On Dec. 2, arguably the busiest online-shopping day of the year, the U.S. Supreme Court declined to settle a dispute between several states and Internet retailers with regard to the so-called “Amazon tax.”
Internet retailers, such as Amazon.com, have been criticized for failing to collect sales tax (or “use tax,” as it is called when levied on out-of-state purchases) from their customers.
A number of states have passed laws, referred to as an “Amazon tax,” that require Internet retailers to collect sales tax from residents if they use “performance marketing.” Performance marketing is a form of advertising where Internet retailers without a physical presence in the state contract with individuals to display a link on their websites that connects a user to the retailer’s website.
New York passed the first “Amazon tax” in 2008. The law was challenged by Amazon as well as Overstock.com in Overstock.com, Inc. v. New York State Department of Taxation. The retailers argued that the law violated the U.S. Constitution’s commerce clause. While the U.S. Supreme Court has not ruled on a similar issue in more than 20 years, the general rule is that only merchants with a physical presence (or “nexus” in tax jargon) in a state are required to collect that state’s sales taxes. The case was appealed to New York’s Court of Appeals, the state’s highest court, which found that the use of performance marketing had the effect of creating an “in-state sales force.” Thus, the court held that a substantial nexus existed necessary to force the company to collect New York sales taxes.
In 2011, Illinois passed the Main Street Fairness Act, its version of the “Amazon tax,” which was modeled after the New York law. The law was challenged by a trade group that represented businesses engaged in performance marketing in Performance Marketing Association, Inc. v. Hamer. This group argued that the Illinois law was pre-empted by a federal law and violated the commerce clause. The trade group won in Cook County Circuit Court and the case was appealed directly to the Illinois Supreme Court.
The Illinois Supreme Court decided 6-1 that the law was pre-empted by the federal Internet Tax Freedom Act, which prohibits states from imposing “discriminatory taxes on electronic commerce.” The court found the law was void and unenforceable because Internet retailers who sell through links on Illinois websites would be required to collect sales taxes, whereas web retailers who simply advertised in Illinois through print or broadcast media would not. The court did not address the lower court’s ruling that found the law in violation of the commerce clause.
Justice Lloyd Karmeier wrote a lengthy dissent and argued that the law did not “impose any new taxes or increase any existing taxes,” but rather changed the definition of who was required to collect such taxes. He also argued that the law was not discriminatory and concluded by saying he would rule, as the New York court did, that the in-state affiliates’ activities created a substantial nexus which could require the Internet retailers to collect the state’s sales tax.
Justice Karmeier also noted that the Internet Tax Freedom Act is set to expire on Nov. 1, 2014, unless it is extended by Congress. If Congress does not extend IFTA, then the Illinois case will become moot and will need to be decided again based on the commerce clause issue.
Thus, the Illinois and New York courts reached different conclusions based on different reasons. The New York court upheld its law because it did not violate the commerce clause while the Illinois court found its law was void since it was preempted by an existing federal law. While the U.S. Supreme Court has declined to hear the New York case, it could decide to hear the Illinois case if the Illinois Department of Revenue petitions the Supreme Court.
Congress is considering legislation that would change how online sales taxes are collected in all states. The proposed law, called the Marketplace Fairness Act of 2013, would allow states to require sellers not physically located in their state to collect taxes on sales made to residents of their state. Smaller retailers that make $1 million or less in annual sales and have no physical presence in a state would be exempt from the statute. Amazon has publicly supported the bill. The bill passed in the Senate on May 6, however, its future in the House is uncertain. That said, the U.S. Supreme Court’s decision to stay out of the issue for now may put more pressure on Congress to come up with a national solution.
In the meantime, Illinois residents should not expect refunds for the items purchased via Amazon and other similar Internet retailers over the past two years. Illinois law is clear that even if a retailer does not collect sales tax, Illinois taxpayers are obligated to pay the tax themselves.
Carson Maricle is as associate at Mathis, Marifian & Richter who focuses his practice in business law, taxation, and estate planning.