E-Tailers vs. the States: The Sales Tax Man Cometh

From Massachusetts to California and all points in between, states face painful budget gaps. An increasing consumer shift to e-commerce may have twisted the dagger. Much online commerce happens across state boarders. Merchants don't collect sales taxes and states get less revenue to balance the books.

States want that extra income and increasingly are trying to force e-commerce companies to collect sales tax. The companies have fought back with varying degrees of success. Ironically, one of the big factors that help the e-tailers in their fight is what would seem to undercut their position: physical presence in the states. That's because they then have jobs as a bargaining chip. E-tailers with highly centralized operations may find themselves at a bargaining disadvantage to those that offer thousands of jobs across the country.

How bad are state budgets? Here are a few examples:

• Wisconsin Democrats have gone into hiding to block a vote cutting pay and benefits of public workers.
• North Carolina will cut 10,000 government positions in an attempt to close a $2.4 billion budget gap.
• Texas faces a two-year $27 billion shortfall.
• California needs $26.6 billion in spending cuts or revenue, and that's just for next year.

Amazon (AMZN) has distribution centers in ten states and plans additional ones in two others. In most of the states in which it operates, Amazon avoids collecting sales taxes by setting up the distribution center as a legally separate business. The company argues that the centers fulfill orders on behalf of Amazon, but don't actually sell, and so shouldn't collect tax.

The states: desperate and conflicted
But states have become desperate and conflicted. The comptroller of Texas -- as pro-business a state as they get -- ruled a distribution center as a physical presence and sent Amazon a $269 million sales tax bill. Amazon said it would shut down the center because of the state's "unfavorable regulatory climate." Gov. Rick Perry tried to distance himself from the decision, and then passed the buck to the legislature, asking it to "craft some legislation" that would give Amazon a exemption.

And yet, Amazon's threat to close the center and end the 119 associated jobs seems a tactical gambit. The company already collects sales taxes in three states where it has distribution centers (including its home of Washington) and further collects taxes in two other states where it has no operations. Building a new distribution center elsewhere would take time and more money. Why is collecting tax so much more a burden in Texas than in New York, North Dakota, Kansas, or Kentucky?

The Amazon Texas skirmish isn't the only one. Colorado is in the middle of a legal fight with e-commerce companies. The state wanted to force the businesses that don't collect sales tax to report in-state sales so the Colorado Department of Revenue could collect appropriately from the consumers. There's currently a temporary injunction, but no guarantee that Colorado won't ultimately win. (North Carolina recently backed down from a similar attempt because of legal challenge.)

Where E-commerce gets the e-bill
However, e-commerce doesn't always come out on top. Expedia lost its appeal to the Supreme Court of South Carolina over paying sales tax on full revenue and not the discounted prices it pays for hotel rooms. Because Expedia purchases a taxable service, it is in a different position than Amazon. Would the pre-legal bargaining have been different if Expedia created extra jobs in the state?

Fights will only get more serious as e-commerce continues to grow and take a larger chunk of what otherwise would be store purchases that generate sales tax. If companies have nothing to offer in exchange -- jobs -- it seems likely that they will face increased antagonism from states.

Fighting sales tax collection can also put an e-commerce company in danger from competitors that already do. As my BNET colleague Lydia Dishman wrote, Amazon threatened to terminate affiliate programs in states that required tax for such sales. Barnes & Noble (BKS) moved to scoop up that business, as it collected tax anyway because of its stores in every state.

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