With California Aboard, 4 New Factors in the Online Sales-Tax Debate

by Heather Clancy

3 min read

After years of fights and reprieves, California’s sales tax for online retail purchases officially went into effect on Sept. 15. That means every out-of-state business that sells more than $1 million to California customers has to start collecting tax on those transactions.

This is welcome news for local bricks-and-mortar companies statewide, because it erases the advantage that big cyber-sellers like Amazon.com and Overstock.com have had over them in pricing flexibility.

But the new policy has been disruptive to small businesses that generate revenue by referring visitors from their own websites or blogs to Amazon and other online retailers in exchange for a cut of sales. It also paves the way for more debate on the controversial topic of online sales taxes.

For example, one negative impact on small businesses: Overstock.com canceled its small-business affiliate program in California, and it has been critical of so-called tax nexus laws. “The focus of these affiliate tax nexus bills is to try to create an artificial physical presence by implicating the business connection [that] out-of-state retailers have with in-state affiliate advertisers,” the company states on its website. “Once such a law is passed, the only means for an out-of-state retailer to avoid the tax collection obligation is to cease doing business with all affiliate advertisers in that state.” Amazon.com originally followed suit with a similar tactic but later negotiated a broader deal with California that inspired it to reinstate its program last fall.

Meanwhile, proposed federal legislation could mandate online sales-tax collection everywhere by eliminating the provision that requires a business to have a physical presence in any state before it can be taxed there. Instead, states would be allowed to tax e-commerce retailers based on parameters such as their overall annual sales and the amount of sales generated in a particular state.

With that in mind, here are four things small businesses should consider now that California’s new online sales-tax law is in effect.

1. Other states are joining in. California may be the state with the biggest economy to take a stand on online sales taxes, but it isn’t the only one. Amazon now collects tax in Kansas, Kentucky, New York (although Amazon is fighting that state’s policy), North Dakota, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, and Washington state. Policies are progressing in Indiana, Nevada, and New Jersey. This makes sense, since a study from the University of Tennessee [PDF] estimates that states and local governments which don’t collect could lose out on some $12 billion in revenue in total.

2. Delivery times are the next battleground. In exchange for delaying its sales-taxation obligation for a year, Amazon’s deal with the state of California calls for it to open two 1 million-square-foot distribution centers, one each in Northern and Southern California. That means Amazon will be able to get orders out within the state very quickly and cheaply, which is something for smaller online retailers to keep in mind.

3. New policies will focus more attention on “showrooming.” About one-third of sales in physical stores are influenced by “pre-shopping on the internet,” according to Forrester Research. More frequently, that sort of comparison shopping is happening while customers are inside your store, a practice some have dubbed “showrooming.” That means your team needs to be more attuned to online pricing dynamics than ever (now that the tax playing field is level in certain states), and it shouldn’t try to get in the way of this practice.

4. Federal legislation is probably coming, albeit slowly. Congress is considering two different bills that would set a national policy for online sales tax. They are the Marketplace Fairness Act and the Marketplace Equity Act. Hearings on both were held earlier this year, but neither has gotten very far. The main issue is the point at which companies would be obligated to start collecting taxes — and how costly it would be to do so. Right now, that cutoff is about $500,000, which could end up making things more difficult for small retailers that sell only online and creep up over that revenue mark.

A lobbying organization called the We R Here Coalition is forming to oppose the federal legislation. “It is not the job of small businesses to collect taxes for state and local governments where they don’t live, do business, or receive government services,” notes Phil Bond, the group’s executive director. “…This is not the time for governments to pile regulations on small businesses — it is unfair, unwise, and it will undermine innovation.”

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