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States Seek New Ways to Tax Online Sales

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02/23/2016 | 04:33pm EDT
By Richard Rubin 

Joe Garrett, Alabama's deputy revenue commissioner, wants his state to get sued--and the sooner, the better.

Mr. Garrett and like-minded officials in South Dakota, Utah and 10 other states are tired of waiting for Congress to write national rules to let them collect sales taxes from out-of-state Internet retailers. So, in a loosely coordinated effort, they are moving to impose those taxes themselves and daring merchants to challenge them.

The gambit is aimed at creating business blowback and a confusing national patchwork of laws that might prompt Congress to act. Short of that, the states want their moves to be questioned legally so they can ask the Supreme Court to overturn a 1992 ruling that forbids taxation of Internet sales by retailers that lack a physical location in a state.

In Alabama, the revenue department began enforcing an old law it says allows taxation of out-of-state sellers. The first taxes were due Feb. 20, and the state plans to audit companies that don't file returns.

"We're confident that some remote sellers will not comply and therefore it will lead to litigation," said Mr. Garrett. "We have been very open about what we're doing."

The moves are a reaction to years of inaction in Congress that have disadvantaged local businesses, said Deb Peters, a Republican state senator in South Dakota. Her bill, which would apply sales taxes to out-of-state purchases, moved through the state Senate last week without opposition.

"Our businesses simply can't survive without someone stepping up to make the marketplace fair and even again," Ms. Peters said in an email. "Since Congress has once again failed, it falls to us to fill that void."

Separately, a federal appeals court Monday sided with Colorado on its approach to the issue, giving states another avenue to pursue. The Colorado law requires out-of-state retailers that don't collect taxes to send the state a list of in-state customers.

The latest maneuvers reopened fractures within the Republican Party between small-government advocates and business executives. The state officials, even in heavily Republican states, back brick-and-mortar retailers in favoring broader state taxation powers. But antitax groups, online companies such as eBay Inc. and their allies in Congress call the congressional proposals tax increases that would subject businesses to overlapping audits in states where they don't have employees.

"The biggest threats are in these red states," said Christine Harbin, director of federal affairs and strategic initiatives at Americans for Prosperity, a conservative group. "They purport to be tough on taxes. They purport to be tough on spending."

The Supreme Court ruled in 1992, in Quill Corp. v. North Dakota, that states can apply sales taxes only to companies with a physical presence in the state. As tax-free Internet sales expanded, states and big-box retailers grew increasingly frustrated with the Quill ruling, which dates to the mail-order-catalog era of commerce.

Technically, customers must pay a so-called use tax on out-of-state purchases, but almost no one does. A University of Tennessee study estimated that states lost $23.2 billion in revenue in 2012 because of remote sales; others say the number is significantly lower.

Congress has clear authority to regulate interstate commerce. States pressed for a law that would let them tax sales from out-of-state retailers, and the Senate passed one on a 69-27 vote in 2013.

But the bill languished in the House, where it divides Republicans. Even though Senate Majority Leader Mitch McConnell (R., Ky.) promised another vote this year, states are taking matters into their own hands.

Utah's state Senate will soon consider a bill that would expand its definition of a retailer's physical presence to include certain third-party delivery companies, said its sponsor, Republican Wayne Harper. Similar bills have been introduced in at least 11 other states, including Nebraska, Mississippi and Louisiana, according to the National Conference of State Legislatures.

Unlike the more direct South Dakota and Alabama approaches that challenge the Quill ruling, Utah's bill is "nuisance" legislation because it would require online retailers to adhere to a different taxation system in that state but not others, said Steve DelBianco, president of NetChoice, an e-commerce trade group. He said litigation and renewed efforts in Congress would likely start, but was doubtful states will get the result they want.

State officials are buoyed by a comment from Supreme Court Justice Anthony Kennedy in a concurring opinion last year involving the Colorado case, when he wrote that "dramatic technological and social changes" since 1992 have made the states' argument stronger. He wrote that "the legal system should find an appropriate case" for the court to reconsider the Quill ruling.

The Colorado law requires online retailers to report in-state customers' names and their purchases to the state government, allowing Colorado to enforce its use tax. The 10th U.S. Circuit Court of Appeals this week affirmed that power, while also distinguishing it from the Quill precedent that prohibits Colorado from forcing out-of-state retailers to collect the taxes themselves.

Amazon.com Inc., which backs the states' preferred bill in Congress because it could bring national uniformity to online tax rules, doesn't collect taxes on goods shipped to Alabama or South Dakota. The company declined to comment.

"Nobody really wants this to be the way this problem is addressed," said Joe Henchman, vice president of legal and state projects at the Tax Foundation, a Washington group whose board members include former Republican officials. "Everybody would say that Congress is the best place to resolve this."

Write to Richard Rubin at richard.rubin@wsj.com

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MICROCHIP TECHNOLOGY, INC. -0.48% 107.28 Delayed Quote.2.89%
SEEK LIMITED 2.30% 22.2 End-of-day quote.-1.55%
THE LEAD CO., INC. 1.68% 363 End-of-day quote.-6.92%
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