Many More Taxpayers May Soon Pay Sales Tax on Online Purchases under the Marketplace Fairness Act

Hello, everyone.  I’m very glad to have joined The Seay Law Firm and am looking forward to the opportunity to help you with your Texas tax law issues.  I hope to share lots of interesting Texas tax information with you on this blog, particularly information about the Texas sales and use tax.

For my first post, I’d like to update you on what could be the most important federal sales and use tax bill in decades – the Marketplace Fairness Act.  If it becomes law, it’s likely that many more taxpayers will end up paying sales tax on online purchases.  This is because the bill will allow states to require out-of-state retailers to collect sales tax from state residents when they previously could not.  While it’s not certain that this bill will become law, it’s likely — The Senate just approved it, and the House will vote on it soon.

In this post, I’ll explain what the bill does and what it may mean for sales and use tax law in general and Texas sales and use tax in particular.

Background: Who Has To Collect Sales Tax Now?

Currently, states may only require out-of-state retailers to collect sales tax from state residents when the retailer has a physical presence in that state, such as an office, employees or independent contractors, or property.  In tax jargon, we say that this physical presence creates “nexus” with a state (which has nothing to do with shampoo).  If a taxpayer has nexus with a state, that means they have enough connection with that state for the state to require them to collect sales and use tax.

This physical presence requirement comes from a 1992 U.S. Supreme Court decision called Quill v. North Dakota.  In Quill, the Supreme Court reasoned that since retailers without a physical presence in a state receive little or no benefits from that state’s government, it unduly burdened those retailers to require them to go through the trouble of learning that state’s sales and use tax laws.

However, in Quill, the Supreme Court noted that Congress may choose to get rid of this physical presence requirement because the Constitution gives Congress, not the courts, the power to regulate interstate commerce.  So far, Congress hasn’t chosen to do so.

To try to encourage Congress to adopt a lower standard than physical presence for sales and use tax nexus, several states formed something called the Streamlined Sales Tax Project and entered into an agreement called the Streamlined Sales and Use Tax Agreement.  The idea is that the member states agree to make their sales and use tax laws identical.  So, if a taxpayer learns the sales and use tax laws of one state, the taxpayer knows them all.  This would eliminate the Supreme Court’s justification for the physical presence requirement for sales and use tax nexus.  Currently, 24 states have entered into the Streamlined Sales and Use Tax Agreement, so the sales and use tax laws of these states are largely uniform.

What the Marketplace Fairness Act Will Do

If the Marketplace Fairness Act becomes law, it will allow states to require retailers with no physical presence in the state to collect sales tax from that state’s residents if (1) the retailer makes $1,000,000 or more in gross annual sales into states where it doesn’t have a physical presence and (2) the state simplifies its sales tax laws.

States have two options for simplifying their sales tax laws under the Marketplace Fairness Act:

1. They may enter into the Streamlined Sales and Use Tax Agreement; or
2. They may simplify their sales tax laws according to the Marketplace Fairness Act’s requirements. These requirements include notifying the retailers in advance of any sales tax rate changes within the state; designating a single state organization to handle sales tax registrations, filings, and audits; establishing a uniform sales tax base for use throughout the state; using destination sourcing to determine sales tax rates for out-of-state purchases; and providing free software for managing sales tax compliance; and holding retailers harmless for any sales tax errors that result from relying on state-provided systems and data.

So, in a nutshell, the Marketplace Fairness Act allows states to require many more online retailers to collect sales tax from their residents.

A common misconception about the Marketplace Fairness Act is that it imposes a new Internet sales tax on purchase that were not previously subject to sales tax.  This isn’t true.  Most states already impose a use tax on their resident in addition to the sales tax.  This means that if a resident of a state buys something for use in that state and doesn’t pay sales tax when they buy it, they’re required to pay the amount of sales tax they would have otherwise paid as use tax.  Of course, as a practical matter, states don’t often enforce the use tax because the cost of a use tax audit or other tax collection action typically exceeds the amount of use tax the state would actually collect.

What the Marketplace Fairness Act Will Mean for Texas Sales Tax

If the Marketplace Fairness Act becomes law and Texas implements it, the Texas Comptroller could require many online retailers who previously lacked nexus with Texas to collect Texas sales tax from their Texas customers.  Before the Texas Comptroller could require these retailers to collect Texas sales tax, Texas would have to either join the Streamlined Sales and Use Tax agreement or the Texas Legislature would have to simplify the Texas sales tax laws in accordance with the Marketplace Fairness Act.  However, if Texas implements the Marketplace Fairness Act and simplifies the Texas sales tax laws accordingly, many more Texas residents will pay Texas sales tax on purchases.  Further, the Texas Comptroller could subject many more taxpayers to Texas sales tax audits.  Therefore, it is important for anyone who deals with Texas sales and use tax to keep an eye on the Marketplace Fairness Act.