States push to collect taxes on Internet sales

Shopping online can be a way to find bargains while steering clear of crowds — and sales taxes. But those tax breaks are starting to erode. With the recession pummeling states' budgets, their governments increasingly want to fill the gaps by collecting taxes on Internet sales, which are growing even as the economy shudders.

And that is sparking conflict with companies that do business online only and have enjoyed being able to offer sales-tax free shopping.

One of the most aggressive states, New York, is being sued by Amazon.com Inc. over a new requirement that online companies must collect taxes on shipments to New York residents, even if the companies are located elsewhere. New York's governor also wants to tax Taxman covers and other songs downloaded from Internet services like iTunes.

The amount of money at stake nationwide is unclear; online sales were expected to make up about 8% of all retail sales in 2008 and total $204 billion, according to Forrester Research. This is up from $175 billion in 2007.

Based on that 2008 figure, Forrester analyst Sucharita Mulpuru says her rough estimate is that if Web retailers had to collect taxes on all sales to consumers, it could generate $3 billion in new revenue for governments.

It's unclear how much more could come as well from unpaid sales taxes on Internet transactions between businesses. But even with both kinds of taxes available, state budgets would need more help. The Center on Budget and Policy Priorities estimates that the states' budget gaps in the current fiscal year will total $89 billion.

Collecting online sales taxes is not as simple as it might sound. A nationwide Internet business faces thousands of tax-collecting jurisdictions — states, counties and cities — and tangled rules about how various products are taxed.

And a 1992 U.S. Supreme Court ruling said that states can't force businesses to collect sales taxes unless the businesses have operations in that state. The court also said Congress could lift the ban, which remains in place — for now.

As a result, generally only businesses with a "physical presence" in a state — such as a store or office building — collect sales tax on products sent to buyers in the same state. For instance, a Californian buying something from Barnes & Noble Inc.'s website pays sales tax because the bookseller has stores in the Golden State. Buying the same thing directly from Amazon would not ring up sales tax.

That doesn't mean products purchased online from out-of-state companies are necessarily tax-free. Consumers are usually supposed to self-report taxes on these items. This is called a use tax, but not surprisingly, it tends to go unreported.

In hopes of unraveling the complex tax rules — and bringing states more money — 22 states and many brick-and-mortar retailers support the efforts of a group called the Streamlined Sales Tax Governing Board. The group is getting states to simplify and make uniform their numerous tax rates and rules, in exchange for a crack at taxing online sales.

Among other things, participating states need to change how they define things such as "food" and "clothing." For example, one state might now consider a T-shirt clothing and tax it as such, while another might consider it a sporting good and tax it differently.

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