The tax man cometh — online

By Arik Hesseldahl

updated 12:40 p.m. ET March 12, 2005

The forces of Internet taxation are beginning to muster themselves once again in the statehouses of America. Right now ground zero in the fight is in Madison, Wis.

That's where Gov. James Doyle, a Democrat, thinks he's solved his state's budgetary shortfall in part by levying a tax on the goods Wisconsin residents purchase over the Internet.

Under his proposal Wisconsin residents would be required to pay the state's 5 percent sales tax on anything they buy over the Internet, which would include books and CDs from Amazon.com or songs on Apple Computer's iTunes Music Store. The estimated return to the state's coffers? A measly $3.2 million over two years.

That seems hardly worth the effort to add the extra cost that businesses will have to eat in order to come into compliance with the law. And if Doyle gets his way, other states may seek to follow his example and start a new offensive in their long fight over "tax equity" between Internet and brick-and-mortar businesses.

Technically speaking, when you buy something on the Internet, you owe the same amount of money in sales and use taxes to your state and local government as you would if you had bought them on Main Street. The complication — and cost — comes in keeping track of those taxes. States have no real means to do it, and so they leave it to the businesses, most of which ignore it if they can.

If you're buying something online from a company with a physical presence in your state, you will likely pay sales tax. But some vendors get around this by creating separate subsidiaries. You can thank a 1992 Supreme Court decision, Quill vs. North Dakota, for that.

Accounting nightmare
The federal government has so far prevented states and cities — Wisconsin being an exception — from imposing new taxes on Internet sales. This prevented state and local authorities from collecting some $8 billion in taxes in 2003 and could prevent them from collecting $12 billion to $18 billion by 2008, according to economists at the University of Tennessee, who wrote an oft-cited study on the matter. That's the kind of money that gives tax collectors a funny twitch.

But imagine the accounting nightmare — not to mention the cost — of having to keep track of the tax rates of some of some 7,500 tax-collecting jurisdictions.

That's exactly what the multi-state "Streamlined Sales and Use Tax Agreement" is supposed to address. Forty-two states are involved in the efforts to set uniform standards on how Internet and catalog transactions can be taxed. Once the rules are simplified, the thinking goes, states and cities will be better able to convince Congress to lift the ban on new Internet sales taxes and thus tap into a new revenue stream.

But is it really that simple? Apparently not. Another University of Tennessee study looked at the potential revenue impact of the "streamlined" rules on all of that state's 95 counties and 382 cities.

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