US SALES AND USE TAX SYSTEM NEEDS FEDERAL C.P.R.
Consumer Private Reporting Legislation – Draft of Summary for House Judiciary Committee
Exploring Alternative Solutions on the Internet Sales Tax Issue - March 12, 2014 at 10:00 AM EST
By James H Sutton, Jr., CPA, Esq.
First – Let me tell you why I was asked to testify before the house judiciary committee. I am a Florida CPA and Attorney whose law practice is devoted almost entirely to sales and use tax controversy in a state with projected sales tax revenues of over $22 billion this fiscal year. I handle audits, protests, controversy, collections, revocations, and even criminal defense – all for sales tax. I'm not talking about a few of the Fortune 1,000 companies. Each year my firm represents hundreds of small, medium, and large businesses as well as individuals who all feel they are not being treated fairly by the Florida Department of Revenue. As a result, I see firsthand every single day how a single state tax department can walk all over the rights of business owners. I could tell you hundreds of horror stories – all just within Florida where the people can call to complain with their state congressional leaders. If states are able to have jurisdiction over every remote vendor in this country, then I can tell you there will be chaos with a few years when the states begin auditing, collections enforcement, and criminal prosecutions on one of our countries most valuable resources – businesses.
Everyone else that has been addressing these issues with Congress is discussing the issues around (1) determining what is taxable in what state, (2) collecting and remitting the tax, (3) filing tax returns, and (4) the confusing world of nexus. What I deal with every day is what happens well after the returns are filed. State tax departments can be extremely aggressive and you don't want 45 state taxing authorities unleashed on all of our businesses around the country. One revealing example: if a company goes under owing a couple of months of sales tax, which happens more often than you can imagine, then the responsible parties would likely be looking at more than 100 years combined jail sentence based on the criminal statutes in every state for which the collected use tax was not remitted. This is one of a hundred unforeseen consequences of expanding a state's jurisdiction for use tax reporting. These post-compliance consequences are the main thing I will be discussing. However, I will also propose the idea of a Consumer Private Reporting system, aka. C.P.R., at the hearing and in the submitted materials because our country's sales and use tax system desperately needs immediately legislative attention at the federal level.
Second – Let me cover something that most people do not grasp about the
sales and use tax issue for remote transactions. Both sales tax and use
tax are excise taxes – a tax on the right to do something. Sales
tax is on the right to sell (or in some states, buy) a good or service
within the borders of a state. In-state vendors charge sales tax, because
under most state laws, it is a tax on their right to sell. Yes, they have
to pass the tax on to their customers – but the taxable activity
is the business selling. This is why brick/mortar companies collect sales tax.
Use tax is a tax on the right to use that good or service in the state,
if sales tax has not already been paid. Use tax is not the obligation
of an out of state seller because they have not done a taxable activity
in the destination state. Selling something in GA to someone in Florida
simply is not a taxable event for Florida. There is no legal mechanism
in place to tax the GA seller for sales tax or use tax purposes in Florida
(as long as the GA company does not have nexus with Florida). The taxable
event in Florida is the purchaser using the good or service in Florida.
Now Florida would love to force the GA seller to act as a collection agent
for Florida's use tax that the purchaser owes. But the GA seller literally
has not done anything that would subject the GA seller to tax.
This is a very real distinction that almost no one outside the full time
SALT profession knows. It is why the remote seller is not getting away
with anything. They simply are not doing a taxable activity. The result,
however, creates an unfair result for in-state vendors that must collect
sales tax and the states, who are losing hundreds of millions of dollars
in use tax revenue because they do not have the details necessary to enforce
their use tax laws on their own citizens.
Third – All states with a sales tax already have every law and procedure is in place for in-state purchasers to file returns, pay, collect, and enforce the taxes that are escaping remote sales in this country. The mechanism is called a "use tax" and every state that has a sales tax has the use tax in place. What everyone wants to see happen is the states get their use tax on remote sales, well, almost everyone. The problem is – and really it's the only problem – the states do not have the information necessary to enforce their own use tax laws. They do not know what their own citizens (and in-state businesses) are buying, and the purchasers know it. So virtually no one files and pays the use tax. Forcing remote sellers to collect and remit the use tax (not sales tax) in 45 states – then expect them to go through audits from 45 states (about 8 a year) – then be liable for the mistakes, is outrageously expensive, no matter what people say about free software. Even the free software is extremely expensive for many remote sellers to integrate and maintain into their existing software – some of which is custom made.
