Online merchants won an important technical victory at the Supreme Court on Tuesday, empowering them to challenge state sales tax reporting requirements in federal court.
Rejecting the pleas of two dozen states including Idaho, Texas, Mississippi and Washington, the court unanimously sided with online companies that favor federal court as the place to dispute state tax laws. The decision foreshadows future legal fights relating to the taxation of increasingly popular Internet-based sales.
“Although online businesses may not have a physical presence in some states, the Web has, in many ways, brought the average American closer to most major retailers,” Justice Anthony Kennedy noted, adding that “a connection to a shopper’s favorite store is a click away.”
States, in turn, have been vexed by their difficulty in collecting sales taxes from Internet commerce. California, Kennedy observed, has estimated that it is only able to collect about 4 percent of the taxes due on sales from out-of-state businesses purveying goods via the Web.
Nationwide, online sales are now estimated to exceed $4 trillion annually.
A Supreme Court ruling in 1992, prior to the founding of online commercial behemoths like Amazon, eBay or Google, established that vendors that did not have a brick-and-mortar physical presence in a state did not have to collect sales tax. Instead, the burden was on the consumer.
Few consumers voluntarily pay the state taxes, though, prompting legislators to seek creative ways at getting their rightful share. Kennedy, for one, said it’s time for the court to reconsider the 1992 decision, which he said has caused a “startling revenue shortfall in many states.”
All told, state and local governments are now losing an estimated $23 billion in annual tax revenue due from online sales, according to a brief filed by the National Governors Association and other groups
“States’ education systems, health care services, and infrastructure are weakened as a result,” Kennedy wrote.
Kennedy voiced his alarm in a concurring opinion, one of two issued Tuesday to accompany the unanimous decision authored by Justice Clarence Thomas. While Kennedy’s three-and-a-half page opinion does not have the force of law, it could serve as an invitation to future litigants.
Charles Rothfeld, a Supreme Court practitioner with the law firm Mayer Brown who’s been closely following the case, called Kennedy’s observations notable and suggested that the prospect of another legal challenge could spur legislation permitting the imposition of a state sales tax on some Internet commerce.
The immediate decision Tuesday involved Colorado’s effort to corral taxes from online sales, even when the vendor doesn’t have a physical presence in the state. Colorado lost out on an estimated $170 million in uncollected taxes in 2012, according to one study.
“In hopes of stopping this trend, Colorado enacted legislation in 2010 imposing notice and reporting obligations on non-collecting retailers whose gross sales in Colorado exceed $100,000,” Thomas recounted.
Out-of-state retailers must send a report to all Colorado purchasers who buy more than $500 worth of goods annually, under the 2010 law. The retailers must also send a report to the state, identifying purchasers. The provisions are meant to help ensure taxes are collected.
The Direct Marketing Association, which represents mail-order and online merchants, challenged the Colorado reporting requirement as a violation of the Constitution’s Commerce Clause. The Commerce Clause prohibits states from placing undue burdens on interstate commerce.
A trial judge agreed with the Direct Marketing Association, but Colorado argued that a law called the Tax Injunction Act blocked federal courts from considering the challenge. The Supreme Court then had to decide whether Colorado’s reporting requirements were covered under the Tax Injunction Act’s reference to an act of “assessment, levy or collection.”
“These three terms refer to discrete phases of the taxation process that do not include informational notices or private reports of information relevant to tax liability,” Thomas concluded.
The decision Tuesday means an appellate court can now dig into the merits of the constitutional challenge; potentially setting up, in time, a higher-stakes return to the Supreme Court.