Online Sales Tax: How Much Could it Cost to Collect?
On Monday, the Senate passed the Marketplace Fairness Act, which would give states the power to force online businesses to collect sales taxes – an initiative that continues to fire up pro-business advocates on both sides of the debate.
But it looks like the bill is moving nowhere fast. House Judiciary Committee Chairman Bob Goodlatte (R-VA) announced Tuesday the House’s consideration of the bill “will be more thoughtful,” and expressed his opinion that the Marketplace Fairness Act is still not simple enough for businesses.
In a released statement, Chairman Goodlatte also said the committee will “look at alternatives that could enable states to collect sales tax revenues without opening the door to aggressive state action against out-of-state companies.”
Even without the passage of the new law, sales tax compliance is the biggest challenge for small businesses, says Bruce Phillips, CPA. Phillips is a managing member at Harshman Phillips & Company. He also works with Xero, an online accounting solution, specializing in cloud accounting practices.
“Sales tax compliance is already behind and lacking, and the reason is that it’s so complex,” says Phillips.
“There are 45 states that charge sales tax, and different jurisdictions within those states have their own taxes,” he adds, mentioning that Alabama, for instance, has different sales taxes from county to county.
Phillips says many accounting systems just aren’t prepared to track sales taxes for all 45 states, and that small businesses who sell online will have a hard time providing solid data to the person preparing their compliance.
“The cost of accounting the tax and reporting it, and then remitting, can eat away at multiple percentage points of margins. This will just make it worse,” says Phillips. He adds the forms and filing systems differ from state to state, so the process itself will be a huge drain on resources.
Even online companies based in states where there is no sales tax will face compliance issues.
“The people who live in those states – Alaska, Delaware, New Hampshire, Montana and Oregon – won’t have to pay sales tax for purchases they order that are shipped from out of state,” says Phillips. “But if you’re a company based in Oregon, you’ll have to collect sales tax from California, remit and file a sales tax compliance.”
Phillips estimates compliance costs alone could cost a small online business anywhere from $250 to $500 each month.
$1 Million Exemption Doesn’t Do Enough for Small Businesses In its current state, the Marketplace Fairness Act includes an exemption for small businesses with under $1 million in gross annual sales. But many argue the $1 million threshold is too low – and that calculating just on the basis of gross sales isn’t enough.
“I see a lot of small businesses that have around $1 million in sales, but their margins are 10%. So their costs are $900,000, but they’re only making $100,000,” says Phillips, who adds that compliance costs would likely be very harmful to these businesses.
These companies are likely much smaller than a number – such as $1 million – suggests, he says, pointing out many have only one to two other employees – or none at all.
Based on his professional experience, Phillips believes the threshold should be $5 million at the very least, and $10 million, he says, would be even fairer. “Even for retailers doing $5 to $10 million, I’d be shocked if they had more than 20 employees,” says Phillips.
In a letter on the subject, eBay CEO John Donahoe said the online retail company is advocating for an add-on to the legislation that would “exempt businesses with less than $10 million in annual out-of-state sales or fewer than 50 employees.”
EBay has been vocal in the fight against the Internet sales tax on behalf of its online sellers – many of whom are entrepreneurs and small business owners. Meanwhile, online behemoth Amazon and other big box retailers have actually lobbied on behalf of the law, arguing the tax is legitimate – and not “new” -- and consumers should pay their dues. They say online businesses that sell to consumers are given an unfair advantage when no sales tax is collected. As the law currently stands, consumers are required to declare online purchases when filing their annual income tax, though not many do.
According to a 2009 study by three business professors at the University of Tennessee, states have lost a total of $11.4 billion on uncollected sales tax from online purchases.
Auditing Costs and Restricted Growth Compliance would be only the first hurdle for small businesses, says Phillips.
“Sales tax audits can be just as bad or worse than IRS audits – and imagine you could have 10 to 20 auditors going through all of your sales!” says Phillips.
He says audits can take anywhere from two months to a year.
“It costs businesses money to hire someone to get through the audit, and then they have to pay the result of the audit,” he says.
He also says that a Marketplace Fairness Act might lead to the same types of restrictions on growth some have experienced due to the Affordable Care Act.
“With healthcare, I’m seeing businesses keep employees under 30 hours to get around it,” says Phillips.
Intentionally hurting sales could save small online sellers a huge headache in compliance. Phillips adds, “I think businesses will do whatever they have to do to keep sales under $1 million to avoid the sales tax.”