E-Commerce Tax Implications of the Marketplace Fairness Act

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Laura A. Malowane has consulted in a number of matters concerning e-commerce and taxation issues. Stephen E. Siwek specializes in the analysis of economic, financial, and accounting issues.

Retail e-commerce has grown into an industry with over $225 billion annually in U.S. sales. Under current law, these sales escape state sales taxes if they are “remote” sales, those made by a vendor with no business connection to the state. By some estimates, allowing these remote sales to escape taxation means that between $5 and $13 billion in potential tax revenue remains uncollected. The Marketplace Fairness Act would enable states to collect these revenues by requiring retailers with annual e-commerce revenue over a given amount to collect state sales tax on remote sales. The Senate passed this act last May, and the House Judiciary Committee is now reviewing it. Determining the effects of the Act requires answering two questions: first, what factors need to be accounted for when assessing the volume of potential tax revenue from e-commerce sales; and second, how would the exception for small sellers affect this assessment?

The tax exemption for e-commerce results primarily from a 1992 U.S Supreme Court decision (Quill Corp v. North Dakota, 504 U.S. 298 (1992)) in which the Court struck down a North Dakota law that imposed tax collection on out-of-state vendors. The Court reasoned that with over 6,000 potential tax jurisdictions in the United States, allowing taxes on out-of-state vendors would impede interstate commerce. To overcome this problem, the Marketplace Fairness Act only grants states the authority to collect such taxes if they have simplified their sales tax laws. This simplification can be done either by meeting some mandates listed in the bill or by adopting the simplified tax measures of the Streamlined Sales and Use Tax Agreement (SSUTA).These simplified tax measures include such things as uniform tax definitions, rate simplification and state funding of the administrative costs. Thus far, 22 states are fully in compliance with the SSUTA.

The Marketplace Fairness Act would not make all $225 billion of annual e-commerce sales subject to sales taxes. Currently, five states (Alaska, Delaware, Montana, New Hampshire and Oregon) do not have a sales tax, and thus e-commerce in these states would not be taxed. These states represent approximately 3% of all U.S. commerce. Moreover, states with sales taxes often do not assess those taxes on all sales. E-commerce transactions in products exempted from sales tax would not be taxable. Different states have different laws in this regard, but sales of groceries, prescription items, and contacts lenses are commonly non-taxable.

Moreover, many e-commerce sales already are subject to state sales taxes and thus would not be affected by the Act. Specifically, a company’s e-commerce sales are already subject to taxation in a particular state if that company has a link or “nexus” to that state. A company is said to have a nexus if it maintains a sufficient presence of employees or property in the state. For example, if a company has a retail store in a particular state, then all online sales of that company to consumers living in that state are subject to taxation. Staples, the second largest U.S. online seller after Amazon, has retail stores in all states other than Hawaii and already is collecting sales taxes on over 99% of its online sales. The largest online seller in the United States, Amazon, currently collects taxes in 13 states because it has distribution centers or other forms of nexus in those states. In addition to sales taxes being paid on some transactions because of retailer nexus, consumers pay sales taxes directly on other transactions. For example, because of registration and licensing rules, sales taxes likely are already paid on online motor vehicles transactions. Thus, the Act would not add any additional tax revenue from those transactions.

In its present form, the Act allows for a small-seller exception for retailers with e-commerce revenue of less than $1 million annually. That is, any sellers with less than $1 million of online sales would not be required to collect taxes on such sales. The exemption is based on the assumption that e-commerce taxation would place an unfair tax burden on small vendors. Some retailers, most notably eBay, argue that this small-seller exception should be raised to $10 million. With a small-seller exception set at $1 million, only 1% of online retailers would be subject to taxation. If this threshold were raised to $10 million, only approximately 0.1% would be subject to taxation.

It is a straightforward process to estimate the amount of e-commerce sales on which sales taxes are already paid and the amount remaining for taxation for the largest of retailers, since a wealth of information is available for these companies. Determining the amount of incremental tax for the remaining almost 5 million retailers, however, is a more involved statistical process. While an estimation of this amount is beyond the scope of this article, it is reasonable to state that as retailers get smaller, the portion of e-commerce sales on which taxes are already paid declines. The larger online retailers are likely to have nexus in more states due to the presence of bricks and mortar retail stores or distribution centers. Overall, while the smallest retailers may represent a minority of total online commerce, they conversely represent a majority of potential incremental taxes.

Ultimately, the magnitude of additional taxation to be collected from the passing of the Marketplace Fairness Act will largely be determined by the existence and extent of a small-seller exception. Excluding small sellers from any new e-commerce tax collect requirement would significantly reduce the amount of new tax revenues that could be collected.