Image: South Carolina tax form
In many states, residents who buy online are expected to complete complicated forms, like this one from the South Carolina tax return, and voluntarily send in sales and use tax payments.
By M. Alex Johnson Reporter
msnbc.com
updated 9/17/2010 7:39:27 AM ET 2010-09-17T11:39:27

It’s too early to know exactly how much the Nebraska chapter of the March of Dimes raised this week at its annual Signature Chefs Auction in Omaha, but odds are that more than 10 percent of the charity’s proceeds are going straight to the tax man.

That’s because the March of Dimes went online when it bought about 4,000 T-shirts from a Florida vendor to give to donors during its March for Babies Walk last April. The charity often buys supplies and other materials online, and it also raises money online by selling items at auction — racking up a big tax bill in each case.

“We didn’t know that,” said Rosemary Opbroek, director of the Nebraska chapter. “We wish the law was different. It is taking money away from helping ... babies.”

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Specifically, it is taking away about $26,000, the amount the State of Nebraska says the March of Dimes owes for unpaid taxes on the April purchase and other online transactions over the past five years.

Opbroek acknowledged that “we owe the money,” which she said would have to come out of proceeds from this week’s fundraiser. Assuming the final tally is the same as last year’s, about $215,000, the state tax bill will eat up nearly 13 percent of the donations.

The law the March of Dimes stumbled over is similar to statutes in most other states — arcane regulations that mean you are probably a tax scofflaw, along with just about everybody else who has bought something online. That’s roughly 80 percent of all U.S. adults, Nielsen Online calculates.

The reasons are complicated, because they involve variations in tax codes in the 46 states (plus the District of Columbia) that collect sales taxes, not to mention thousands of local tax regulations across the country. That leads to confusion even among advocates for or against enforcing existing tax policies on online purchases, which are often misleadingly characterized as attempts to “create” a new “Internet sales tax.”

Sales taxes or similar levies have always been in place on most online purchases in most states. But they are almost never paid. And with their budgets in crisis, states are more determined than ever to get their share.

Do you have a ‘physical nexus’?
The confusion boils down to who does the collecting and when. As with everything involving tax legislation, there are exceptions and other complications from state to state. For example, if you live in Delaware, Montana, New Hampshire or Oregon, which have no sales taxes, none of this applies.

Under a 1992 Supreme Court ruling, businesses are responsible for collecting sales taxes on every sale they make in a state where they have a “physical nexus.” In other words, if the business has a store, an office or even a single sales rep in your state, it’s supposed to tack the state’s sales tax onto your bill.

Online retailers like Amazon.com typically don’t add the tax, except in the states where they’re based or where they have physical facilities like warehouses or distribution centers. Amazon, for example, collects sales taxes only in Washington (its home state), Kansas, Kentucky, North Dakota and New York.

The tax is still supposed to be paid, however. And if the seller’s not responsible, then you, the buyer, are. In general, you’re supposed to voluntarily file your own report and pay the standard tax on your out-of-state online purchases. (The appropriate forms are available on state tax agency websites, revenue officials are happy to remind you.)

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But it turns out that the vast majority of Americans are completely unaware of those rules, so the forms don’t get filed and the taxes don’t get paid — to the tune of $8.6 billion in 2010 alone, the National Conference of State Legislatures estimates.

That’s a big problem, because sales taxes (as they’re called when they’re handled by a  retailer) and use taxes (as they’re called when the customer handles them after an out-of-state transaction) most often pay for schools and public safety.

NCSL data sheet: Uncollected taxes on out-of state sales (PDF)

“It’s just a lack of education,” said Adrienne Fairwell, a spokeswoman for the South Carolina Department of Revenue, which is estimated to have missed out on $94 million in uncollected online taxes last year.

“There are taxpayers that are willing to comply with the law and remit the appropriate amount of taxes that are due, but they don’t know that that’s what they’re supposed to be doing,” Fairwell said.

