Tax-free Internet days numbered

ALBANY, N.Y. — Almost 20 years ago, Harley Duncan and the Kansas tax department he headed set out to encourage people to pay state sales tax on mail-order purchases, required by law but enforced only by a rarely used honor system.

“Well, I was out preaching the sermon, and a reporter asked me, ‘OK, what do I do if I want to pay the tax?'” Duncan recalled. “And I said, ‘Hmm. Good question.’

“Well, we didn’t have any procedure,” he said.

With the growth of Internet sales taking out-of-state sales to a new level, Duncan, now executive director of the Federation of Tax Administrators, said states have a bigger stake in collecting sales taxes, estimated at $10 billion a year.

Eighteen states and New York have added lines on their income tax forms for taxpayers to declare their owed sales tax from Internet and mail-order purchases with out-of-state firms. Three more have separate forms in their income tax packages.

But revenue rarely rises above a few hundred thousand dollars as taxpayers ignore the law when ordering books, CDs, computers and gourmet food on the still mostly tax-free Internet. New York’s Legislature, for example, estimated last year that $25 million could be reclaimed, while the governor guessed it would be no more than $5 million.

Ohio may have the best record in collections so far: $2.1 million in 2002 from 46,000 taxpayers, out of 5.7 million returns, said Gary Gudmundson, spokesman for the Ohio tax department. Revenue remains a fraction of the estimated uncollected sales tax: $497 million owed to the state, another $100 million owed to local governments.

The 18 states besides New York that have added lines on their income tax forms seeking to recover some of the estimated $10 billion lost nationally each year on uncollected sales taxes for purchases on the Internet and through mail order:
New Jersey
North Carolina
Rhode Island
South Carolina

States with forms in their tax preparation instruction booklets:
also, the District of Columbia

Source: Federation of Tax Administrators

Yet the single line on a tax form forces a taxpayer to confront his or her liability or face an audit that could uncover credit card statements and mounting tax debt.

The backlash has prompted a New York lawmaker to try to remove the line from the state’s income tax form this year, the first time it showed up.

“I believe it’s unwieldy, totally unworkable, unenforceable and inadvertently we’re going to make tax evaders out of law-abiding citizens and policemen out of tax preparers and accountants,” said New York Assemblyman Ronald Tocci.

Some states have had difficulty trying to force greater compliance.

Maine created a “default assessment” in the 1990s of 0.04% of adjusted gross income if a taxpayer didn’t fill in the out-of-state sales tax line either with a payment or a zero.

“They did it for three or four years,” Duncan said. “They left the line in, but eliminated the default assessment … I think their participation dropped off.”

Maine tax officials didn’t immediately respond to requests for comment Tuesday.

California, Minnesota and a few other states offer an allowance of a few hundred dollars before Internet and mail-order purchase would incur sales tax, as an incentive to report bigger ticket items and large tax liabilities.

“Who the hell do you know who keeps tabs of what they buy on vacation in the Bahamas or Canada? Or anyplace? It’s crazy, it’s insane,” said Tocci.

Consumer groups say the effort represents overtaxation that threatens to end competition that keeps sales taxes lower, a closing of the free market, and even taxation without representation because firms would collect taxes for a state in which they have no voice.

“The Internet is not at it’s final stage yet,” said Chris Kinnan of Citizens for a Sound Economy. “You’ll stifle that and the competition of the Internet won’t be realized.”

The U.S. Supreme Court has ruled that consumers, not retailers, are responsible for paying state sales taxes on out-of-state buys. Of the 39 states with individual state income taxes as well as sales taxes, 18 call on taxpayers to pay taxes on out-of-state purchases and three have a form in their tax booklet on how to calculate tax liability, according to the Federation of Tax Administrators’ study of 2002 data.

Despite the explosion of Internet sales — estimated to top $123 billion this year — a state rarely gets back all the sales tax it is due because of the lack of a way to enforce it.

That may change as several states and major retailers are working on a system at the point of retail sale that Congress would establish nationwide, Duncan said.

“That’s the answer to it,” he said. “To try to do it at each individual is simply not cost effective … it would be possible, but the privacy issues are also immense.”

The multistate “Streamlined Sales Tax Project” seeks to simplify sales taxes and pave the way for Congress to permit states to require retailers to collect state sales taxes, said New York Taxation and Finance Commissioner Andrew Eristoff. He said Tuesday that the project will begin voluntarily when a consortium of 10 or more states representing at least 20% of the nation’s population sign on.

Until then, “We are going to rely on New York state residents to be honest with us when filing their income taxes,” Eristoff said. He admits few New Yorkers have reported out-of-state sales tax, although state law required it since 1965.

“The pressure for doing something just keeps growing,” said Bill Fox, director of the Center for Business and Economic Research at the University of Tennessee and a tax policy expert. He said major retailers including Wal-Mart and trade groups support voluntary reporting, states are working together, and the courts await a challenge if Congress doesn’t act.

He expects the days of the virtually tax-free Internet will end in a few years.

Contributing: AP writer Joel Stashenko contributed to this report from Albany.