This, the third blog post in a series about the Marketplace Fairness Act, is concerned with the mechanisms that states have employed to collect sales tax from online retailers, and the problems associated with these attempts. In my opinion, federal legislation such as the Marketplace Fairness Act, is the only viable way to level the playing field.
It is uncontested by the states that online retailers are subordinate to out-of-state retailers. That is, online retailers are a specific type of out-of-state retailers; therefore, state taxation authorities are required to abide by the precedent developed by the cases listed above. Quill is the controlling precedent.
The character of online retail, however, presents several issues not specifically covered by the Supreme Court in its line of out-of-state retailer cases. The primary issue is related to what has been termed “click-and-mortar businesses.” Basically, these hybrid types of retail businesses exist both in cyberspace and tangible storefronts physically located within certain states. For example, Target Corporation is considered a “click-and-mortar” business because buyers are able to purchase merchandise online or at one of the company’s many stores located throughout the United States. Generally speaking, these types of businesses have been held to have sufficient nexus when they have such physical locations within a state.
In recent years, however, these types of businesses have been structuring their businesses in particular ways to escape taxation. The most popular avoidance technique is entity isolation. Entity isolation is when a company structures its business in such a way so that different departments constitute different businesses. For example, if a business wishes to avoid a high sales tax from one state, but it is in the best interest of the company to have a presence in that state, the company will separately incorporate a department that’s sole responsibility is related to something different than sales or manufacturing. Additionally, many corporations will set up separate corporations that deal only in online retailing, so that the “brick-and-mortar” segment of the umbrella corporation does not constitute physical presence within other taxing states. Courts are not certain how to deal with this phenomena sinceQuill requires physical presence, corporate law doctrines allow for such incorporation techniques, but entity isolation is clearly nothing but a means to avoid taxation. It appears that the fear expressed by Justice Clark in the majority decision in Scripto has come true; the arbitrary bright-line rule of Quill has opened the flood gates to inequitable tax avoidance techniques.
Individual States’ Attempts to Circumnavigate Quill and Require Online
Retailers to Participate in Their Taxing Schemes.
In recent years, several individual states have attempted to hold online retailers
accountable for the collection of sales and use taxes in the face of Quill. This is only logical because states are desperately in need of additional funds, and online retailers seem to be a politically acceptable target. It is without question that online retailers have a great amount of lobbying power, but the current political, economic, and social sentiment combined with the equally powerful “brick-and-mortar” lobbing interest creates a perfect storm for online retailers.
A. Going After “Click-and-Mortar” Retailers.
Since most “click-and-mortar” retailers have sufficient taxable nexus, which includes physical presence, to a taxing state, many states’ taxing authorities have initiated actions to collect sales and use taxes from these online retailers.
The State of Virginia has attempted to pass legislation that would require online retailers with a physical presence within the state to collect and remit sales and use tax to the state’s taxing authority. Additionally, the State of Tennessee has recently interpreted its’ use tax statute to hold every person who “[m]aintains, uses, owns, or operates within this state, directly or by a subsidiary, agent or affiliate as defined in § 67-4-2004, any facility, office, distributing house, sales room or house, warehouse, or other place of business” liable for state’s sales and use tax purposes.
Further, in 2010, Texas sent Amazon a letter demanding back sales and use taxes alleging that Amazon had sufficient physical presence in the state due to Amazon’s holding of several distribution centers located within the state. Amazon refused to pay the alleged deficiency claiming that the distribution centers were in fact separate entities. The case is currently being litigated; however, in 2011, Texas passed legislation categorizing any retailer with “a store, distribution center, or other place of business in Texas as having a physical nexus for the purpose of collecting sales tax.”
There are many other states that have attempted to hold online retailers accountable for the collection of sales and use taxes when such retailers have a physical presence within the state, such as distribution centers and the like. “Click-and-mortar” businesses are easy targets for state tax enforcement actions because they fall within the ambit of the physical presence standard established by Quill. However, for the most part, on a macro level they are ineffective. First, it costs a taxing state a great deal of money to litigate individual cases and the results of such cases generally do not carry the force of law for similarly situated companies because the facts of each case are usually different. Second, as mentioned earlier, courts have difficulty in handling cases involving entity isolation, which is the main affirmative defense usually brought forward by online retailers. Attempting to hold “click-and-mortar” businesses liable for such taxes is not the only means that states have used to go after online retailers.