South Carolina, like most states, relies on consumers to be honest. But if you happen to be audited and you haven’t paid up, you could be in for a world of hurt.

“The Department of Revenue realizes that there is concern and there are issues with collecting the use tax,” Fairwell said. “But we aggressively go after that.”

‘Amazon laws’ draw support
As the economic downturn has gouged ever-bigger holes in their budgets, officials have started to turn up the heat. That’s why Nebraska Tax Commissioner Douglas A. Ewald went after the March of Dimes — one of several charities he said the state is pursuing.

Numerous other states are considering legislation or studying proposals that would crack down on non-payment of online taxes:

  • The Alabama Department of Revenue is sending letters to random taxpayers, telling them to review their last three years of online purchases and send in a check.
  • In February, Colorado enacted the so-called Amazon law, declaring that online retailers were part of an “economic nexus” with state residents. Under the law — which has been challenged in federal court — Amazon and other online retailers are required to calculate the sales tax on every transaction and tell their customers how much they have to pay the state. They’re also required to disclose the identities of their customers and how much they spent, which has set off a fierce dispute over Coloradans’ privacy rights. Amazon says the law was enacted “over our strong objections.”
  • Three other states have enacted laws like the Colorado statute since 2008: New York, Rhode Island and North Carolina. And at least a dozen more are considering following their example.

Rep. William Delahunt, D-Mass., in July introduced legislation that would give states legal authority to compel payment of taxes on online purchases, as long as they sign up for the Streamlined Sales and Use Tax Agreement, which the NCSL and the National Governors Association created in 1999. So far, 23 states have joined the effort to set up a nationwide tax collection standard.

Delahunt’s bill is before the House Judiciary Committee and its prospects are unclear, but it has picked up the vocal support of influential industry groups like the National Retail Federation and the Retail Industry Leaders Association. They argue that besides funding vital state programs, a national standard would even the playing field for in-state businesses that have to go through the red tape of calculating and collecting taxes for the state.

“The Internet retailer, when they’re not collecting that sales tax, they’ve got a 5 percent advantage,” said George C. Peyton, vice president of the Virginia Retailers Federation, which is backing an Amazon law in Virginia.

For Amazon and other online outfits, “it’s almost like having a sales tax holiday every day,” Peyton said.

Kelly Justice, owner of the Fountain Bookstore in Richmond, is among those lobbying for such a measure in Virginia. She said that it’s only fair and that she is willing to assume the tax collection burden for her online customers in other states that enact Amazon laws.

"There are advantages to the Internet; I don’t dispute that,” Fountain said. “But I think that we really need to look at seriously playing with the same rules.”

For consumers, a rude awakening
The wild card in the deck is how everyday consumers will react.

Sharif Johnson of Columbia, S.C., was flummoxed when he learned that he was supposed to pay taxes on his Internet purchases, “because from my understanding, you don’t have to — that’s what I always understood.”

South Carolina’s laws are typically perplexing, or, as James Rowson, another Columbia resident, put it, “totally unrealistic with all that we have to keep track of.”

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Residents like Rowson are expected to keep track of their online purchases. At the end of the year, they’re supposed to categorize each purchase by the county where the item will predominantly be used and apply the sales tax as calculated by that county — a special headache for someone who might live in a county with a 6 percent sales tax but run a business in a neighboring county with an 8 percent levy.

The calculation is supposed to go on line 26 of the state return, where it’s labeled not as “sales tax” but as the less familiar “use tax.” The check, of course, is supposed to go to the state.

The law is similarly complex and similarly ignored in Florida, where Amanda Grout of Panama City said she spends hundreds of dollars a year buying books and clothes online but has never paid the use tax.

“I’m not going to go out of my way to go fill out all these forms and mail them in to pay more money,” Grout said.

In a sentiment that must hearten backers of the streamlined national tax agreement, she added:

“The only way I would do it is if they set it up on eBay or the website and forced me to do it.”

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