Supreme Court Justice Suggests Expanding E-Commerce Taxes. Would Small Businesses and Startups Be Able To Deal?

In a relatively quiet Supreme Court decision issued earlier this month, Justice Anthony Kennedy made a suggestion that might jolt e-commerce taxes in America and make it harder for small businesses and startups to compete with established companies.

In Direct Marketing Association v. Brohl, __ US __ (2015), the Supreme Court ruled that the Federal Tax Injunction Act does not bar a trade association from challenging part of Colorado’s use tax law in federal court.  A “use tax” is a tax that most states require their citizens to pay when they purchase an item from outside of the state and do not pay sales tax on the item.  For example, if a Colorado resident purchases a laptop from an online retailer located in California, and is not charged sales tax, the resident may be required to pay a use tax on the laptop to the state of Colorado.  The Colorado law that the trade association wants to invalidate requires out-of-state retailers to notify certain Colorado residents that they may be required to pay Colorado use tax on out-of-state purchases.  The law also requires out-of-state retailers to provide the Colorado taxing authority with a list of Colorado residents to whom the out-of-state retailers sold merchandise during the previous year.

The Supreme Court unanimously ruled that the Tax Injunction Act – which prevents federal courts from hearing challenges to certain types of state tax laws if the challenge can be efficiently resolved in state court – did not bar the trade association from challenging the Colorado law in federal court.

What is remarkable about the case, however, is the suggestion in Justice Kennedy’s concurrence that the time has come for the United States to consider allowing states to force out-of-state retailers to collect and remit use taxes to the states in which the retailers’ customers reside.  Traditionally, the Constitution has barred a state from forcing out-of-state retailers to collect taxes on the state’s behalf.  That is why states impose use taxes on their residents; otherwise, a state has no legal recourse to collect taxes on untaxed out-of-state purchases.

The crux of Justice Kennedy’s position is that e-commerce has reshaped the American economy such that online retailers should be considered to be “present” within the states where their customers reside.  Justice Kennedy noted that the last time the Supreme Court considered allowing states to force out-of-state retailers to collect use taxes was in 1992.  At that time, the Internet was still “in its infancy” and “mail-order sales in the United States totaled $180 billion.”  By 2008, however, e-commerce sales in the United States “totaled $3.16 trillion.”  According to Justice Kennedy, the pervasive spread and ease of e-commerce has resulted in out-of-state retailers being “present in a State in a meaningful way without that presence being physical in the traditional sense of that term.”

What’s more, it is extremely difficult for states to effectively enforce use taxes.  States simply do not have the resources to keep tabs on what people are purchasing, from where, and whether residents may owe use taxes.  As a result, most states collect only a miniscule amount of the use taxes to which they are entitled.  California, for instance, collects “only about 4% of the use taxes due on sales from out-of-state vendors.”  This causes huge revenue losses each year.  Colorado estimates that in 2012 alone it was unable to collect approximately $170 million in use taxes.

The notion that states are suffering nine-figure revenue shortfalls because e-commerce is so pervasive is why, absent a “powerful showing” to the contrary, Justice Kennedy would allow states to collect use taxes directly from out-of-state retailers.

But if either the courts or Congress accept Justice Kennedy’s invitation to reconsider use tax jurisprudence, the Internet may become a much less friendly place for small businesses and startups.  Forty-five states currently have use tax laws.  Obligating online retailers to collect and remit use taxes in compliance with the laws of numerous states would undoubtedly increase the cost of doing business.  Even a system where obligations are triggered based on graduated sales volume could be onerous.  Most established businesses will be able to shoulder the burden of compliance, even if begrudgingly.  But for smaller businesses and startups, the burden might be a much bigger problem.

Indeed, inflicting use taxes on out-of-state retailers may temper the competitive adrenaline shot that e-commerce can provide to startups.  The Internet has dramatically increased the consumer base for fledgling businesses.  The ease and economy of selling products online sometimes substantially increases the degree to which cash-short startups can compete with established companies.  In this regard, the Internet is often said to have leveled the playing field.  Forcing startups to incur the cost required to comply with a smorgasbord of use tax laws could change that.

It also feels wildly unconstitutional to think that New York State can force a retailer whose only shop is located in Idaho to comply with New York tax laws merely because a New York resident buys products from the Idaho retailer’s website.

Yet, there is no doubt that numerous states are facing budgetary shortfalls that could be redressed, at least in part, by making it easier to collect use taxes.  E-commerce has surely increased since the 2008 statistics on which Justice Kennedy relied.  As e-commerce continues to grow, states are missing out on an increasingly greater amount of uncollected use tax revenue.  States cannot afford to miss out on hundreds of millions of dollars.  The use tax dollars not collected are funds that could fix roads, fund schools, or even lower property taxes.

Whether it is right or wrong to permit states to collect use taxes from out-of-state retailers is a question that will have to be answered, either by the courts or Congress.  There is no doubt, however, that Justice Kennedy is right: this is an issue that must be addressed.

*All quotes are from the Supreme Court’s decision Direct Marketing Association v. Brohl, __ US __ (2015).

Article by Michael Keenan, Esq., associate attorney with Hinman, Howard & Kattell, LLP.  To contact Mr. Keenan directly please email or call (607) 723-5341.

Recent Entries

©2017 HH&K Contact Us: 80 Exchange Street, P.O. Box 5250, Binghamton NY 13902-5250 | 607-723-5341 Terms of Use | Privacy Policy

ATTORNEY ADVERTISING  Prior Results Do not Guarantee a Similar Outcome