Consumers can save a bundle and avoid big crowds by shopping online this holiday season. But can they also avoid paying sales tax?

Online shopping is appealing because sites like Amazon not only offer convenience but in many cases they also offer lower prices than their brick-and-mortar competitors. And in some states, online holiday shoppers can sweeten those savings by not paying sales tax, which they'd otherwise be forced to pay if they shopped at a retailer with a physical storefront in their state.

This may be good news for shoppers, but it's bad news for states, which rely on revenue from sales taxes to help fund basic services and initiatives, such as public safety, education, and recreation.

Figuring out where sales tax applies online can be tricky, since it's different in every state. And with this week's news that the Supreme Court has declined to hear a case in New York that challenges its online taxation law, many people are wondering what it all means. In this installment of Ask Maggie, I help a reader negotiate the ins and outs of taxation on Internet sales.

Thanks,
Libby

Dear Libby,

As you've rightfully observed, figuring out who pays sales tax online and who doesn't can be difficult. Some retailers charge sales tax and some don't -- it all depends on what state you're in and whether the seller has a physical presence in that state.

The US Supreme Court has ruled on multiple occasions that a state can force a retailer to collect sales tax only if that retailer has a physical presence in that state. If there's no physical presence in a state, then the state can't require a retailer to pay taxes, Joe Henchman, an attorney and policy analyst with the Tax Foundation, a nonpartisan tax research group based in Washington, DC, explains in a recent blog post.

Obviously, states, which need revenue from sales taxes to provide local services and pay for things like firefighters, teachers, and a police force, would prefer to tax all online stores. So in an effort to make sure they don't miss out on any potential tax revenue, some states have interpreted this notion of "presence" more broadly in order to force online retailers to collect sales tax.

States such as Arkansas, California, Connecticut, Georgia, Illinois, Maine, Minnesota, New York, North Carolina, Rhode Island, and Vermont have each passed so-called "Amazon tax" laws that require retailers to collect sales tax even if they don't own property or have employees in a given state. Most of these laws consider affiliates or Web sites that refer customers to a particular retailer as an in-state employee, and as a result they say those Web sites need to collect sales tax from their customers. These affiliates could be one-person blogs promoting products or companies that run coupon and deal sites.

Different laws for different states
Amazon and other online retailers, such as Overstock, that have affiliate programs, have taken issue with these laws. And they've sued states in court to overturn them. In Illinois, the so-called "Amazon tax" law was struck down. The court sided with Amazon and as a result, online shoppers in Illinois don't have to pay the state's 6.25 percent sales tax when ordering items from sites such as Amazon.

In New York, the courts didn't favor Amazon, and the highest court in the state upheld the law. Amazon and Overstock appealed to the U.S. Supreme Court to get clarity on the constitutional question of whether a state has the right to create such laws. But this week, the Supreme Court declined to hear the case.

The nitty-gritty details of the legal arguments in the Illinois case and the New York case differ, said Ashley Forte, an attorney with the law firm Arnstein & Lehr, based in Chicago. But the result is that some Americans will get to shop online without paying a sales tax while others in different states that also have sales tax won't have to pay that tax. The fact that two different states now have laws that seemingly contradict each other should make this an interesting case for the U.S. Supreme Court, she said.

 

For whatever reason, the court decided not to take the case this session. It's hard to say exactly why, since the justices offered no comment when rejecting the case. But Forte speculates it might be because there's already pending federal legislation that may finally put this question to rest for consumers.

The Marketplace Fairness Act, which has already passed the Senate and is pending in the House of Representatives, resolves this issue. This legislation would require states to simplify their sales tax laws in exchange for being able to tax Internet sales from companies with more than $1 million in sales annually. As part of the law, states will be required to provide free calculation software to retailers, a rates database, a database that offers information on what items are to be taxed and at what rate, and other obligations to help simplify the process for retailers who sell products in every state in the country.

Amazon supports the Marketplace Fairness Act, but tax hawks and others oppose it saying that it simply creates a new tax on consumers.

In his blog post, the Tax Foundation's Joe Henchman also points out that the bill is still missing some important things. One of the biggest things it's missing is an enforcement mechanism.

Sales taxes can't really be avoided
What this means for consumers is that even though there's legislation pending, it looks like there's still a long way to go in terms of resolving the issue. The fact that the US Supreme Court hasn't taken the New York case doesn't change the current status quo. You and other New Yorkers will still be charged sales tax on items you order from Amazon as well as some other online storefronts, while your sister in Chicago and her neighbors will not.

Of course, one thing consumers should keep in mind is that even if the Web site isn't collecting sales tax, in some states you're still required to declare the tax you should have paid on purchased items when you file your taxes at the end of the year.

In fact, Connecticut's commissioner of Revenue Services, Kevin Sullivan, reminded Connecticut shoppers Monday that if an online retailer doesn't charge the state sales tax, the consumer must pay. He said that according to state law, Connecticut residents are still required to pay the state's 6.35 percent sales tax rate on items, even if the retailer hasn't collected the fee. And he said that online retailers are misleading taxpayers and putting them at risk of tax fraud by failing to collect the sales tax or advising customers to make sure they pay it.

Of course, the reality is that most consumers don't pay these use taxes. And most states don't have the money or the mechanisms in place to really enforce these laws. Still, Connecticut's Sullivan says consumers should be aware they are expected to pay these taxes.