Notice to E-Biz: Taxes Due

States get serious about collecting

Mark Twain may not have lived to see the Internet, but long ago he picked up on something that many e-business executives are unwilling to acknowledge today: Taxes are as certain as death. And that applies online as well as off.

Since passage three years ago of the 1998 Freedom Tax Act, which placed a moratorium on new federal taxes on e-transactions, many e-businesses have operated as if sales taxes do not apply to them, collecting taxes on online transactions selectively or not at all. What many businesses dont know—or perhaps pretend not to know—is that, in many cases, companies are indeed required to collect and remit to states, counties and local governments taxes on Internet sales. Fortunately for them, many e-businesses have gotten away with ignoring that reality; there have been few public examples of state and local governments auditing and dunning e-businesses for unpaid sales taxes.

But, as Twain so long ago predicted, that could soon change. Not only is the moratorium on new Internet taxes due to expire in October, but state governments are rapidly gearing up to get e-businesses to pay sales taxes that are already due by helping to simplify and automate their calculation and payment. As a result, experts say, its time for all e-businesses to take a good look at their current sales tax practices to ensure that they are fully complying with current sales tax laws. That means identifying in which states they are required to collect sales taxes and seeking out new technologies such as hosted tax calculation and payment services that help cut the cost of complying. The risk if they dont? The possibility theyll face business-crippling back taxes from state tax collectors.

The origin of confusion

Although the current federal moratorium on new Internet taxes will expire this fall, the greatest pressure for increased collection of currently required e-sales taxes is coming not from Washington but from state governments. Even after October, industry watchers believe, there is a good chance the federal government will continue to hold off on creating new Internet taxes. Thats because many politicians are still expressing concern that new taxes on e-commerce could adversely affect the growth of the Internet economy. "I would give it another two to three years before anything happens there," said David Hardesty, vice president of Markle Stuckey Hardesty & Bott and a certified public accountant in San Francisco.

But while federal legislators figure out what theyre going to do, state governments have grown weary of watching remote online sellers regularly avoid paying sales taxes. According to current federal legislation, businesses need only collect and remit sales taxes in and to states in which they currently hold nexus (some sort of physical presence).

But many e-businesses have interpreted that requirement narrowly, collecting taxes on online transactions only in states where they have major operations. Take Dell Computer Corp., for example. While the company collects and remits taxes on transactions from all its corporate customers, it does so on online sales from consumers in only seven states: Texas, Tennessee, Kentucky, Florida, North Carolina, Nevada and Oregon, where it has major operations.

Collecting sales taxes on consumer transactions in all states—or even those where it may technically have nexus—would be a huge burden on Dell, a company spokeswoman said. One problem is that all Dells current core e-commerce systems have been internally developed, so it would probably have to create its own system for calculating and collecting sales taxes online, the spokeswoman said.

But, state governments say, that approach is costing them big in terms of lost tax revenue. When a company doesnt collect tax on an item it has sold to a consumer in a state where it does not hold nexus, the consumer becomes responsible for paying the tax on that item to his or her state. Unfortunately for state governments, consumers just arent very good about stepping up to that responsibility.

Charles Collins, director of the sales and use tax division for the state of North Carolina, said his state estimates it lost between $10 million and $20 million in unreported use taxes from e-commerce sales last year.

Also, the University of Tennessee last May reported that, if current trends continue, e-commerce will cause a tax-revenue loss of about $10.8 billion nationwide in 2003.

One for you, 19 for me

Now, however, many U.S. states are fighting back. Thirty-nine have joined to undertake an ambitious project known as the Streamlined Sales Tax Project, or SSTP, which, they hope, will get more e-businesses to collect sales taxes by streamlining state and local sales tax rules and helping automate the collection and payment of online-based taxes. They are developing a set of common sales tax rules that all states could apply to online transactions. With states using common rules, online sellers would have far less trouble complying with tax laws, said Collins, who is also the co-chair of the SSTP, in Raleigh, N.C.

The states that have aligned themselves with the SSTP hold the view that simplifying the sales tax process, and providing technical solutions, will not only aid companies in remitting sales taxes to the states in which they clearly hold nexus, but that it may also encourage e-businesses to remit taxes to the states in which their nexus status is not clear-cut. To accomplish that, the SSTP has created one enticing incentive: Any state that agrees to enter the streamlined tax system must agree not to audit the past online transactions of any online seller that joins the system.

One of the ways in which the SSTP is trying to streamline the sales tax process is by coming up with standard definitions for taxable items. Among the 45 states that currently collect sales taxes, there are many differences in how taxable items are defined. For example, a state that taxes food may consider potato chips a food item, while another state that taxes food may not.

Also contributing to sales tax complexity are the many different tax rates assessed by the thousands of local jurisdictions in the United States that impose sales taxes. Currently, a remote vendor must determine the exact rate for each customers location, said Marc Teitelbaum, head of the tax department at law firm Sonnenschein Nath & Rosenthal, in New York.