B. Affiliate Taxes: Broadening the Scope of Nexus.
Much like Bellas Hess, the Court’s holding in Scripto has never been overruled by Congressional or Judicial action. Consequently, many states have taken advantage of Scripto’s ruling that sufficient taxable nexus is established by the presence of employees or individuals acting on an online retailers behalf within a taxing state. Online retailers, however, are aware of the significance of the Scripto holding and therefore do not employ individuals within states that the retailer does not wish to be subject to sales and use tax. Using the Court’s broad holding in Scripto, several states have passed legislation to hold online retailers liable for state tax due to their association with independent contractors known as affiliates. These taxes are generally referred to as “affiliate taxes” or “Amazon laws.”
Fundamentally, an affiliate tax provides a state taxable nexus if an online retailer employs affiliates within the state. Much like the independent sales agents in Scripto, affiliates are seen as extensions of an online retailers’ workforce, and therefore establish the physical presence required by Quill. For the most part, affiliates are independent advertising agents that advertise for the online retailer on certain websites, including their own, for the financial benefit of the online retailer. Seemingly needless to say, the affiliates must reside and be physically present within a taxing state for the state’s taxing scheme to pass Constitutional muster.
Recently, affiliate taxes have been the most popular and most effective weapon used by the states in order to hold online retailers accountable for sales and use tax collection responsibilities. The first state to pass such a tax was New York – the tax is imposed on any online retailer that uses sales affiliates within the state and those affiliates procure greater than ten thousand dollars ($10,000) per year in sales for that retailer. The apparent reason for the ten thousand dollar ($10,000) cap seems to be to exclude small companies that make sales online, but don’t have the resources to perform the collection work. Also, the sales and use tax that would be generated by collecting such taxes from companies that gain less than the cap would be de minimus and not worth the costs associated with such collection.
Since New York’s affiliate tax has been held to be Constitutional, six other states passed similar taxes. In each of these jurisdictions, online retailers have challenged the Constitutionality of these laws to no avail. Additionally, as a corollary to an affiliate tax, two other states have passed legislation requiring online retailers to inform purchasers of the purchaser’s responsibility to remit use tax from any online purchase to the appropriate taxing authority.
C. Individual States’ Actions Come with Grave Consequences.
While it is certainly understandable that several states have taken steps towards holding online retailers accountable for the collection of sales and use taxes, it is not the best solution to the troubling condition, nor do these state actions come without consequence. Online retailers have had very negative reactions to state attempts to collect such taxes.
The first consequence of the states’ individualized attempts to tax online retailers is: many major online retailers have closed stores, manufacturing operations, and distribution centers when states have attempted to collect such taxes. For example, when Texas sent Amazon its demand letter in 2010, Amazon responded by closing a distribution center located in Irving, Texas, more than likely to avoid any further tax collection attempts by the State. Therefore, states’ attempts to hold “click-and-mortar” retailers accountable have resulted in the negative consequence of losing business within the state, and consequently, losing jobs.
In a similar vein, another adverse effect of a state’s individualized action is that online retailers are granted greater bargaining power. That is, major online retailers have refused to open new operations within certain states if those states do not specifically exempt the retailers from taxation. A prime example of this is: recently, Indiana in an attempt to bring jobs to the state amidst poor job growth numbers, has made an agreement with Amazon that if the company opens a distribution in the state, then Indiana will not seek to collect sales or use taxes until 2014. At first impression, this may not seem to be a blatantly burdensome agreement; however, the real effect is felt on the rest of the states. Indiana has a very low sales tax rate, so sales tax is not an important aspect of their taxing scheme. Other states, such as New York, rely on sales and use taxes to insulate their coffers. Therefore, Indiana is being granted a “double advantage” as compared to New York because Indiana has an already low sales tax rate, and New York has made it clear that they will take a hardline approach when it comes to online retailers and taxation.
