The Taxman Is Coming to the Net

Thought you could dodge sales taxes by making your purchases on the Web? Think again.

Anne Kandra

Think back to your last online purchase. Did you pay sales tax? Maybe, maybe not. It depends on whether you bought from a Web site whose parent company is located in the state where you live. It also matters what you bought--some states tax food but not software; others tax software but not clothing. And it may also depend on when you made the purchase, since states' sales tax rates and laws change frequently. Finally, it depends on whether your online merchant bothers to charge its customers sales tax.

Has all this got you confused? You're not alone.

The picture may soon get clearer, but not in a way most Web consumers will like. State and federal officials are working together to make sales taxes on the Net easier for companies to apply and far more common. Some supporters of these changes expect you to be routinely paying sales tax on Web purchases soon--perhaps as early as next year.

Wait a minute, you may be saying, isn't the Internet supposed to be a tax-free zone? Not quite. The Internet Tax Freedom Act of 1998 (which expires in October but will almost certainly be extended for at least a few more years) does ban new taxes on Internet access, discriminatory taxes on Internet transactions that two or more states could tax, and taxes for items purchased online that would not be taxed if purchased offline. But it doesn't outright ban sales taxes on products bought online.

Right now, online retailers typically follow the same sales tax rules as mail-order catalog companies. They're required to charge you sales tax only if they have a retail store, office, or warehouse in your state. If you live in Maine, for example, and order a pair of snowshoes from llbean.com, you'll find a 5 percent state sales tax tacked on to your credit card bill. If you order the same snowshoes from your condo in Maui, you'll dodge the Maine sales tax.

Of course, like most things tax-related, there's more to it than that. Even if you order from an out-of-state Web site, in most states you're still responsible for paying a use tax--a sort of self-imposed sales tax. But if--like most Americans--you somehow overlooked paying your use tax this year, you probably needn't worry about government officials knocking on your door. It's extraordinarily difficult to keep track of use taxes, and most states don't bother trying (only a few, including Michigan and North Carolina, provide a line on their state tax return form for reporting use tax).

The bottom line is that consumers can make the majority of their online purchases without paying a cent in sales or use taxes.

Unfair Advantage?

Understandably, traditional retailers have cried foul: Why should e-merchants enjoy the advantage of offering customers a 5 to 8 percent price break? "It's incredibly unfair," says David Didriksen, who owns a successful bookstore and café in Acton, Massachusetts. "Why should Internet companies get a free ride? We pay a lot of taxes [as business owners], and it's not right to require some businesses to pay and not others. It puts us at a competitive disadvantage, since our customers end up paying more."

Civic leaders have joined in the chorus, claiming that municipal services suffer from sales tax revenues lost to the Web. According to Forrester Research, states stand to lose as much as $14 billion in sales and use tax revenue in 2003 due to online purchases that are made tax-free.

Does that mean you should blame the dot coms when the potholes in the roadway aren't filled? Probably not. Less than 1 percent of total retail sales in the United States took place on the Internet in 2000.

Meanwhile, Internet entrepreneurs argue that they're the ones who need protection, not the brick-and-mortar stores. The young Internet economy needs to gain a foothold unfettered by tax burdens, they say. And the plunge in dot-com stock prices--which is still ongoing at this writing--lends weight to that argument. Suddenly, your neighborhood bookstore may be on more solid financial ground than once-mighty Amazon.com.

Tony Hsieh, co-CEO of San Francisco-based online shoe store Zappos.com, says having to unravel the red tape of states' tax laws will hinder the development of dot coms.

"I don't think [sales taxes] will affect our customer base as long as they're uniformly applied," he says. But Hsieh can see the potential for the tax to slow the pace of innovation if companies have to spend time figuring out tax laws. "Better to work on improving products and services," he contends.

Such arguments, however, seem unlikely to sway lawmakers. Broader application of sales taxes to Internet purchases is almost a certainty. In February, Representative Chris Cox (R-California) and Senator Ron Wyden (D-Oregon) introduced a bill that would extend the Internet Tax Freedom Act while broadening states' ability to enact their own online sales tax laws covering all Internet transactions. Perhaps most important, the proposed law attempts to simplify and streamline states' existing sales and use tax systems. Essentially, the bill offers a deal to the states--Congress will make it easier for them to tax online purchases if the states make their sales tax rules more uniform.

Enter the Streamlined Sales Tax Project, a group established in March 2000 by officials from dozens of states who want to radically simplify sales and use taxes. Proposed legislation developed by the SSTP has already been introduced in several states, and Wyoming recently became the first state to enact a law based on SSTP recommendations. Among the organization's proposals are uniform definitions of what items should be taxed and a single way to calculate tax rates for items that are shipped to other states.

Consumer Reaction

In short, you may want to rev up your favorite shopping bot now because the days of tax-free Internet purchases are numbered. How will online consumers react to what amounts to an across-the-board increase in prices? Opinions vary widely. A Forrester Research study indicates that many consumers are more concerned about shipping charges than about paying sales tax for Internet purchases.

Add taxes to shipping costs, though, and some consumers may decide to bypass their browser and head to the mall instead. "Part of the reason I shop online is to sidestep sales tax," says Doug Ashford, a systems specialist at a Boston financial services company. "But shipping charges often offset the advantage of not having to pay sales tax. That, combined with waiting for the item to arrive--and occasionally the hassle of having to return an item--tips the scales more toward a traditional retailer."

It makes sense. I plan to send Mysimon out on a few more excursions before the sale ends, too--especially for pricier stuff like PCs, software, and household appliances. But when I want a good cup of coffee and advice from someone who understands my six-year-old's addiction to Magic Tree House books, I'll gladly troop to the local bookstore and pay the extra 5 percent for the personal attention.

Anne Kandra is a contributing editor and Grace Aquino an associate editor for PC World.

On Your Side

I ordered a new system from Dell in January. A week later, I called to follow up on the status of my order and discovered that it hadn't even been processed. A helpful salesperson did sort out my request and offered free shipping to compensate for the oversight. A month passed with no sign of my computer. What's more, Dell kept slipping its promised delivery dates.

On March 1, I received a digital camera that was part of my purchase but still no PC. I'm sure Dell was aware of delivery issues when I placed the order. And giving me bad news a little at a time is not an acceptable practice for a reputable company such as Dell.

Danny Morrison, Huntington, West Virginia

On Your Side responds: I've received several complaints about Dell's service--including order delays and inadequate technical support--in the past few months. So I contacted the company. According to Dell spokesperson Bryant Hilton, a wireless networking card was unavailable for several weeks, causing the delay in shipping Morrison's system. Two months after Morrison ordered a PC, Dell finally shipped him one--with a slightly faster processor and graphics card as amends.

--Grace Aquino

Gotten a raw deal? Or a great one? E-mail the details to onyourside@pcworld.com. We'll follow up on and publish items of the broadest interest.