States continue to seek ways to increase revenue to make up for recession-generated shortfalls in their budgets, with sales and use taxes as an important component of their overall tax and revenue strategies.

The unemployment rate is still high and economic recovery is weak compared to other post-recession recoveries, according to a survey released in June by the National Governors Association and the National Association of State Budget Officers. The survey noted that states are challenged with providing resources in critical areas that were cut during the recession, declining federal funds for state programs subject to sequestration, and continued spending demands in areas directly affected by the sluggish economy such as Medicaid, higher education and corrections.

"State spending in fiscal 2013 is still below the fiscal 2008 pre-recession peak," said NGA executive director Dan Crippen. "Lower real spending levels in fiscal 2013 compared to fiscal 2008 indicate that state budgets are not growing fast enough to make up for recession-induced declines and inflation. Additionally, governors are aware that the federal spending cuts started by sequestration will only get worse."

It is against this backdrop that states see transaction taxes, including sales and use taxes, as critical to generating revenue to fund their obligations. Two of the major issues they face - remote nexus and cloud computing -- span several decades.

The reason nexus is an issue is the 1992 Supreme Court decision in Quill, which prohibited states from requiring out-of-state retailers to collect sales tax from residents of the state unless they have a "nexus" in the state. Nexus is the minimum threshold of contact that must exist between a taxpayer and a state that would allow the state to impose tax. The concept 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.

The Quill decision said that whether a tax would interfere with interstate commerce is up to Congress, observed Steven Roll, assistant managing editor of state tax at Bloomberg BNA. As a consequence, the Marketplace Fairness Act, which sailed through the Senate several months ago, aims to give states the authority to require the collection of state sales tax from out-of-state vendors. But the bill has yet to be considered in the House Judiciary Committee, where Chairman Bob Goodlatte, R-Va., has expressed reservations.

"The bill is written in a pretty narrowly tailored fashion," explained Roll. "It says you already have the power to collect if you simplify your sales tax regime in certain ways. It only applies to retailers with annual sales of $1 million or more, and only after the state simplifies its sales tax regime."

"The bill attempts to address the concerns of the court that there are so many different taxing jurisdictions and rules for the sales taxes that made it very difficult for out-of-state retailers to comply with," said Rachelle Bernstein, vice president and tax counsel at the National Retail Federation. "The court indicated that if the rules could be simplified, that would address their concerns, and left it to Congress to fix. The bill includes a number of minimum simplifications that a state would have to adopt before being allowed to collect sales tax from a remote seller."

Two states have already responded to this approach, according to Roll. Colorado (H.B. 1295 and 1298) and Rhode Island (H.B. 5127-A) have already enacted laws that simplify their sales tax regimes. The new laws in both states are contingent upon the enactment of the Marketplace Fairness Act.



Meanwhile, the number of states enacting so-called Amazon laws is growing, according to CCH senior state tax analyst Carol Kokinis-Graves: "Compared to two years ago, there are many more states that have enacted or introduced such legislation. Now, there are fewer states that have a sales tax and have not enacted some type of Amazon law. Currently there are 10 states that have a sales tax that have not enacted any type of Amazon law."

"But the situation is constantly changing," she added. "Many times they'll introduce legislation which might die, and then be introduced the following year. The trend has been toward a greater number of states enacting some sort of Amazon law."

The laws are designed to tax purchases made by a "click-through" purchase from the Web site of an affiliate of an Internet seller such as Amazon.

Under the Marketplace Fairness Act, states that are members of the Streamlined Sales and Use Tax Agreement would automatically be allowed to tax remote sellers, while non-SST members would need to simplify their tax regimes in accordance with the act.

The SST was formed to address the Quill decision, observed Cory Barwick, CCH Corporate Services technical product manager. "It's a logical argument that the tax is already due and we want it, but it is difficult for the states to go through a tax audit. Keeping track of all the differing tax rates and jurisdictions was manually impossible, but advances of technology have made it feasible."

As one of the certified service providers under the SST, CCH as an organization has pointedly not taken a stance on the Marketplace Fairness Act, Barwick added. The bill has been referred to the House Subcommittee on Regulatory Reform, Commercial and Antitrust Law.

Most of the major players in the industry are supporting the bill, according to Jose Curammeng, tax analyst at Thomson Reuters. "Until federal law is enacted to allow the states to collect from remote sellers, the states will continue to enact affiliate legislation and Amazon law nexus," he said. "That's the only way they can get telemarketers and online sellers to start collecting taxes for them."

Support for the bill has blurred traditional political lines, particularly among conservatives. Many, including Reagan-era economist Arthur Laffer, call the Internet sales tax exactly the type of tax that should be supported, since it would help to flatten the Tax Code by taxing the lowest rate on the broadest base. Opponents see it as an unwelcome expansion of state authority, enabling bigger government and hitting small businesses with a host of burdensome requirements. At press time, it looked unlikely that the bill would be voted on in the House prior to the August congressional recess.

Another critical issue facing the states -- cloud computing and the sale of digital goods (including downloads of songs, books or movies) -- is not addressed by the Marketplace Fairness Act. States differ on where they tax digital goods. For example, one state might tax a transaction where the hosting company has the software on a server, while other states will tax it where the accessing computer is located. And Idaho recently provided that cloud computing application software "accessed over the Internet or through wireless media is excluded from the definition of taxable 'tangible personal property.'"

"The whole area involves a lot of issues regarding who can tax what, and where it gets taxed," Curammeng indicated. "The states will have to issue their own guidance that addresses these issues."

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