What I am presenting in writing to the House Judiciary Committee is the idea of a Consumer Private Reporting system, or CPR, in which a procedure would be created so a remote vendor could submit basic purchase information to a pre-approved software service and the basic purchase information would be accumulated for all purchasers and all states. Companies with the software sophistication could handle their own reporting to the information accumulation database. However, it is imperative that the privacy of the consumers are protected so the states do not get the details of exactly what consumers are purchasing. The states would only receive the cumulative amount of remote purchases, from all reporting remote vendors, for each purchaser during a reporting period.
Fourth – You have to understand that the power congress is talking about using to create a new federal sales tax law comes from the Commerce Clause of the US Constitution. This was written by the founders of this country to stop the states from interfering with the free flow of interstate commerce. The power was reserved to Congress to regulate the commerce between the states because the founders believed Congress would act in the best interest of the nation as a whole, instead of the financial needs of the individual states. So if Congress uses the Commerce Clause, then it should be in a way that is the least disruptive of the free flow of commerce in this country. This is what I propose the Consumer Private Reporting Legislation achieves while address unfairness to brick/mortar retailers and the state's revenue needs. Below is a bullet point summary of the proposed Consumer Private Reporting legislation, aka C.P.R.:
The Basics of a Consumer Private Reporting System
- Federally require remote seller to report taxable remote sales. The reporting would either be done by the company themselves (if approved to do so) or through approved software vendors that specialize in helping vendors determine what goods are taxable in what states. The specifics of what exactly is purchased never leaves the remote vendor's system, so the purchaser's private information stays between the vendor and the purchaser.
- Approved software vendors (or companies that self-report) would then report to a newly created federal database that would combine sales information in a 1099 style format for each state and each purchaser.
- The purchaser's would then have the information to file their own use tax returns with the state and remit the use tax that has always been due. Because the purchaser knows the state has the information, filing use tax returns will be encouraged.
- If the state has information that a purchaser did not file a use tax return, then every state that already has a sales tax already has a letter audit process in place to send a friendly letter to the resident purchaser reminding them to pay the use tax. Each state could choose to be strict or lax about the use tax compliance, but the people being taxed would have a vote on the government officials representing them.
- The purchaser would have the right to reveal the specifics of a purchase to the state to prove that an item should not be taxed. Otherwise, the state would not have the specifics of what was purchased.
Additional Details of the Consumer Private Reporting System
- Set federal standards for the minimum information and a standard format of that information that needs to be provided to the software vendors and to the federal database. This will allow standardization for the whole industry.
- Approved software vendors will be funded by the states, not the remote vendors, potentially based on a percentage of (taxable and exempt) sales reported through the system (by state). Companies that are approved to self-report into the federal database would also be reimbursed for the cost of implementation.
- States would have the right to audit the software companies for compliance with the individual state's laws.
- For approved remote vendors that choose to self-report into the federal database, the states would have the right to review the remote vendor's tax coding process for good faith compliance. The remote sellers would not be liable for mistakes in taxability coding, but substantial non-compliance based on a reason standard could result in the remote seller to be required to use an approved third party software vendor for tax determination and reporting.
- Whether using an approved third party software provider, remote vendors could apply for reimbursement of expenses to upgrade software to account for the new reporting system during the first year – to be funded by the states.
- If a remote seller has nexus with a state, then normal sales/use tax collection rules would apply.
- If a remote seller is discovered to have nexus, then the remote seller would be pardoned for all periods reported to the states through the new federal system, but then normal sales and use tax rules would apply.
- The federal law would create a bright line nexus standard at the federal level for sales and use tax purposes similar to the rules established in Quill vs. North Dakota, 504 U.S. 298 (1992) (physical presence required). If use taxes are being collected via self-reporting, then the state will not have a need to push for nexus of remote sellers. Create a bright line test at the federal level to create certainty for businesses.
- Purchaser's information would be accumulated based on several sources: federal tax identification number, credit card number, and/or, if opted by the purchaser, a completely separate US sales tax identification number issued by the authority overseeing this process.
Controversial Possible Additions
- A small seller exemption could be part of the legislation, such that a minimum number of remote sales or a minimum dollar of remote sales. Otherwise, the expense to occasional sellers and low dollar volume sellers would be too high and keep these businesses from engaging in interstate commerce. For example, if a brick and mortar company ships a good to out of state customer, then that would be a remote sale. Merely for potential illustration purposes, an exemption might be available for a brick and mortar company that only does 50 or less of these a year or less than $100,000 a year, then they could be exempted from the reporting law. The same exemption, whatever it was determined to be, would apply to all remote sellers. If the sales tax rate across the country is 6%, then the unreported remote sales could result in $6,000 of use tax going unreported to all 45 states ($133 per state). The threshold for the exemption could be set at the estimated cost (time/labor) to implement the system versus the average unreported use tax potentially lost related to those sales.
