Last week, the Illinois Supreme Court issued a stunning opinion, unexpectedly holding that an Illinois law requiring the collection of taxes from online sales was unenforceable because it conflicted with current federal law. Performance Marketing Association, Inc. v. Brian Hamer, 2013 IL 114496. This decision stands in stark contrast to a New York court ruling earlier this year, holding a similar law constitutional on other grounds.
A Little Background
Most nonprofits engaging in the interstate sale of good can attest that evaluating specific state sales and use tax requirements can be an administrative and legal maelstrom. (Sales taxes are for purchases made within a state; use taxes are closely related and are for purchases of goods used in that state.) State sales and use taxes are technically imposed on the consumer. Since it is impractical for states to track and collect the taxes from each individual purchaser, state laws typically require sellers to collect and remit them.
Unlike many other countries, the US does not have a national sales tax. Congress has been reluctant to pass proposed legislation to develop national collection and enforcement standards. Instead, a state “nexus” test generally applies, by which the extent of a retailer’s physical presence determines whether its sales are subject to sales and use tax in each state at issue. An organization engaged in multi-state sales activity thus must conduct a state-by-state analysis of its activities, to determine whether it has a sufficient “nexus” with the state to subject it to the state’s sales/use tax laws.
In the 1992 landmark case of Quill Corp. v. North Dakota (504 US 298), the US Supreme Court ruled that retailers without a physical presence in a state do not need to collect and remit taxes in that state. While this decision clarified much in the consumer sales industry in the 1990s, the emerging online retail activity over the last twenty-one years has raised significant new “nexus” questions.
Online retailing giants like Amazon and Overstock.com have carefully structured their business models to minimize their physical presence in states to minimize where they pay state sales taxes. This has often resulted in a significant tax advantage over traditional brick and mortar stores. Not surprisingly, the non-online retailers have been less than pleased.
Since 2008, approximately 13 states including Illinois have enacted legislation that seeks to capture this lost taxing revenue by extending the definition of physical presence. Such states include organizations that have a contract with an in-state person who, for a commission, refers potential customers to the organization through the in-state person’s website. See, e.g., 35 ILCS 110/2 (2010). These taxes are often referred to Amazon or affiliate tax laws.
Retailers are now fighting back by challenging these state statutes. The retailers generally claim that the laws violate the US Constitution’s Commerce and Due Process Clauses, by imposing tax on a retailer without substantial “nexus” with the state. Earlier this year, the New York Court of Appeals considered and rejected a challenge to New York’s Amazon tax, based on these constitutional considerations.
The Stunning Illinois Decision
In Illinois, Performance Marketing Association (“PMA”) mounted a similar challenge, arguing that Illinois law violated the Commerce Clause of the US Constitution. In addition, PMA asserted that the state law was preempted by a federal law called the Internet Tax Freedom Act (ITFA) (47 USC Sec. 151 2000). The ITFA was originally enacted in 1998 to help preserve the educational and public informational purposes of the Internet. Under the ITFA, states are prohibited from imposing discriminatory taxes on Internet use and other electronic commerce. The PMA claimed the ITFA effectively precludes states from imposing “Amazon” type taxes, because such taxes unlawfully discriminate against online retailers.
The Circuit Court of Cook County ruled in PMA’s favor on both the Commerce Clause and preemption arguments. On appeal, retailers and the general legal community expected the Illinois Supreme Court would take up the important Commerce Clause issue.
Surprisingly, however, the Court artfully avoided the Commerce Clause argument entirely and instead agreed that the IFTA preempted the state law, rendering it ineffective.
The Illinois Supreme Court’s decision is controversial for several reasons. First, as explained in Justice Karmeier’s lengthy dissent, the legal reasoning for invalidating the Illinois law based on the preemption clause has a number of technical flaws. Second, because the ITFA is a temporary law that is set to expire on November 1, 2014, the potential conflict with state law should disappear next year. It is thus likely that the Court will have to address the Amazon tax issue again.
Where Do We Go From Here?
The diverging court decisions in New York and Illinois, as well as other state rulings addressing Amazon taxes, make it extremely problematic for retailers and attorneys to plan responsibly and accurately for sales/use tax collection across state lines. Federal legislation aimed at resolving these issues is presently pending, but the likelihood that any tax reform will be passed in the coming year is difficult to imagine given the current Congressional gridlock.
Notably, the New York case has already been appealed to the US Supreme Court. Given the opposite results in New York and Illinois, we can hope that the Supreme Court will accept the appeal and resolves this critical “nexus” question for online retailers.
Nonprofits actively engaged in Internet sales should continue to closely monitor these developments. In addition, they should otherwise closely track their sales and other program activities in each state, in case of potential sales tax liability.