A third adverse consequence of states going after online retailers is that the states which pass legislation or litigate cases against these online retailers often lose jobs within the state. In the case of Texas’s attempt to recover the tax delinquency from Amazon, one hundred and nineteen (119) people lost their jobs when Amazon closed the distribution center in Irving. As for affiliate tax imposition, the state of California lost over 10,000 jobs when Amazon terminated all of its affiliates within the state to avoid the effect of the passage of the state’s new affiliate tax law. In addition, Overstock fired all of its’ 3,400 affiliates in New York to escape future tax liability.
In light of the issues associated with states’ individualized efforts to collect sales and use tax, this method should not be preferred. The principal behind this statement is simple. States cannot attempt to collect these types of taxes without opening themselves up to a panoply of adverse consequences, all of which are not covered by this blog post. Individualized state actions result in some positives for the taxing state, but also incur many negatives, and taken as a whole, these specialized state actions can result in inequities for the entire country.
 Karen K. Harris, The Shriver Brief, Amazon: Giving Up the Fight on Internet Taxes? (Oct. 31, 2011), http://www.theshriverbrief.org/2011/10/articles/budget-and-tax-justice/amazon-giving-up-the-fight-on-internet-taxes/; These states are: Rhode Island (R.I. Gen. Laws § 44-18-15 (2012)), North Carolina (N.C. Gen. Stat. § 105-164.8(b)(3)(2012)), Illinois (35 ILCS 120/2 (2012)), Arkansas (A.C.A. § 26-51-202 (2012)), Connecticut (Conn. Gen. Stat. § 12-216a (2012)) and California (Cal. Rev. & Tax. Code § 6203 (2012)). See also Jason Dannemiller, Amazon Laws: An Idea Better In Theory Than In Practice, 19 Metropolitan Corporate Counsel 6 (2011), available athttp://www.lexisnexis.com/lawschool/research/default.aspx?ORIGINATION_CODE =00092&signoff=off.
 See, e.g., Dell Catalog Sales L.P v. Taxation and Revenue Dep't, 199 P.3d 863 (N.M. Ct. App. 2008); In re Appeal of Scholastic Book Clubs, Inc., 920 P.2d 947 (Kan. 1996).
 Institute for Local Self-Reliance, supra nota 131.
 See, e.g., Elizabeth Henderson, The Heartland Institute, Research & Commentary: Amazon Taxes (Dec. 22, 2011), http://heartland.org/policy-documents/research-commentary-amazon-taxes.
 Barry Harrell, The American Statesman, 119 to Lose Jobs When Amazon Closes Texas Facility (Feb. 11, 2011), http://www.statesman.com/business/119-to-lose-jobs-when-amazon-closes-texas-1248784.html.
 Cf. Cohen, supra note 135, at 16.
 See, e.g., Benjamin Spillman, Taxation Committee Drops Internet Sales Tax Amendment, Las Vegas Review Journal, May 19, 2011, available at http://www.lvrj.com/blogs/politics/Taxation_committee_drops_In ternet_sales_tax_amendment.html; Frank Lapanza, A Reversal on Amazon, The Herald South Carolina, May 30, 2011, available at http://www.istockanalyst.com/business/news/5190107/editorial-a-reversal-on-amazon.
 Braden Lammers, News and Tribune, Distribution Center Delivered? (Feb. 2, 2012), http://newsandtribune.com/ local/x1826119537/Distribution-center-delivered.
 Indiana’s sales and use tax rate is seven percent (7%). See Federation of Tax Administrators, supra note 1.
 See, e.g, NY CLS Tax § 1101 (2012).
 Marc Lifsher, Amazon Won't Collect Sales Tax; Cuts Off California Affiliates, L.A. Times, June 30, 2011, available athttp://latimesblogs.latimes.com/money_co/2011/06/amazon-wont-collect-sales-tax-cuts-off-california-affiliates.html.
 Cade Metz, The Register, Overstock and Patrick Byrne Sue New York Over Amazon Tax (June 2, 2008), http://ww w.there gister.co.uk/2008/06/02/overstock_sues_new_york/.
 Cf. Travis Cavanaugh, Iowa Can Do Better than the Affiliate Tax: A Proposal for an Intermediary Tax, 97 Iowa L. Rev. 567, 577-581 (2012).
