The $1.5 Billion Loophole

REVIEW SUMMARY
What. Collecting sales taxes owed by out-of-state businesses.
Issue. How to close the Internet sales tax loophole.
Impact. By one estimate, the loophole costs Florida $1.5 billion a year.

In the world of sporting equipment sales, customers have several retailers to choose from. But Sandy Fortin, owner of 28 franchises of sporting goods store Play It Again Sports in Florida, says he's competing on an unlevel playing field with his online competitors because of a legal loophole: out-of-state Internet retailers don't charge sales tax.

“The challenge we have is that people will come into our store and ask to be fitted for the right bat, and then go on the Internet and buy that product,” says Fortin, who's also treasurer of the Florida Retail Federation. “We end up spending payroll and time with customers, and then they go spend it on the Internet.”

Purchases of goods via the Internet continue to grow, and it's costly to Florida's brick-and-mortar businesses, like Fortin's. According to the U.S. Census Bureau, from 2007-2009 Internet sales grew 4.8%, while brick-and-mortar store sales sank 9.1%.

And because out-of-state business aren't required to remit the state's 6% sales tax or additional local option sales taxes that push the rate to as high as 7.5% in some counties, local businesses argue it puts them a disadvantage.

It's what the Florida Alliance for Main Street Fairness calls the Internet sales tax loophole.

Think Amazon and other companies without a physical presence in the state who compete against small businesses like independent electronics stores, auto parts businesses, sports equipment shops, jewelry stores and bookstores.

It also costs state and local governments, which are unable to collect sales tax revenue on e-commerce purchases. Florida TaxWatch sums it up in a report this way: “By far, the most significant tax compliance and collection issue facing Florida and other states is the application of sales and use taxes to sales by remote vendors.” Those vendors transact business via telephone, mail and the Internet without having a physical presence — or nexus — in Florida.

In a University of Tennessee study updated in 2009, it's projected that for 2012 the state and its local governments would fail to collect nearly $1.5 billion in sales tax revenue due from out-of-state transactions.

“The problem is we have a retail marketplace that is changing,” explains Rick McAllister, president and CEO of the Florida Retail Federation. The organization is a big supporter of leveling the playing field along with other major business groups including the Florida Chamber of Commerce and Associated Industries of Florida. “It's no longer brick and mortar,” observes McAllister, “the Internet is growing, growing, growing. We have a tax system that is not changing with a market system that is changing.”

State Sen. Evelyn Lynn, R-Daytona Beach, has been pushing legislation to solve the problem for most of her 12 years in the Legislature. She calls it the No. 1 issue because sales tax revenue is 70% of the state's general revenue.

This past session, Lynn sponsored Senate Bill 1548, titled the “Streamlined Sales and Use Tax Agreement, or SSUTA.” The agreement has been crafted as part of a cooperative effort of 44 states including Florida, local governments and the business community. The Nashville-based coalition is known as the Streamlined Sales Tax Governing Board Inc.

The National Governors Association and the National Conference of State Legislatures developed the concept in 1999. Originally adopted in 2002 and amended since, the agreement aims “to simplify sales and use tax collection and administration by retailers and states.”

But after passing 5-1 in the Commerce and Tourism Committee, the measure never got a hearing. In the House, no committee took it up. “I cannot get leadership to support the bill and hear the bill all the way through,” says Lynn. “They say it's a tax. It's not a tax. It's money owed to the state of Florida.”

Nevertheless, Chief Financial Officer Jeff Atwater's office also showed little interest. “That's not a bill the CFO's office was intimately involved with this year,” responds spokesperson Alexis Lambert.

The agreement
The main purpose of Lynn's bill is to implement the requirements of the agreement that, so far, 24 states have signed. Florida, California and Texas make up a big part of a group of nine more states where legislation conforming to the agreement has been introduced.

The need for such an agreement stems from two U.S. Supreme Court cases. The court ruled that states can't force retailers to collect the tax even though the court acknowledged that consumers owe the sales tax when they buy goods via the Internet or through catalogs.

In Florida, such purchasers are legally required to file Form DR-15MO available from the Department of Revenue to pay the tax, or pay it online. Out of $18.5 billion in combined sales and discretionary sales tax revenue last year, according to McAllister, the state received just $7 million in such collections.

