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States Get New Tool to Collect Taxes Due on Internet Sales

A federal court just handed states a powerful new tool to collect a larger share of the taxes that are legally due — but often go unpaid — on purchases made over the Internet.  The court upheld a 2010 Colorado law that requires Internet, catalog, and other out-of-state sellers either to charge Colorado sales tax on their sales to Colorado buyers or to provide information about the tax due on those purchases to the buyer and the state revenue department.

The U.S. Supreme Court held in 1967 and 1992 that a state can’t require companies not physically present in the state to charge the state’s sales tax when state residents make purchases from them.  The tax (technically a “use tax” rather than a sales tax) is still legally due; buyers are supposed to pay it directly to the state.  However, state revenue departments can’t collect more than a tiny fraction of what households owe because (a) many buyers are unaware they owe the tax and (b) tax agencies have no idea who made taxable purchases and for how much. 

Colorado’s path-breaking law addresses both problems.  It requires Internet sellers that don’t charge the tax themselves to: 

  • inform buyers at the time of purchase (for example, via a pop-up window on their Web order form) that they might well owe tax on what they just ordered;
  • send all customers a year-end notice reminding them that they might owe tax, totaling the amount of their annual purchases, and breaking it down into broad categories;
  • provide an annual report to the revenue department with the names, addresses, and total annual purchase amounts of Colorado customers (but no information about the nature of those purchases); and
  • inform customers in their year-end notice that this information is being provided to the revenue department.

The Colorado law has been tied up in litigation since shortly after enactment.  Monday’s decision by the federal Tenth Circuit Court of Appeals that the reporting requirement doesn’t discriminate against remote sellers or impose an excessive compliance burden should pave the way for the law to take effect. 

In light of Monday’s decision, all states with sales taxes should seriously consider their own version of Colorado’s reporting law.  Widespread adoption of the law would likely improve tax collection both by informing many unknowing buyers that they owe the tax and by giving states needed information to compel non-compliant buyers to pay it — especially for “big-ticket” items like jewelry and TVs, where enforcement activities can be cost-effective. 

Sales taxes are a major revenue source for states and localities, helping pay for schools, health care, public safety, and other critical services.  Uncollected sales taxes on Internet sales alone represent well over $10 billion annually, leading to higher-than-necessary rates for sales taxes and other taxes or reduced funding for schools or other services.

Widespread adoption of the Colorado law could also promote long-sought federal legislation that would address the problem comprehensively by giving states the power to require even non-physically-present sellers to charge tax.  This legislation has stalled in Congress in no small part because many Internet and catalog customers don’t realize their tax obligations, which enables anti-tax forces to falsely characterize the federal legislation as imposing new taxes.