 See generally Ryan J. Swartz, The Imposition of Sales and Use Taxes on E-Commerce: A Taxing Dilemma for States and Remote Sellers, 2 J. High Tech. L. 143, 149 (2004).
 Pamela Swidler, The Beginning of the End to a Tax-Free Internet: Developing an E-Commerce Clause, 28 Cardozo L. Rev. 541, 555 (2006).
 “Also called ‘bricks and clicks,’ it refers to businesses that offer online services via the Web as well as the traditional retail outlets (offline) staffed by people. Coined in 1999 by David Pottruck, co-CEO of the Charles Schwab brokerage firm, it refers to running the two divisions in a cooperative and integrated manner where they both support and benefitfrom each other.” IT Encyclopedia, PC Magazine, Click and Mortar (2012), http://www .pcmag.com/encyclopedia_term/0,1233,t=brick++click&i=39785,00.asp.
 Compare Orvis Co. v. Commissioner, 654 N.E.2d 954 (N.Y. 1995) (holding that Quill should be applied loosely, and that click-and-mortar businesses are subject to taxation) with SFA Falio Collections, Inc. v. Tracy, 652 N.E.2d 693 (Ohio 1995) (holding that Quill should be read strictly, and that click-and-mortar businesses are not subject to collect sales and use tax).
 See generally Mark J. Cowan, Tax Planning Versus Business Strategy: The Rise and Fall of Entity Isolation in Sales and Use Taxes, 44 Idaho L. Rev. 63, 65-66 (2007).
 Id. at 410.
 For example, if that state has a high rate of residence that are experienced in certain technologies.
 See generally Scripto, at 211.
 See generally Declan McCullagh, CNET News, Privacy Inc., Politicians, Retailers Push for New Internet Sales Taxes (Apr. 17, 2012), http://news.cnet.com/8301-31921_3-57415505-281/politicians-retailers-push-for-new-internet-sales-taxes/.
 Joe Dashiell , WDBJ7, Schurz Communications, Virginia Legislation Targets Amazon.com (Jan. 30, 2012), http: //www.wdbj7.com/news/wdbj7-virginia-general-assembly-sales-tax-legislation-targets-amazoncom-20120130,0, 437201.story; Accord Wikipedia, Amazon Tax, http://en.wikipedia.org/wiki/Amazon_tax (using similar case examples as those provided in this paper for notes 117-122, and 127-136; however, the sources were found independently).
 Robert E. Cooper, State of Tennessee, Office of the Attorney General, Out-of-State Dealer’s Nexus with Tennessee Due to Activities of In-State Distributing Centers 2 (June 28, 2011), available at http://media.timesfreepr ess.com/news/documents/2011/06/28/Attorney_Generals_Opinion_on_Amazon_taxation.pdf.
 Dallasnews.com, The Dallas Morning News, Editorial: Texas is Right to Pursue Amazon for Uncollected Sales Taxes (Feb. 17, 2011), http://www.dallasnews.com/opinion/editorials/20110217-editorial-texas-is-right-to-pursue-amazon-for-uncollected-sales-taxes.ece.
 Tex. Tax Code § 151.024 (2012).
 See, e.g., Janet Novack, Forbes Online, Personal Finance, Pa. Sales Tax Crackdown Means Grief For Amazon Merchants(Dec. 6, 2011), http://www.forbes.com/sites/janetnovack/2011/12/06/pa-sales-tax-crackdown-means-grief-for-amazon-merchants/.
 The force of law argument is derived from Administrative Law principals.
 See Scripto, at 212-213.
 Cowan, supra note 112, at 68.
 Andrew J. Haile, Affiliate Nexus in E-Commerce, 33 Cardozo L. Rev. 1803, 1805 (2012).
 Id. at 1814.
 Id. at 1815.
 See generally Quill, 504 U.S. at 315-317; Scripto, 362 U.S. at 211-213.
 Institute for Local Self-Reliance, Internet Sales Tax Fairness (May 23, 2011), http://www.ilsr.org/rule/internet-sales-tax-fairness/; NY CLS Tax § 1101 (2012).