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E-commerce companies don’t pay local sales taxes. They need to get serious about fixing that.

The U.S. has been trying to figure out how to tax out-of-state transactions since before the internet.

The Supreme Court building in Washington, D.C., with a flag on a flagpole and framed by blossoming cherry trees
Supreme Court justices are deliberating whether to overturn a pre-internet precedent exempting many online merchants from collecting sales taxes, despite broad agreement that the e-commerce revolution had made the rule “obsolete.”
Bill Clark / CQ Roll Call / Getty Images

This is a contributed post by Alex Paladino, global managing director of Thomson Reuters Technology Practice Group.

One of the biggest public relations fears confronting e-commerce companies today comes from one of the sleepiest corners of the corporate finance department: State-level taxes collected on out-of-state transactions.

Commonly referred to as the internet sales tax, the issue reached a fever pitch this month as President Trump launched a campaign to shame companies that are not collecting their fair share of local taxes. Adding fuel to the fire, the Supreme Court will hear arguments on the issue this week.

For the e-commerce companies at the center of it all, getting out in front and addressing this challenge before it becomes a reputational black mark involves a deep understanding of a complicated set of state and local tax laws, and a leap of faith that now is the right time to start proactively collecting sales tax.

To understand the scope of this issue, it’s important to first understand where it comes from. The U.S. has been trying to figure out how to tax out-of-state transactions since before the internet. In fact, the issue traces its roots back to a 1967 Supreme Court decision involving mail order and catalog sales. The decision in the case, which has set the stage for all subsequent debates, was that retailers needed to have a physical presence in a purchaser’s state before they were required to collect sales tax in that state.

That same basic logic has been applied to the taxation of e-commerce sales, whereby internet retailers are only legally required to charge sales tax in states where they have a physical presence. When selling into states where they do not have a physical presence, the onus for paying the state sales tax is actually on the purchaser of goods who is supposed to keep of track of these purchases and pay the state taxes on them when they file their taxes each year.

Few consumers ever do this, however, which means upward of $17.2 billion in sales taxes go uncollected each year. State and federal governments are well aware of this issue and have introduced several different legislative proposals over the years to try to force e-commerce companies to collect local sales taxes on all goods sold. This has led some large e-commerce companies to start voluntarily collecting sales taxes ahead of any formal regulation.

Amazon, for example, collects local sales taxes on its own inventory sold in all 45 states that have sales and use taxes in place. However, many smaller retailers, some of which sell products through larger e-commerce sites, are not set up to collect state taxes in this manner. That’s because it’s an incredibly complicated exercise. There are presently just under 10,000 different taxing jurisdictions in the U.S., each with its own compliance requirements, rates and collection processes.

For example, a retailer based in New York that sells a product to a consumer in Chicago must factor in a 1.25 percent Chicago city sales tax, a 1.75 percent Cook County sales tax, the 6.25 percent Illinois sales tax and a 1 percent “special” sales tax. And that’s just one city. Multiply that by every municipality in the nation and the amount of bespoke calculations that need to be done by a retailer add up very quickly.

Ironically, a federal law governing this process would probably make the compliance side of the equation a little easier for internet retailers, because it would bring some standardization to the process.

That’s one of the factors the Supreme Court will be considering this week when it hears arguments on the internet sales tax. It won’t be the first time the Supreme Court has reviewed this topic. Back in 1992, in the precedent-setting Quill vs. North Dakota, the high court upheld the decision that retailers need to have a physical presence in a state before they are required to collect sales taxes there. However, the case also introduced a new wrinkle: A clause that gives Congress the right to overturn the decision.

Congress has been trying — unsuccessfully — ever since. The most recent attempt was part of the omnibus spending bill that President Trump passed this March to fund the government through the end of September. An internet sales tax was originally embedded in that bill, but was pulled out at the last moment.

What all this means for electronic retailers is this: Whether the change is mandated by Congress, a Supreme Court decision or just the fear of bad publicity, the sooner businesses get ready to collect state sales taxes in every jurisdiction around the country, the better off they will be.

Whether or not it’s fair, e-commerce companies will be the pawns in government efforts to force change around this issue. Those that start addressing the inherent complexities of the issue now are going to be best suited to weather that storm and mitigate any associated reputational damage.

Alex Paladino is a member of the executive leadership team of Thomson Reuters Corporate Strategy Office. Based in New York, she heads the Technology Practice Group for the firm, a global practice group focused on delivering technology companies the strategic insight and solutions they need to advance their businesses in today’s complex tech environment. She has been instrumental in the strategy and launch of the Industry Practice Groups at Thomson Reuters. A customer-focused global leader, Paladino has a proven history of driving sales and revenue growth in risk, tax, legal and financial markets across the Americas, Europe and Asia. Reach her @AlexZPaladino.

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