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Instead of tasking third party software providers (or approved remote vendors) to determine taxability of remote sales state by state, have the remote sellers simply report gross remote sales by person, by state. The process would still need some type of federal database for accumulating the information so that the states do not receive any details on what was purchased. The federal database would issue a 1099 style report to the state and the purchaser so self-reporting of use tax would be easy and commonplace. To account for a portion of the sales that would be exempt under state law, each consumer would be allowed to elect a certain percentage be exempt. If the purchaser wanted to claim more exemptions, then the purchaser has the right to prove a higher exemption level. Each state could set their own exemption level to account for the typical exemptions available in that state. Remote sellers would be subject to the federal reporting requirements, not the remote state's jurisdiction.
Summary
The explosion of interstate commerce of the second half of the last century created some truly difficult problems in our state sales and use tax legal system. From carpet baggers to mail order catalog companies, everyone felt the strain of uncertainty – including our court system with over 300 full dress court opinions dealing with Commerce Clause by 1959. The explosion of electronic commerce exponentially deteriorated the condition of the U.S. sales and use tax system. There is a growing unfairness to brick/mortar vendors that operate purely inside a state's borders that have to collect tax while a consumer can use their smart phone to buy the same goods online without sales tax. There are also billions of dollars of use tax going unreported and uncollected by the states, because the states do not have the information to enforce the use tax laws on their own citizens. The Marketplace Fairness Act, which generally requires remote sellers to collect and remit use tax for the states, seems to solve the issues for brick/mortar vendors and the states, but does so in a way that allows 45 states to have extreme powers of remote vendors everywhere. The compliance burdens alone are crippling for remote vendors, even with federally funded software to assist. Combine this with all the additional audit, collection, and criminal issues – by 45 different states – that remote vendors would face under the Marketplace Fairness Act, and the eventual burden on interstate commerce is truly impossible to even determine.
The sales and use tax system in this country is struggling and it needs help. Only the federal government has the power to legislate in a way that can assist, but it must do so in a way that interferes with interstate commerce the least. I propose the Consumer Private Reporting system is that solution. It takes sales and use tax out of the competitive equation between brick/mortar vendors and remote sellers. It also allows the state to realize the dream of regular and systematic use tax reporting by its own citizens. However, the proposed Consumer Private Reporting legislation does so in a way the burdens remote sellers – and interstate commerce – the least.
In my humble opinion, the US Sales and Use Tax system needs Federal C.P.R.
I'm presenting this idea to the House Judiciary Committee on March 12, 2014. Constructive feedback is very much appreciated.
UPDATE: MARCH 7 - I received an email from Richard Ainsworth this morning, the director of the graduate tax program at Boston University Law School and probably the leading expert in the US on the EU's VAT system. He said that the EU has a reporting system similar to CPR already in place and working in the EU. It is required for B2B cross-border transactions. This gives me a glimmer of hope....
ABOUT THE AUTHOR: Mr. Sutton is a Florida licensed CPA and Attorney and a shareholder in the law firm the Law Offices of Moffa, Sutton, & Donnini, P.A. Mr. Sutton is in charge of the Tampa office of the firm and his primary practice area is Florida sales and use tax controversy. Mr. Sutton worked in the State and Local Tax department of a "big five" accounting firm and a state tax consulting firm for 8 years and has been an adjunct professor at Stetson University College of Law since 2002 teaching State and Local Taxation as well as at Boston University's LLM in Taxation program Spring 2014 teaching the sales and use tax portions of a Consumption Tax course. You can read more about Mr. Sutton in his firm BIO.
ADDITIONAL RESOURCES
AAA-CPA OPPOSES MARKETPLACE FAIRNESS ACT, by James Sutton, CPA, Esq., Posted May 2, 2013
Hearing Before the Committee on the Judiciary, Subcommittee on Regulatory
Reform, Commercial & Antitrust Law,
U.S. House of Representatives, testimony by Joseph Henchman, of the Tax
Foundation, on February, 26, 2012 (discussing how the state tax nexus laws of this country are unmanageable
and that congress needs to create a federal state tax nexus standard).