on how it should be taxed.
For example, in some states, candy is considered food; in others, it's not. So if a state taxes food, it's important to know exactly what is and is not food. The same applies toward clothing. Is a baby blanket considered clothing? The answer is yes, but what about a belt?
"They have to use a uniform definition, so a retailer won't have to know whether belts are clothing in New Jersey and not in Indiana," said Bruce Johnson, tax commissioner from Utah and co-chairman of the SSTP Implementing States Group. "All they have to know is that a belt is clothing, then they can look at the Web site and see if the state has exempted clothing. Uniform definitions will tremendously simplify that process for the retailer."
The SSTP agreement goes into effect Oct. 1, 2005, and on that date, online retailers are expected to begin compliance with sales tax collection for all sales that are made to customers receiving goods in SSTP member states. Many companies already collect sales tax on online sales - Wal-Mart, Target, Toys R Us and Macy's are among the companies that got on the online sales tax collection bandwagon early.
At the Chicago meeting, 12 states were admitted as full members of the SSTP; another six states are defined as associate members. Full members include Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, Oklahoma, South Dakota and West Virginia. Associate members - the states that are almost members but just have a few loose ends to tie up - are Arkansas, Ohio, North Dakota, Tennessee, Utah and Wyoming. Ten states were required to qualify as full members in order to move forward with the agreement.
Different reasons have been cited as the motivation for agreeing to collect sales tax on online sales, even if the retailer has no presence in the state. In 2003, when some of the stores began online sales tax assessment, Toys R Us spokesperson Susan McLaughlin indicated that the reason they started online tax collection was to make it easier for people who shop online to make in-store exchanges and returns of merchandise. Wal-Mart spokesperson Cynthia Lin suggested a more altruistic motive, stating that Wal-Mart just wanted to help the states where their customers live by chipping in and joining the struggle against lower tax revenues.
According to David Hardesty, vice president of CPA firm Wilson Markle Stuckey Hardesty & Bott, and an e-commerce taxation consultant, many online retailers are hesitant about collecting sales tax for fear of calling attention to the fact that they haven't collected sales tax on online sales in the past. "Some of these sellers fear they may be required to collect tax in a state, but are reluctant to register under the current system, because state auditors may find that a seller should have collected tax in earlier years," Hardesty wrote in Road Rules for the Streamlined Sales Tax.
The SSTP has created an amnesty program to address this issue. The SSTP agreement states that a seller that registers to collect sales tax for a participating state within 12 months of that state's effective date of participation - Oct. 1 for the first wave of participating states - is entitled to amnesty for uncollected or unpaid sales or use tax. The amnesty does not apply to back taxes that are already under audit. All participating states must agree to the amnesty program.
While taxing authorities in the participating states are eagerly awaiting the Oct. 1 launch date for online sellers to start willingly collecting and handing over sales tax on purchases made by residents of those states, many retailers may adopt a wait-and-see attitude about this whole collection business.
Even though the states have chosen Oct. 1 as the effective date for sales tax on online sales, the program is still completely voluntary for companies without nexus in the participating states, and there is no sales tax collection required at all for out-of-state sales that are shipped to residents of non-participating states.
The SSTP will remain a voluntary program until such time as the U.S. Congress or the Supreme Court take some action making participation in the program mandatory. Retailers not wanting to participate need only turn to Quill Corp. v. North Dakota 504 U.S. 298 (1992) for their proverbial leg to stand on. Quill states that a remote seller, i.e. one without a physical presence in the state, cannot be required to collect that state's sales tax.
The Supreme Court ruled in Quill that expecting a retailer that sells out of its own state to collect and pay tax to all of the states, and all of the many smaller jurisdictions within those states, was an unreasonably complex task.
Currently there are approximately 9,600 taxing jurisdictions in the country, including states, counties and cities, all of which assess different types of sales tax. Further complicating the situation is the fact that each jurisdiction has its own interpretation of what is and is not taxable.
For example, are goggles clothing or protective equipment or sports and recreational equipment? Are drinks that contain fruit soft drinks or food? Is dandruff shampoo a grooming and hygiene product or an over-the-counter drug? According to the SSTP agreement, goggles are classified as sports and recreational equipment, drinks are food if they contain more than 50 percent vegetable or fruit juice, and dandruff shampoo is a grooming and hygiene product.
"That's why this has taken us this long," explained Utah's Johnson. "Depending on whether or not candy is food, it can mean tens of millions of dollars of difference in a state the size of Texas."
