Billions Lost as Thousands of Sellers Flout State Sales Tax Laws
By Michael J. Bologna and Tripp Baltz
Posted: June 22, 2021, 4:46am
• Less than half of remote sellers comply with Wayfair rules
• More states getting aggressive about collection
State revenue agencies are finally getting serious about requiring out-of-state retailers to collect tax on e-commerce transactions, frustrated that less than half of such sellers are in full compliance with their sales tax codes.
A more aggressive compliance posture is emerging three years after the U.S. Supreme Court created a framework for the 45 sales tax states to require out-of-state retailers to collect tax on online sales.
The new tone reflects the fact that only a fraction of the estimated 2.1 million online merchants
operating in the U.S. are collecting from customers and remitting to states that have established such obligations after the high court’s ruling in South Dakota v. Wayfair . This compliance gap leaves the states with a revenue gap that is likely more than $1 billion annually, according to at least one economist monitoring sales and use tax trends.
“Most of the sellers still haven’t come forward. Numerically, there are thousands and thousands that have not complied,” said Richard Cram, director of the Multistate Tax Commission’s National Nexus Program. “My gut feeling is it’s way below half.”
Voluntary compliance programs and friendly letters to online businesses have helped, but state tax specialists expect more states to use hammers, issuing assessments and penalties to unregistered remote sellers with unpaid tax liabilities.
A dozen states already have reputations for active enforcement strategies targeting remote retailers. California, Massachusetts, Minnesota, Pennsylvania, Washington, and Wisconsin are pursuing sellers with inventory in their states for enforcement. Illinois and Maine frequently send out assessments to new registrants, asserting they likely had tax duties prior to their registrations.
Arizona is going further, bringing in a private data analytics company to identify non-filers and help with audits, a step that raises eyebrows among trade groups that represent business taxpayers.
“I would expect later this year and in 2022 you will see the states up their enforcement activity even further,” said Craig Johnson, executive director of the Streamlined Sales and Use Tax Agreement (SSUTA), a 24-state sales tax harmonization pact. “At that point, you’re three or four years past Wayfair, past the state remote seller collection requirements.”
The landmark Wayfair ruling, issued June 21, 2018, permitted states to impose tax collection duties on remote retailers based on economic activity, instead of physical presence, in a state. Over the last three years all 45 sales tax states have enacted economic presence laws and marketplace facilitator laws, which require large e-commerce websites such as Amazon.com Inc., Etsy Inc., and eBay Inc. to collect and remit taxes on sales by third-party sellers using their platforms.
Most of these laws feature safe harbors, imposing collection duties only on sellers with more than $100,000 in sales or 200 transactions into the state.
The laws have been a revenue bonanza, collecting at least $35 billion a year for state coffers, said William Fox, a University of Tennessee economist who has researched tax issues around online sales for decades.
Much of the revenue arrived as large sellers began complying with the new state laws. Revenues accelerated with the adoption of the marketplace facilitator laws, gathering taxes from thousands of small businesses selling over these marketplaces.
But the universe of sellers avoiding the requirements is vast, said Diane Yetter, founder of the Sales Tax Institute, a tax education and advocacy think tank.
The best proxy for compliance nationally is the running tally of active sellers registered through the SSUTA, which operates a centralized portal for sellers operating in roughly half of the sales tax states. The SSUTA currently has 14,500 active sellers, Johnson said. That number is minuscule compared with the 2.1 million online businesses operating in the U.S. identified by etailinsights.com, which gathers detailed information on e-commerce companies.
‘The Fourth Inning’
Many of those businesses have no duty to collect, because of their small size or their exemption
status under various state rules, but it’s clear that thousands do, Yetter said.
“When I get asked about registrations, I often use the analogy of a baseball game and say maybe we’re in the fourth inning,” Yetter said. “I just think there are still a lot of sellers that have no idea they have this obligation.”
This registration gap leaves the states with a revenue gap that is hard to predict, but is at least $1 billion annually, according to Fox. He pointed to the U.S. Census Bureau’s retail e-commerce sales data revealing consumers spent $759.1 billion online in 2020, and his own estimate of at least $35 billion in sales tax collections as a direct result of the Wayfair ruling.
“Suppose the noncompliance rate is just 3% or 4%—that’s a billion dollars,” Fox said.
Every state has used various soft approaches to boost registrations in the post-Wayfair period,
including web announcements, media campaigns, and direct outreach to sellers, said John Valentine, Utah’s tax commissioner and president of the Federation of Tax Administrators.
Several states, including Utah, have had success with voluntary compliance agreements, which
permit sellers to register and pay past-due liabilities with some reduction or waiver of penalties. Well before the Supreme Court affirmed states’ authority to require tax on remote sales, Utah registered 950 sellers through voluntary compliance. Afterward it registered 650 more that way, and now has 9, 982 remote sellers registered.
Valentine, Cram and Johnson are expecting states to adopt more aggressive compliance strategies in the next year.
Almost every revenue department has purchased lists of internet sellers and compared them against the retailers registered in their states. These campaigns generate “friendly letters” to sellers suggesting they have a duty to register and collect taxes, Cram said. But the letters eventually escalate to assessments and demand letters for sellers that don’t register.
At least one state is taking the additional step of hiring an outside data analytics company to identify patterns of noncompliance and potentially assist with audits.
Arizona struck an agreement with ASR Analytics LLC earlier this year. For 17 years the Potomac,
Md.-based company has used machine learning and financial investigative techniques to identify tax violations under contracts with the Internal Revenue Service and revenue departments in 10 states. The company’s fraud models and audit identification processes have protected more than $425 million in state tax revenue, ASR said in its proposal to Arizona.
Arizona’s contract with ASR estimates the company will generate roughly 100 leads per month.
Those leads have already triggered dozens of discovery letters to the non-compliant sellers, Department of Revenue spokesperson Michelle Carella said.
“I would be surprised if other states aren’t actively pursuing similar types of strategies as Arizona,” Valentine said. “It just makes sense.”
Business taxpayers say the revenue agencies’ use of outside contractors and data analytics experts to detect noncompliance and assist with audit selection is reasonable in the current climate. But the practices become “very troublesome” when third parties conduct audits and receive compensation linked to the revenues they collect, said Fred Nicely, senior tax counsel for the Council on State Taxation.
“A major concern with data mining and the use of artificial intelligence is really with using that data to issue assessments, and not contacting the taxpayer, and not letting them to explain their situation,” Nicely said.
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