It's hardly a secret that shoppers hate paying sales tax and love a tax-free bargain -- case in point, thetax-free shops in airports that are so successful at separating Bahama-bound travelers from their money. But because you need an international boarding pass before you can buy a bar of tax-free designersoap, sales from these shops pose little threat to either Main Street merchants or tax collectors.

Enter the Internet, which takes tax-free shopping to a new level. In fact, no-tax shopping has become aprime lure of online retailers looking to hook consumers on click-and-charge buying. Despite what yousometimes hear, however, some Internet sales are subject to sales tax and consumers often have aresponsibility to remit any unpaid sales tax on online purchases directly to their state.

Collecting Sales Tax: Some Do, Some Don't

The obligation to pay sales tax is determined by the location of the buyer, not the seller. If a business doesnot have a physical presence in a particular state, such as a store or warehouse, it is not required to collectsales tax for sales from customers in that state. In legal speak, this connection between sales and locationis referred to as a "nexus" and was established by the U.S. Supreme Court in Quill v. North Dakota, 504U.S. 298 (1992).

Margo is passionate about rare orchids. Unfortunately, she lives in a small town in Indiana, where her local nursery doesn't carry the varieties she loves. Instead, Margo orders her supplies online from an orchid supplier with headquarters in Vermont. The supplier has all of its facilities in Vermont and collects payment in Vermont. Margo does not have to pay Indiana sales tax on her orchids.
A few months later, the supplier opens a warehouse in Indiana to handle its online orders for the entire country. Margo continues to order her orchids from the headquarters in Vermont, but she must now pay Indiana sales tax. Her ride on the tax-free train is over.

Exceptions to the Rule

Many big retailers with local stores can sell their products tax free over the Internet because they haveestablished separate legal subsidiaries to handle Internet business. Put another way, the Barnes & Nobleyou buy a book from online is a different company from Barnes & Noble at the mall. Since the onlineBarnes & Noble doesn't have a physical presence in your state, no sales tax is charged for onlinepurchases. The practice of establishing a separate legal entity principally to avoid sales taxes has raisedthe ire of thousands of brick-and-mortar retailers whose customers must still pay tax.

The issue becomes even stickier when a company's online and offline entities experience some customerinteraction. For example, a consumer buys tax-free golf clubs from but is allowed to returnthem offline to the local Wal-Mart store. Whether such entities are legally independent of each other is amatter that has not been tested in the courts.

Your Responsibility to Pay Sales Tax

If you live in a state that collects sales tax but avoid paying it on an Internet purchase, you are stillrequired to pay the tax to the state. When you pay it directly to the state, it is referred to as "use" tax ratherthan sales tax.

The only difference between sales and use tax is which person -- seller or buyer -- pays the state.Theoretically, use taxes are just a backup plan to make sure that the state collects revenue on every taxableitem that is purchased within its borders. But because collecting use tax on smaller purchases is so muchtrouble, states have traditionally attempted to collect a use tax only on big-ticket items requiring a license,such as cars and boats.

Now, however, some states, including Connecticut, Maine, Nebraska, New Jersey, and North Carolina,have changed their attitudes and are stepping up efforts to collect use taxes. But bureaucracy, complex taxrules, and limited state resources have thus far prevented most states from pursuing use taxes. Since stategovernments are losing substantial revenue, the collection of use taxes may become a priority if the federalgovernment continues its ban on Internet e-commerce taxes.

The Internet's Future as a Tax-Free Zone

It's difficult to predict whether Internet purchases will remain tax free. In 1998, Congress passed theInternet Tax Freedom Act, which established a three-year moratorium on taxing Internet accessservices at the state or local level. "Internet access service" is defined as any service that allows users toobtain information, e-mail, or other online services and includes small Internet service providers,large information portals such as Yahoo, and other Web sites and companies that provide connectivity andinformation, such as AOL.

Under the 1998 moratorium there can't be any new sales or other taxes applied to Internet purchases. Thecurrent moratorium on new taxes will last until October 2001. However, this ban does not affect yourobligation to pay any sales or use tax owed under previous law.

To determine the future of taxes on the Internet, Congress created a 19-member Advisory Commission onElectronic Commerce to study Internet taxation and report on April 21, 2000. Early reports from thecommission indicate that it will recommend that Congress continue to maintain the Internet as atax-exempt zone until 2006. Federal legislation following these proposals has already been introduced inCongress.

Naturally, there is a great deal of opposition from state governments and brick-and-mortar retailers. Alook at the numbers explains why. Sales tax revenues currently amount to about $150 billion annually andmake up approximately one-third of all state revenues. These taxes pay for everything from schools andpolice to roads, parks, and other state services. States that don't have a personal income tax, like Texas,are even more dependent on sales tax revenue. (The five states that don't have a sales tax -- Alaska,Delaware, Montana, New Hampshire, and Oregon -- aren't hurt at all). Based on commonly acceptedInternet sales projections, lost revenue in unpaid sales tax from online transactions could go as high as$10.8 billion by 2003.

Many Main Street retailers feel that allowing consumers to avoid sales tax gives online retailers an unfaircompetitive advantage, especially in states where sales taxes are high. They are particularly incensed bylarge retailers whose Internet subsidiaries permit tax-free sales but allow online purchases to be returnedto brick-and-mortar stores. Supporters of equal taxation for all retailers have expressed anger that thecommission does not adequately represent their interests, and feel that the commission's report toCongress will be biased.

Copyright © 2000 Inc.