It is because of the Quill case that the SSTP has incorporated its amnesty program into the project. Although retailers making a sale to a state where they have no nexus are not required to deal with the out-of-state sales tax, they lose the amnesty provision if they don't sign on within the first 12 months that the state is in the SSTP program. If Quill gets overturned and the retailers who took a pass on collecting tax are suddenly required to pay the out-of-state taxes, they may find themselves on the line for back taxes and penalties in many states.
The states have learned that if they hope to overturn the Quill ruling, they must agree on a simplified and coordinated process for assessing, collecting and remitting sales tax - thus the SSTP.
The participating states have agreed that not only do they have to categorize everything sold by remote sellers, they have to have the same definitions in place for in-state sellers who sell on their own premises.
Participating states are changing the way that they tax many items as a result of the new agreement. "In Minnesota, people will now be able to buy over-the-counter drugs exempt from tax," said Cathy Wicks, assistant director of Minnesota's corporate and sales tax division. "Previously, they were subject to tax."
The decision of whether to tax or not to tax particular items is still up to the individual states. But now, for states participating in the SSTP, "They have to use a uniform definition," said Johnson.
Destination vs. source
Another issue that has given some states pause about joining the SSTP is the issue of taxation at destination, rather than source. Many states are origin-based, meaning that the sales tax structure taxes sales at the point of origin, rather than at the point of destination. The SSTP is destination-based, and this "creates some real differences in states that have been origin-based," said Dan Noble, administrator of the excise tax division of the Wyoming Department of Revenue. "The sourcing issue is probably the most difficult thing for states to overcome."
Part of the SSTP package includes an electronic filing system that will take care of determining how much tax is owed and to whom on any given sale, and then processing the payment of that tax. The participating states plan to offer this software system at no charge to retailers who sign up for the SSTP.
Johnson explained that the cost of this automated system "will come out of the revenues from each state, based on arrangements that are currently being negotiated, so when sellers use certified service providers, the service providers will retain some of the money they collect."
The SSTP is now negotiating the start date with the seven service providers that have applied for participation in the project. It is expected that the automated services will be in place by Oct. 1.
Changes in the tax department
If the SSTP becomes law, corporate tax departments in companies that do business nationwide can expect enormous changes in the way they do business. For example, "If you're in a company that does business in all 46 states and the District [of Columbia] that charge sales tax, there is a large burden that will be lifted from you as far as reporting goes," said Noble. "If all the states ultimately sign on to this agreement, for one company that files about 600 sales tax returns a month, that number will go to 46," one for each taxing state. The local jurisdictions will coordinate their tax collection with the states, so there will be only one payment necessary to a state in which there is a sale.
Noble suggested another change that large corporations can anticipate is "not having to have a permanent place for auditors" from state and local taxing jurisdictions. Many large retail corporations are constantly under audit just as a natural result of filing tax returns in hundreds of different jurisdictions.
What happened to use tax?
The enthusiasm for the SSTP stems from the vast sums of money that some states are certain they'll amass at a time when state purse strings are perhaps at the tightest they have been in decades.
Some estimates, most notably those published in 2001 by a group of economists at the University of Tennessee, contend that, left unchecked, states can expect to lose as much as $54 billion in revenue by 2011 to the loss of sales tax on online sales. The controversial findings have been refuted by the Direct Marketing Association which, claiming its own estimates are based on actual 2001 sales figures reported by the U.S. Department of Commerce, contends that the 10-year loss would only amount to about $4.5 billion in tax revenue.
Keep in mind, of course, that all of this expansive sales tax activity would not even be necessary if people simply obeyed the law. As Wicks pointed out, "Some sellers want to collect the sales tax, otherwise customers have to accrue use tax and they prefer not to do that." That's an understatement. The use tax laws, those most overlooked tax laws in the country, were designed to alleviate just the sort of problem the states feel they are suffering.
While the voluntary tax system seems to work just fine at the federal and state income tax level, the system suffers a considerable breakdown when it gets to the use tax level, where purchasers of out-of-state items, particularly individual taxpayers, regularly ignore or are unaware of the use tax laws and fail to pay the tax. Rather than finding a way to enforce the use tax laws, the states appear to be prepared to junk the honor-system use tax in favor of having the sellers collect and remit tax.
Meanwhile, those consumers who want to shop online and avoid paying sales tax altogether can consider relocation. There is no sales tax in Delaware, Montana, New Hampshire and Oregon, so sales to residents of these states are not subject to sales tax under any circumstances.
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