In Illinois, shopping on Amazon used to feel like it came with a discount: no sales tax charged at checkout. That ended 3 years ago, when the Seattle e-commerce behemoth opened its first distribution centers in the state, gaining an obligation to collect taxes like any bricks-and-mortar retailer.
Shoppers could end up paying sales tax at many more online retailers if the U.S. Supreme Court sides with South Dakota in a case being heard Tuesday.
Under a 2016 law, South Dakota requires any retailer that conducts at least 200 transactions or has least $100,000 in annual sales within its borders to collect sales tax, regardless of whether the business has a location in the state. Soon after the law went into effect, South Dakota sued online retailers Wayfair, Overstock and Newegg for allegedly failing to comply.
In a 1992 case involving mail-order office supply company Quill, the Supreme Court ruled that retailers can’t be forced to collect taxes in states where they don’t have a physical presence. But South Dakota argues that’s an outdated approach in an era when e-commerce accounts for an estimated 9.1 percent of all retail sales in the U.S.
A victory for South Dakota before the high court could open the door for more states to begin requiring previously exempt retailers to collect taxes, providing a potential revenue boost for cash-strapped governments like Illinois’.
Charging sales tax regardless of whether a business has a local presence is unpopular with retailers that still operate mostly online, like eBay and Etsy. They argue that it’s unreasonable to expect businesses to keep up with sales tax regulations in parts of the country where they’ll never set foot. Many want Congress to set up more standardized rules.
But retailers with more stores or distribution centers argue the exemption gives some online competitors an unfair advantage.
Viking Ski Shop, which has stores in Chicago and northwest suburban Barrington, will match online retailers’ prices on most items, but “we can’t give the tax away,” owner Bob Olson said. “Our profit margins are only a few percent, and at the end of the year, we don’t have room for that.”
“All I ever ask is to be on a level playing field, and we’re not when we have people advertising they can be 10 percent cheaper,” Olson said.
State and local governments, meanwhile, complain of lost revenue – an estimated $8 billion to $13 billion nationwide in 2017, according to the U.S. Government Accountability Office. That includes $383 million to $626 million in Illinois.
Shoppers should have been covering the difference as use tax – that’s line 23 on your Illinois tax return – but underreporting is an issue, experts say.
“The only people who pay use tax are those who think they may be appointed to a federal judgeship,” University of Illinois law professor Richard Kaplan said.
Seeing sales tax at more online stores could make consumers feel like they’re paying more, even if the tax isn’t new.
“I think there’s a basic American notion of fairness, that everyone should be subject to the same rules, but when people put on their consumer hat, there’s going to be some uproar,” Kaplan added.
Daniel Hemel, an assistant professor at the University of Chicago Law School, said consumers would benefit from paying sales taxes on more online purchases, and not just not just because they’ll no longer have a guilty conscience about unpaid use tax.
“You bear the cost of collective noncompliance every time you hit a pothole,” said Hemel, who along with Kaplan was among a group of academics who filed a brief with the Supreme Court supporting South Dakota.
In Illinois, whether a shopper is charged sales tax at online checkout depends on if the retailer has a large enough physical presence in the state to trigger collection requirements. That includes retailers with an Illinois store, office or warehouse. It also includes businesses that sell through marketplace websites – think third-party sellers on Amazon – and store inventory in the state at the time of the sale, according to the Illinois Department of Revenue.
Of the three online retailers involved in the South Dakota case, only Wayfair, which has a small warehouse outside Chicago, collects sales tax from Illinois buyers.
Now that Amazon’s distribution network spans the country, it collects sales tax nationwide, though it doesn’t collect on behalf of third-party sellers. Etsy and eBay also leave it up to their individual sellers to collect taxes.
If established digital brands like Warby Parker and Bonobos continue the recent trend of opening physical stores, more retailers will end up collecting taxes, regardless of the Supreme Court’s decision.
A tangle of taxes
In addition to skewing buyers’ decisions about where to purchase goods, sales tax laws also could make retailers hesitant to expand into new states, U. of C.’s Hemel said.
Overstock has considered state sales tax rates and the potential impact on sales there when choosing warehouse locations, said Jonathan Johnson, a member of the company’s board of directors.
But other companies argue the same calculations could push the smallest online businesses – like individuals selling items on eBay and Etsy – to curtail their sales if forced to begin collecting tax from out-of-state buyers.
That’s particularly concerning for Bubblefast owners Mark and Robin Le Vine of Gurnee, who signed on to a brief eBay filed with the court backing Wayfair, Overstock and Newegg.
Bubblefast sells shipping supplies like packing peanuts, bubble cushion wrap and easy-to-seal plastic bags to other online sellers, mostly other mom-and-pop businesses, Mark Le Vine said. The vast majority of the company’s sales are done online, and it collects sales tax only from Illinois buyers, who account for a small percentage its business.
Le Vine said he would have no problem collecting sales tax from more customers if there were an easy way to do it. Sales tax regulations vary between state and local governments – not just tax rates, but which products qualify and how they’re classified.
And Le Vine said he’s concerned about the challenge of keeping up with changing rules. Software can help, but it’s expensive for small businesses. Then there’s the risk that a mistake could lead to a lawsuit from a state, if he collected too little, or consumers, if he collected too much.
If complying with new tax collection responsibilities is too great a burden for the smallest online sellers, that could also hurt demand for Bubblefast’s products, Le Vine said.
“How does a small business keep track of all that?” he said. “If we can’t do it, certainly our customers can’t.”
Some states will likely set minimum sales requirements to exempt the smallest companies, Hemel said, and there are efforts to make states’ sales tax regulations more consistent. Big retailers that already collect sales tax in multiple states have clearly found a way to do it.
Still, Wayfair and Overstock say they favor legislative proposals that would create standardized rules
“We just want Congress to put some certainty on the issue in a way that’s the same across all states rather than a patchwork of different rules,” Overstock’s Johnson said.
But since Congress hasn’t yet offered a solution, a ruling in South Dakota’s favor could nudge legislators to lay out rules addressing some retailers’ concerns, like creating more consistency in how states classify products or exemptions for small sellers, U. of I.’s Kaplan said.
“Apparently, [Congress doesn’t] want to touch it until the Supreme Court says everyone’s paying,” he said.
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