The impact of the economic downturn has been felt particularly hard at the state level, with many states operating under a deficit. Since taxes based on income don't produce as much revenue during a recession as they do during good times, transaction taxes, including sales and use taxes, become even more important to a state's ability to fund its obligations.

"Indirect tax in the U.S. has become the preferred way to generate revenue," said Peggi Rockefeller, chief tax officer at Vertex. "The biggest trend within corporate tax departments is the fact that sales and use taxes have taken on increased significance over the past decade. This was accelerated by the global economic slowdown."

Two issues are at the forefront of sales and use tax: nexus (the constitutionally required relationship between an out-of-state business and a state, allowing the state to tax the business on its activities), and cloud computing.

"Nexus" is based on two clauses in the Constitution: the Commerce Clause, which prohibits states from unduly burdening interstate commerce, and the Due Process Clause, which requires a minimum connection between a state and an entity it wishes to tax.



States are increasingly looking at Amazon-type legislation to help close their tax gaps. Amazon laws, targeting Amazon and other remote sellers, create a presumption of nexus for remote vendors with sales associates located in the state. "The goal is to put as much tax compliance burden on retailers who they think can handle it, and the big Amazons are in a better position to handle it," said Tom Frascella, director of state and local tax at Smart Devine & Co.

In addition, many states are now including a section for the purpose of calculating and remitting use tax, he noted. "One of the things that has most residents concerned is the presumption that if you have an annual income of x, then your use tax should be w. It may be something they just came up with as a guideline to help taxpayers realize what their use tax obligation might be. That's certainly one way of combatting it, but states feel there's a much better chance of collecting the appropriate tax if they put the burden on the remote seller, which is what the states are going after in the Amazon legislation."

Cloud computing is evolving when it comes to sales tax, according to Frascella. "States are still trying to figure out what it is and how they should tax it," he said. "For example, Pennsylvania historically said a transaction was only taxable if servers were located in the state. Now they've done an entire about-face and say the transaction is taxable if the end user is located in Pennsylvania, so the location of the seller or the server is now irrelevant."

"Remote nexus and digital goods are two of the biggest things we're seeing," agreed Diane Yetter, president of sales tax consulting firm Yetter. "The states are getting much more aggressive in asserting nexus. They're looking at their current positions and figuring out how they can assert nexus without passing any additional laws. "

"States are struggling in the area of digital goods," she said. "The cloud presents two issues: What is it, and where should it be taxed? There's a lot of complexity just in determining what it is. Is it software, or the right to use software? Is it a service, data processing or other computer service, or the rental of space, such as file storage?"



States vary just as widely on where to tax digital goods. "Tennessee takes the position that a transaction is taxable where the hosting company has the software sitting on a server," said Yetter. "Most of the other states say it should be taxed where the accessing computer is located, but this adds to the complexity of how you track and bill the accessing computer. For example, what if I access my Chicago account while I'm on the road or in the air? There are a lot of challenges in identifying the 'where.'"

"It's not just cloud computing but all digital goods," she added. "When you download a song or a book or a movie, should you be taxed at your home address or where you are when you download it?"

Most states only tax the sale of tangible personal property, noted Sean Kanousis, tax principal at Berdon LLP. "Some, like New York, also tax services. Most of them tax the sale of software and treat it as tangible personal property. It used to be easy - you go to a store and buy the software, but with cloud computing, you never physically possess the software in any way. You don't receive anything tangible, but you have the use of the software."

"Years ago," he added, "New York came out with a regulation stating that the sale of software includes the constructive possession of software. I don't think they were anticipating cloud computing, but they have successfully used this to tax it."

A number of states have adopted Amazon-type legislation, or "click-through" nexus laws, requiring remote vendors to collect sales tax based on the physical presence of associates in the state, observed Steven Roll, assistant managing editor of state tax at Bloomberg BNA. "These states include Arkansas, Connecticut, Georgia, Illinois, New York, North Carolina and Rhode Island. Vermont's law will take effect Sept. 15, 2012, if no federal legislation is enacted before then," he said.

Colorado had a different type of Amazon law, which sought to sidestep the physical presence requirement set forth in Quill, a 1992 Supreme Court case under which, for a state tax to satisfy the constitutional standard of the Commerce Clause, the taxpayer must have a substantial connection with the state. The Colorado law required vendors that lacked nexus with the state to notify their customers of their obligation to pay use tax, and to mail annual reports to each customer and to the state, detailing the customer's purchases.

Recent court decisions have struck down both the Colorado law and the Illinois Amazon law. Illinois and Colorado have indicated their intent to appeal the respective decisions, according to Roll.

"It's important to realize that 'Amazon law' is used to describe a lot of different things," said Shane Ratigan, content compliance manager at sales tax solution provider Avalara. "New York passed an Amazon law that was upheld, while the Illinois law was struck down. Colorado's law had nothing to do with nexus. It all adds up to chaos for vendors."

Nevertheless, he indicated, "The day that Congress agrees to a uniform sourcing regime, none of these cases matter."



That could come none too soon. "In every single sales and use tax case, the Supreme Court has said that it's up to Congress to figure out," he said. "They have the power, and there's no constitutional reason for them not to fix it. There's no longer any principled stance for any politician to not look for a national solution."

There are currently three bills before Congress allowing states to collect sales taxes from remote retailers, and hearings have been held. "But other than these hearings, there has been a lack of action in Congress to support the notion that remote-collection authority will be granted to the states in the near future," said Roll. "None of the federal proposals allowing states to collect sales taxes from remote retailers has advanced since being introduced," he said.

Of the three bills, the Marketplace Fairness Act is the most likely to eventually pass, said Yetter. "It's a hybrid of the other two bills, and has bipartisan support," she said.

Because of their economic situation, states are making administrative changes to get money to them sooner, Yetter noted: "For example, a lower threshold for prepayment of tax; requiring more businesses to lower the threshold for paying electronically, instead of by paper; moving the due dates to earlier in the month; and reducing vendor discounts, which allow retailers to retain a portion of the sales tax for their work in collecting it."

"We're also seeing a number of states passing legislation prohibiting automated sale suppression devices," she said. "These devices attach to a cash register and zap the transaction out of the system. The customer gets the receipt and it looks like the sales tax was paid, but it never goes through the financial system, and the seller is pocketing the sales tax and the revenue. The legislation makes the possession of the device a felony."

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