New York Internet Tax Could Face Blowback After Supreme Court Rules

(Bloomberg) -- The U.S. Supreme Court’s decision about online sales tax is viewed as a win for states -- but those with aggressive collection policies, such as New York and California, could face challenges from online retailers.

By overturning a ruling that had made much of the internet a tax-free zone, the court delivered a victory to South Dakota and effectively blessed its model of collecting sales tax from online retailers like Wayfair Inc. and Etsy Inc. Justice Anthony Kennedy defended the state’s measures as preventing “discrimination against or undue burdens upon interstate commerce.”

South Dakota taxes most products at a single rate, exempts small sellers and doesn’t allow retroactive collection. New York and California’s rules are more complex, and they’ve sought to increase sales tax collection by using broader definitions of what it means to do business in their borders. Both states already require retailers to collect tax if they have digital ties to the states.

“New York and California would likely have to make some pretty big changes,” said John Buhl of the Tax Foundation. “South Dakota has a uniquely simple law since it generally taxes all consumer purchases instead of carving out a bunch of exceptions, and online sellers can remit their taxes to the state instead of each and every locality.”

The decision reverses a 26-year-old standard that allowed states to levy sales taxes on e-commerce sales only if the sellers had a physical location in the state. Among the biggest winners are small or less populous states where retailers are not as likely to have brick and mortar stores or employees. While states like New York may be emboldened to test the bounds of what’s possible now, retailers will likely look to rein those states in through legal action.

The New York State Department of Taxation and Finance didn’t respond to a request for comment.

Read more about the decision to force online retailers to collect tax

“This decision is not the end of the days for this case,” said Jamie Yesnowitz, a National Tax Office leader at accounting firm Grant Thornton.

Representative Tom Reed, a New York Republican, said he supported the ruling’s creation of a level playing field between online sellers and brick and mortar retailers. But he said he’s concerned that it will create a complex web of online sales rules that could prompt some businesses to relocate.

“When you are dealing with the virtual cloud, it gets complicated,” Reed said. “This is an area that’s very much in a state of disruption.”

Online retailers, whose stocks plunged on the news Thursday, will have to deal with a hodgepodge system until Congress enacts a federal standard -- which is unlikely this year given midterm elections in November. Amazon.com Inc. and Overstock.com Inc. are among the companies that say they support a nationwide law that would relieve retailers from dealing with a patchwork of state tax laws.

Lawmakers have tried unsuccessfully to pass online sales tax legislation for years, with the most recent attempt failing after several conservatives, including Senator Ted Cruz of Texas, called the provision a tax increase on online shoppers. Some Democrats also opposed the measure.

‘Safe Bet’

Broader taxing power will let state and local governments collect an extra $8 billion to $23 billion a year, according to various estimates. Thirty-one of the 45 states that collect sales taxes have some sort of laws allowing them to expand their tax collection beyond the physical presence standard vacated in the court ruling, according to an analysis from the Tax Foundation.

The 16 states with laws similar to South Dakota’s, including Indiana and Maine, are less likely to face challenges. And states that don’t have laws governing online sales tax are likely to move quickly to follow South Dakota’s approach, including its threshold of $100,000 in sales, according to Gary Botwinick, a tax, business and estates lawyer at Einhorn, Harris, Ascher, Barbarito & Frost in New Jersey.

“The South Dakota model is a safe bet for states, so it’s reasonable for them to start there” said Max Behlke, who directs budget and tax issues at the National Conference of State Legislatures.

The ruling means some states can expand their tax collection systems, but it will take months to get systems up and running, Behlke said.

‘Not a Blank Check’

Another question for states to weigh will be whether they push to collect tax on previous transactions. Kennedy didn’t directly weigh in on retroactivity, but he said the issue wasn’t a reason to keep the physical-presence rule. He said the court had other legal tools to ensure that sales taxes don’t become an "undue burden" on small businesses and startups.

Tax lawyers including Richard Jones, a tax partner at Sullivan & Worcester in Boston, said they interpreted the decision as meaning sales tax could be applied retroactively -- perhaps on sales as far back as 10 years.

But taxpayers could raise challenges, including the argument that collecting sales tax for prior sales could subject the seller to double taxation if the customer had already remitted sales tax. Congress could also step in and block retroactivity, Jones said -- as well as whether to set thresholds.

“Today’s decision will certainly change how states look at these laws but we may see states trying to see if their versions could survive even if they are less simplified and direct than South Dakota’s law,” Joseph Bishop-Henchman, an executive vice president at the Tax Foundation, said in a blog posting Thursday. “This ruling is not a blank check for states.”

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