July 18, 2006 at 6:01 AM ET
Internet shoppers know the drill. You buy something online and think you’ve cleverly avoided paying sales tax, but sometimes you lose the gamble and have to pay anyway, depending on a cryptic set of tax laws full of legal terms like "nexus." Ultimately, you trust the Web site to charge the proper taxes, because what else can you do?
For nearly half a million Dell computer purchasers in Washington state, that trust was apparently misplaced. From 1999 to 2005, Dell overcharged 470,000 consumers nearly $24 million in sales tax, and now, the company must refund the money under terms of a lawsuit settlement reached in May.
The case doesn't only impact Washington residents, however. Similar cases are pending in five other states around the country, including California and Massachusetts. The lead counsel in the cases, Rick Ellis, thinks ultimately the price tag will be over $100 million and involve several million consumers around the nation.
The case is a cautionary tale on two fronts: First, consumers should carefully review the sales tax they're being charged by retailers both online and offline. And they should beware bundled deals from retailers. A service contract or extended warranty that might appear to be free may actually be costing you a lot of money.
On to the details:
In 1999, Dell decided to collect sales tax on service contracts for computers it sold in every state, allegedly in contradition of some state laws. Tax wasn't charged on the computer, just the service contract. As an example: A $600 system might come with a $100 service contract bundled into the deal. A consumer in a state where the sales tax was 8 percent would be charged $8 in taxes on the purchase --since in Dell's determination only $100 of the total price was subject to sales tax.
But here's where the nuances of tax law -- and language -- kick in. We might use words like "service contract," "extended warranty" or "maintenance contract" interchangeably, but to the Washington state Department of Revenue they mean very different things. An extended warranty is simply an insurance policy that consumers pay. Because in most cases it is never used, Washington state law and case law at the time considered warranties untaxable. On the other hand, a maintenance contract, which involves a company representative regularly making on-site visits for check-ups, was deemed a service, and thus taxable.
Dell treated the extended warranties like maintenance contracts, and uniformly charged sales tax for them -- even though about half the states mirrored the Washington state tax-free model. In 2003, attorney Ellis spotted the discrepancy, and filed suit in Massachusetts. Colleagues also sued in five other states. So far, the Washington case is the only one to reach class-action status, and the only case that’s been settled. A similar case in Maine was dismissed.
Big money is involved, and some buyers will be getting big refunds. The University of Washington, for example, will be getting a check for $398,000, according to J.D. Stahl, the attorney who filed the Washington case. The average consumer will be getting a much smaller check, perhaps $10 or $20 for each computer purchased.
Dell, for its part, says it was an honest mistake. It did not keep the money; it dutifully passed it along to Washington state. So, in effect, the Washington state government will be paying the refunds, while Dell foots the bill for the legal fees.
But Ellis didn't believe Dell was making an honest error, which is why he filed his case under Massachusetts’ deceptive trade practices law.
Dell was saving itself millions of dollars each year by charging the excess sales tax, Ellis said. Here's how he says it worked: Generally, when companies repair computer hardware during a home visit, they have to pay a "use tax" for the replacement parts carried into the state. But if consumers had already paid sales tax for the computer service contract, Dell took the position it did not have to pay the use tax on the replacement parts. In effect, the company was charging consumers a sales tax up front to avoid having to pay a use tax at the other end, Ellis argues.
Dell would not comment on that theory. Spokesman Jess Blackman said his firm was simply obeying the law.
"We thought we had to collect sales tax, but somebody filed suit,” he said. “We reached a settlement. And we are reimbursing the consumers for the amount of sales tax collected."
Given the complications of sales tax collection, it's easy to see how there might be confusion. But something else about this story bothers me. In many cases, consumers were unaware that the warranties on their computers had a dollar value, and in many cases, a very significant dollar value.
Dell, like many computer companies, often sells "bundles" on its Web site. These are package deals that roll together a bunch of desirable items like LCD monitors or printers, all for one low price. Bundles usually appear to be a pretty good deal, but often, they aren't. They usually include low-quality printers, or overpriced accessories, for example. So consumers who piece together their own deals usually end up ahead.
But in Dell's case, something more confusing was going on. The invoice sent to consumers listed a single price for the package deal, including the warranty. Other items were itemized on the invoice, but the there was no dollar amount listed for them, said Ellis. Except for the most industrious consumers, who hunted around and found a price list, there was little chance Dell buyers knew what they were paying for their warranty/service contract. The only hint was a box on the invoice that said "taxable amount."
"We don't make it a separate line item but there is a cost associated with that," Dell's Blackman said. In other words, to Dell, service contracts were a free tack-on, but their price was separated out by the company for accounting purposes.
Such practices are at a bare minimum confusing for consumers. I purchased a Dell computer three years ago and had no idea I paid for a service contract. I also had no idea there was a possibility of declining the contract and getting a better price. Doing so may not have saved me money, but it's never a good situation when consumers are confused about what they're paying for. I would have gone to my grave not knowing I had paid for a warranty were it not for this lawsuit.
If you are a Washington state resident who bought a Dell in the past seven years, lucky you. You likely have a small refund coming your way. You can read more about this by clicking here.
But consumers elsewhere should take this story to heart and remember to examine any purchase carefully for hidden costs associated with extended warranties or inaccurate sales tax charges. Extended warranties are almost always a bad deal, so consumers should usually decline them. Deciphering the correct sales tax is much harder. Retailers use special software to calculate taxes. Consumers with any concerns have to call their state's department of revenue for a straight answer.
When you do, you might not like the answer. When you buy an item online, it may be sales-tax free but it's not tax free. Consumers who buy items from Web sites in other states are obligated to pay a use tax for bringing an item into their state. And if you live in the same state where a Web site does business and has a regular presence (that's nexus), you will be charged sales tax when you make the purchase.
One postscript to the Washington state story: Last year, the state legislature passed a law making the collection of sales tax mandatory on extended warranties, largely in response to the Dell lawsuit. So even though the practice was not legal from 1999-2005, it is legal today. You didn't expect a state government to let go of a revenue stream that easily, did you?
Have you ever been overcharged on sales tax? Sound off below.