Yesterday Governor Pat Quinn of Illinois signed HB 3659 into law. There is plenty of background on the so-called Advertising Tax / Affiliate Tax / Amazon Tax / whatever you call it so I will give some basics and then move on to a view of solutions that might work.
Consumers are required to pay sales tax regardless of whether or not a retailer collects it. Retailers who do not have nexus, a physical presence in a state, are not required to collect sales tax, leaving the burden on the taxpayer. Most individuals do not pay the sales tax (also known as use tax when not collected by the retailer). In an effort to collect this tax, some states have passed laws that make an affiliate relationship the equivalent of nexus for retailers.
There are two main problems with these laws:
- These laws may not be legal. In 1992, before eCommerce began, the US Supreme Court ruled in Quill v. North Dakota that only the federal government had the right to pass laws related to interstate commerce.
- These laws may decrease, not increase, revenue for states enacting them. When out-of-state retailers such as Amazon and Overstock.com terminate their relationships with affiliates, these affiliates will lose revenue, be less competitive with other affiliates and, in some cases, flee the state. This results in lower income tax and sales tax and higher unemployment payments.
Where are the relationships?
While I am extremely biased on this issue, I like to take a non-biased approach. I have been looking for a solution that works for both sides and doesn’t wind up having the states spend a lot of money fighting this in court.
The only perfect solution would be for Congress to enact a law requiring the collection of sales tax for the entire country. That levels the playing field in the US and, unlike in affiliate marketing where foreign companies can step in with a new-found advantage, foreign companies are less competitive due to shipping costs so they can’t take advantage over companies within the jurisdiction of the new law. But Congress won’t pass a law that will feel like a new tax to consumers/voters and where someone else (i.e. state legislators) get to spend the money.
The state of Illinois does not have a relationship with Amazon. It has a relationship with FatWallet which has a relationship with Amazon but that is not enough to create nexus. Better yet, the state of Illinois has a relationship with its residents. Residents are two things in this relationship: Shoppers and taxpayers.
In fact, it is the resident, not the store, who has the requirement to pay sales and use tax. Stores are the conduit to the collection of the tax similar to employers for income and employment taxes. You may be wondering why employers have to collect taxes and remit them to the government but stores don’t have to. Simple: It is a federal mandate. Plus, an employee establishes nexus for their employer in a state while a shopper does not create nexus for a store. Were Congress to define a shopper as establishing nexus, this would all be over.
Who do states have authority over? Taxpayers!
States can mandate what taxpayers need to do, say when they file their annual tax returns. States also have agencies that license accountants and enrolled agents, the only people licensed to prepare tax returns.
Think about how the Feds finally got Al Capone… that’s right, it was for tax evasion! There is your answer: Tax returns.
The Illinois Department of Revenue figured that out and added line 22 to the form IL-1040 for 2010. It is a required field for “Use tax on internet, mail order, or other out-of-state purchases.” Your next question should be how effective has collection been? You might assume that it wasn’t effective and that’s the reason for HB 3659. The only problem is that very few individuals have filed the IL-1040 with this new line. Believe it or not, with all of the yelling and screaming going on the Illinois legislature, there has never before been a line on the IL-1040 for individuals to pay their use tax. I did some digging and there has been form ST-44 for payment of use tax but it was not referenced in the 2009 IL-1040 instructions.
It seems to me that the best course of action for Illinois to take (or any state for that matter) is to let line 22 take effect and roll out an education program to inform taxpayers about this requirement. In addition, leveling fines for non-compliance would work as well. [Disclaimer: I report my online purchases on my California form 540.]
What about tax preparers?
When a tax professional, whether a CPA or an enrolled agent, prepares a tax return, they are required to sign it. They state that to the best of their knowledge, the return is correct.
Illinois has a use tax worksheet as part of the IL-1040 instructions. Why not make it a form that gets included with the return? Better yet, if this is such an important issue, require that both taxpayers and tax preparers must sign it. Again, educate taxpayers that they must pay use tax.
Plus, every state has a department that certifies CPAs. In Illinois it is the Department of Financial & Professional Regulation. As part of continuing professional education, the state could require training regarding use tax. I don’t know how it would be more than 10 or 15 minutes but it sure would get the point across.
Tax software can help
Intuit and other makers of tax software like to maintain good relations with the various makers of tax forms (e.g. Illinois Department of Revenue). The states can ask Intuit to have a question posed to taxpayers and tax professionals before a return can be printed or filed electronically: Did you pay your use tax? Of course, it could also be a required field that doesn’t have an override.
Some states may also be able to require this. While the Federal government cannot copyright documents that it produces (they belong to us, the people), most states can. If the tax software companies want to use these forms, they will have to agree to certain terms.
An alternative solution
When I met with state legislators and their staffs in Sacramento and their home offices in Los Angeles, I was surprised that they always asked me for an alternative solution to raising the money if they didn’t pass this bill in California. It baffled me why I should be required to have one. This is a bad bill. To me, it would be akin to my proposing to close all of the prisons in the state to save billions of dollars annualy. No one would do that because there are negative repercussions to it. Well, killing small businesses is bad in my book.
I finally have a solution: The states have legal relationships that they should work with to collect use tax. Stop trying to improperly use affiliate relationships to (quite possibly illegally) establish nexus. The best part for lawmakers is that under my plan, they don’t need to take sides between small businesses (e.g. affiliates) and the big box retailers (who donate millions to politicians campaigns).
As for Illinois, HB 3659 doesn’t go into effect until July 1. There is still time to put it on hold and give line 22 a chance to work.