In the more recent case — the 1992 Quill v. North Dakota case — the court offered clues about what states could do to fix the problem, notably to address the complexity of state sales tax systems and the difficulty faced by out-of-state retailers in determining the tax owed in about 7,500 different taxing jurisdictions in the U.S.

According to the governing board, roughly 1,400 retailers have voluntarily collected more than $700 million in sales taxes for “streamlined” states. That's a small fraction of a $23.3 billion estimated for collection loss in 2012.

And e-commerce sales are rising faster than total retail sales. For 2010, the U.S. Census Bureau estimates sales through the Internet increased 14.8% above 2009 levels compared to a 7% increase for total retail sales.

The agreement encourages out-of-state businesses that sell products through the Internet or by mail order to collect sales taxes from customers living in the “streamlined” states. The agreement helps simplify collection for retailers by standardizing several details of tax collections, such as tax definitions and rate simplification.

Certified software packages made available to businesses to manage their sales tax responsibility come with immunity from audit liability for sales processed through the software. The states also help pay for the software for some retailers.

Stumbling blocks to fairness
While the aim is simplification for out-of-state retailers, the changes required of Florida sales tax laws to comply with the agreement aren't so simple. And some of the changes open up Lynn's bill to criticism that it would increase annual costs to the state when budgets are tight, and in some limited ways increase tax payments for some purchasers.

For example, the change in the definition of “sales price” would result in an increase in sales tax revenue because the new definition includes all delivery charges. The agreement also requires removal of the $5,000 local option sales surtax cap on certain tangible personal property.

Another stumbling block, according to a staff analysis of Lynn's bill, are changes to definitions of fruit drinks, ice cream, medical exemptions, and farm equipment. That's because those changes would result in a loss of sales tax revenue to the state. And changing the method used to calculate sales taxes from brackets to rounding to three decimal places would also end up cutting the state's revenue.

While that may be good for taxpayers, all the issues combined have a negative $41.5 million recurring impact on state revenues. However, the changes would have a positive fiscal impact for local governments of $41.1 million, nearly balancing it out.

Florida TaxWatch has recommended a way to make it revenue neutral by reducing the amount of transferred funds from the state's local government sales tax clearing trust fund by $41.1 million each year and moving it to the state's general fund.

TaxWatch also estimates that if Florida joins the compact it could collect $35 million to $50 million in additional sales taxes in fiscal year 2011-12. Plus, the group claims that it's not unreasonable to assume collections could grow 15% a year after that given the growth rate of Internet sales.

But what TaxWatch, Sen. Lynn and the Retail Federation's McAllister all agree on is that state and local governments could collect significantly more sales tax revenues if the federal government requires the remote retailers to collect and remit the sales and use tax.

“It's definitely needed,” says Lynn about federal legislation that was introduced nearly a year ago. That measure, H.R. 5660, “The Main Street Fairness Act,” would give Congress' consent to the agreement and require sellers to collect and remit the tax.

But that bill died when its sponsor left Congress following last year's elections. Now, according to Scott Peterson, executive director of the governing board, a new but similar bill will be introduced by U.S. Sen. Dick Durbin, D-Illinois.

With all that's happened at the state and federal levels, McAllister's not holding his breath. He says he's planning a strategy that would target businesses such as Amazon that have affiliates in the state earning commissions from out-of-state companies when a sale originates from the affiliate's website.

Other states, says McAllister, have claimed those affiliates constitute a nexus, thus giving the state the legal authority it needs to go after the sales tax revenue.

Yet another but ... Peterson says that's not a good idea because Amazon, for one, has instead chosen to discontinue its affiliate relationships to avoid paying the taxes, as it did in New York. “No disrespect to Florida,” says Peterson. “If Amazon.com will kill its affiliate relationship in New York, then they'll kill it in Florida.”

With so much money at stake, Peterson remains optimistic. “If this doesn't work, and Congress doesn't act we're going to think of something else,” he predicts. “Online sales have become so great that we can't ignore the issue any longer.”

One person not ignoring it is Play It Again Sports' Fortin. “It definitely affects your sales,” he notes. “We're the ones creating the jobs. If we do more business in sports, we're going to open more stores and hire more people.”