To complicate matters even more, often many of these jurisdictions will change their rates or add a new sales tax. To help simplify things, the SSTP is moving to limit when and how often local governments can change sales tax rates each year, the SSTPs Collins said.

Another goal of the project is to test and endorse software applications that automate the process of calculating the correct sales tax on online purchases, regardless of where the buyer is located, and then electronically remitting the tax to the appropriate tax authority. The applications would do this by electronically routing the funds of the collected sales tax into a central bank account that the tax software vendor could then draw from and remit to the appropriate state.

So how close is the SSTP to accomplishing its goals? The pilot project, which is scheduled to begin this month in Kansas, Michigan, North Carolina and Wisconsin, will run about one year. The current pilot involves three software tax vendors, Taxware Inc., in Salem, Mass., Vertex Inc., in Berwyn, Pa., and Inc. The SSTP would eventually like to approve several tax software vendors. It is considering a couple of ways in which approved tax software could make money. One way would be to have the state pay a fee on each transaction processed. Another would be to have the vendor earn a percentage of the total amount of the tax on the invoice. If all goes well, states could be using the SSTPs automated remitting process as early as spring 2002, Collins said.

Getting on board

While the SSTP and state governments are optimistic that the project could lead to a streamlined way to collect sales taxes generated from online transactions, tax vendors said it has been difficult to get companies to sign up for the pilot. is still looking for one. "Its hard to give companies a compelling reason to be part of a system that will require them to file more taxes," said Shawn Fahey, director of development at the company.

The reason for that reluctance is obvious: Many e-business officials fear that collecting sales taxes—even if done in an automated fashion—will discourage online sales. According to recent research, however, this may not be the case. One of the key findings of a recent survey shows that most consumers do not select online merchants based on whether or not the merchants charge a sales tax.

At least one enterprise is clamoring to get on board the SSTP project, however. Risk Management Associates Inc., in Philadelphia, a nonprofit financial services trade association that currently takes orders for its training materials through the phone, the mail and the Internet, sees the SSTP project as a way to cut the cost of collecting taxes on online transactions and avoid the risk of being audited. RMA, which had sales of $18 million last year and regularly sends sales representatives to every state in the country, was audited a couple of years ago by the state of New York. The state claimed that the company had nexus there and should have paid sales taxes on both online and offline transactions. The state slapped the company with huge back taxes, said Dwight Overturf, RMAs controller. "We managed to negotiate the fee down, but in the end, we were still left with a large sum to pay," Overturf said.

Concerned with the possibility of future audits, the company had a lawyer make anonymous inquiries to each state. Finding that many of them had "ambiguous" definitions of nexus, the company decided to start collecting and remitting sales taxes to every state that charges them, regardless of the states individual policies on nexus.

To help calculate the sales tax for each item ordered by a customer from anywhere in the country, RMA chose a software application from Taxware. The software, which integrates with a companys order fulfillment system, includes a database with the latest information on state tax laws and rates. Through a subscription, Taxware regularly sends to users upgrades that contain changes from any states that charge sales taxes.

But the Taxware system didnt address the task of remitting sales taxes to states—and all the paperwork that goes with it. For that, Overturf has had to hire an extra employee. Therefore, the idea of being in a program like the SSTP pilot, where at least some of his companys state sales taxes will be remitted to the states electronically and automatically, was very appealing.

Due diligence

The changes in state sales tax regulations stemming from the SSTP project may be months or a few years away. Still, experts say, businesses—whether pure-play Internet companies or click-and-mortar concerns—should take a good look at their Internet sales tax practices now. Specifically, said Internet e-commerce tax expert Hardesty, its a good idea to get experience with automated tax calculation software, which may eventually become the foundation of new state sales tax collection processes. Doing so now can not only help e-businesses get a jump on new regulations, but it can also result in improved online customer service.

BeautyClik LLC, in Windsor, Calif., for example, has signed on with application service provider to help the beauty salon product online seller calculate sales taxes in real time on its site so customers can see what the taxes will be before they order. Though BeautyCliks distributors must still fulfill orders and send invoices—including sales tax charges—to customers, BeautyClik Chief Technology Officer Matt Marshall said being able to advise customers in advance of sales taxes due avoids unwanted surprises when the actual invoice arrives in the mail.

Meanwhile, experts say, e-businesses should determine in which states they hold nexus. This is not always easy because different states interpret nexus in different ways, said Hardesty, who operates a Web site ( devoted to online tax issues.

As online tax laws and technologies evolve, keeping track of compliancy requirements is no picnic. But dealing with consequences, experts say, is worse.

Its tempting to look around at your neighbors and note that they arent collecting sales taxes in regions where they should. "But you dont know who the tax collectors are currently building files on," Hardesty said. And thats one surprise a business can do without.