Forcing online retailers to reveal their customers and their customers' purchases will be challenged as unconstitutional.
Record-breaking budget shortfalls have caused states to search for new revenue using tools that arguably are unconstitutional and, at a minimum, violate the consumer privacy that online shoppers have come to expect. A new twist to increasing taxes is an effort -- adopted by Colorado and under consideration in California and Tennessee -- to force online retailers to reveal their customers and their customers' purchases. The Colorado law will be challenged as unconstitutional. Meantime, Colorado consumers should be concerned that their state government is busy collecting data about their purchases that will be used to send them a tax bill.
By way of background, existing sales and use tax laws require only in-state retailers to collect sales tax from their customers. Sales by out-of-state vendors are subject to tax, but states lack the power to force companies with no in-state physical presence to collect sales tax. However, sales by out-of-state sellers are subject to use taxes -- taxes imposed at the same tax rate as sales taxes and owed and payable by purchasers. The problem is that most purchasers don't comply with use taxes, and the states lack the resources to effectively enforce them.
This inability to force remote vendors to collect sales tax has frustrated states and has led to aggressive tax enforcement practices. As online sales continue to grow, so does state desperation to find a way to require remote vendors to collect taxes. Colorado's recent approach may be clever, but it's also coercive and unconstitutional.
In February, Colorado Gov. Bill Ritter signed House Bill 1193 in an effort to circumvent the constitutional protections for out-of-state vendors. The law was designed with the goal of burdening out-of-state vendors, and their customers, to the point that the vendors would relent and voluntarily collect tax on goods shipped into the state. The law imposes significant and onerous reporting requirements on companies that cannot be otherwise required to collect tax. These requirements are tantamount to forcing the companies to collect tax and, in fact, some companies are buckling to the pressure.
Colorado's new reporting regime places a number of reporting and disclosure requirements on out-of-state vendors. For instance, the law forces remote vendors to inform each of its customers of their Colorado tax liability. Even more egregious, the law requires the vendor to report to the state the online purchase history of Colorado residents. Such disclosure may have a chilling effect on online sales.
Additionally, retailers must provide a detailed notification to Colorado purchasers of their obligation to pay use tax directly to the state. Retailers are also required to provide each customer with a year-end summary of purchases. Stiff penalties apply to retailers that fail to provide the required notice or year-end reports.
Some commentators have argued that the reporting scheme is fair -- that in-state retailers have been at a disadvantage because of their obligation to collect sales tax. Regardless, the U.S. Constitution's protection of interstate commerce is clear. Remote vendors cannot be required to collect tax; and they should not be required to comply with a tax-reporting regime that places an arguably greater burden on interstate commerce than that of simply collecting the tax. In short, the law is unconstitutional and should be struck down.
State efforts to expand their tax collection authority are not new, and Colorado's law will likely go the way of other efforts to burden interstate commerce. In the late 1980s, states were attempting to force catalog retailers to collect sales tax. North Dakota forced the issue and took a case to the U.S. Supreme Court in its effort to require out-of-state vendors to collect tax. In 1992, the high court held that remote vendors were protected from North Dakota's tax collection obligation. Colorado's approach should face the same judicial scrutiny and, given that the reporting and notice regime is arguably more burdensome than just collecting the tax, ought to be found unconstitutional. Meantime, Colorado consumers beware -- your purchases will be reported to the state.
As states and local governments continue to struggle with budget deficits, it's likely that more of them will consider adopting laws patterned after Colorado. Bills have already been introduced in California and Tennessee, and the local governments in Colorado are working to determine how best to obtain the data being collected on sales in the state. As the problem spreads, online retailers will be faced with an untenable choice: Comply with the individual reporting rules of each jurisdiction or break down and collect tax for the several thousand taxing jurisdictions nationwide.
While one can sympathize with policymakers struggling to make budget ends meet, the solution isn't the adoption of a law seeking to compel vendors to do that which they are constitutionally protected from doing. Unless the trend is stopped politically or judicially, vendors and consumers alike should expect online purchases to be tracked and reported for tax purposes.
Stephen Kranz is an attorney in the Tax Practice Group at Sutherland Asbill & Brennan LLP, where he focuses on state tax controversy and tax policy matters, including advocating for the fair treatment of interstate retailers. Kranz represents clients before state legislatures, the U.S. Congress, National Conference of State Legislatures, National Governors Association, Multistate Tax Commission, Streamlined Sales Tax Governing Board, and the Federation of Tax Administrators.