Online Retailers Beware: States Broaden the Tax Net

While the stock market has rallied, state tax revenue collections continue to come in at dismal levels compared to a year ago. A recent survey by the nonprofit Nelson A. Rockefeller Institute of Government shows that state income tax revenue in the first four months of 2009 fell 26 percent vs. the same period of 2008. With collections from sales and property tax on the decline, states are under great pressure to raise additional revenue from new sources. One target squarely in the sights of legislators: internet sales.

The debate over whether online retailers are required to collect sales tax has traditionally focused on whether the online retailer has a physical presence in the state. Without having to resolve this constitutional question, states have identified a common business arrangement that they now assert results in sales tax nexus, requiring collection of tax, even when the seller has no physical presence in the state. This business arrangement is the use of affiliate programs to generate internet sales for out-of-state online retailers.

New York was the first state to adopt such “affiliate nexus” legislation, doing so in 2008. The New York law provides that an online retailer that makes sales of taxable property or services in New York will be presumed to be vendors required to collect sales tax if it enters into an agreement with a New York resident under which a commission or other consideration is paid for directly or indirectly referring potential customers to the seller’s website. Exceptions to the new “affiliate nexus” standard apply if the party providing the link to the seller’s website doesn't engage in any solicitation activities on behalf of the online retailer, or if the gross receipts as a result of referrals by all of the seller’s representatives don't exceed $10,000 in the previous four quarters.