SALES TAX ON INTERNET PURCHASES

There has been much debate about requiring internet retailers to collect Sales Tax for all states to which sales are made.  There are currently two bills proposed in Congress on this topic.  This post addresses the issues of fair competition, and collection of taxes due which are going unpaid.

Currently internet retailers are not required to collect Sales Tax for states which they do not have nexus in. The same has always applied to catalogue sales.  Nexus can be a physical location - meaning an actual store, warehouse or other building, or nexus can mean the presence of other assets or employees in a particular state.  If there is no nexus in a particular state, there is no requirement to collect Sales Tax from that state.  Many internet sellers have nexus in only one state - this gives them a distinct competitive advantage over a store selling the same goods in a different state that must collect Sales Tax.  In addition, the store has to pay rent, wages and other costs to display their merchandise. The store in effect becomes a showroom for the internet sellers.  The shoppers go to the store to examine the goods, and then buy it cheaper on line because they don’t have to pay Sales Tax (or stated another way, Sales Tax is not collected - more on that later).

As a former Tax Audit Administrator for New York State, and also in my current capacity as a tax consultant, tax fairness is always key.  We all want to pay less tax if possible, but it’s not fair if one pays less which causes others to pay more.  There is no getting around the fact that the states’ primary income comes from taxes.  The public has to contribute to the state coffers to allow the state to operate.  Furthermore, it is not news to most of the tax professionals reading this post, that Sales Tax (or Use Tax) is due on these transactions already.  If the tax is already due, then what’s the problem?  The problem is, that the tax is due on a voluntary basis.  Instead of the internet seller collecting the tax from an out of state purchaser, the purchaser is required to voluntarily report the (Use) Tax to their home state.  Again, most of us realize that this happens only in a small percentage of cases.  In fact, many purchasers don’t even understand that the tax is due.  They think internet purchases are tax free, and someone is trying to levy a new tax here.  That, as we know is entirely false.  The result is that everyone else has to pay more in higher income tax rates, or other taxes to make up for the shortfall that the states need to operate.  If the Sales Tax was collected on all internet sales, then by simple mathematics other taxes could be lowered. 

People are writing anti-proposal pieces that simply don’t understand that this is not a new tax, but a tax that doesn’t get paid.  See Jessica Melugin’s article in the Washington Times: “Internet sales taxes attack states’ rights”, where she dramatically cries “…taxation without representation...”(1)

The tax is not due from the out-of-state seller, it is due from the purchaser, to the state they live in. They’re just not paying the tax that they owe, putting the burden on others; that’s the part that isn’t fair.  It’s more like representation without taxation.  What are these dissenters saying?  They approve of non-payment of tax due?  Do they have a better way to collect it?  Do they also disapprove of income tax withholding?  Many out of state businesses are required to withhold income taxes in multiple states.

Why is it that wage earners report their income properly for income tax purposes?  It’s because there are W-2 forms submitted to the government as well as withholding tax.  People voluntarily file income tax returns, because the tax has been previously withheld.  Sales of securities are reported by financial institutions to the Federal government on 1099 forms, and the government also recently required these companies to report purchase amounts, because individuals often make “errors” reporting their gains or losses.  This is not a commentary on human nature, but it is a known fact that when there is no government control such as W-2 forms or 1099 forms, where the government has knowledge of a taxable event, many people will not report or pay the full tax due.  Do the dissenters want a completely voluntary tax system?  Where will the revenues come from?

All the states are asking, is that internet sellers “collect” the appropriate Sales Tax for the state in which their customer is located.  They are not being asked to pay a new tax.  They are being asked to collect a tax which is already due from the purchaser by law and remit it to the appropriate state,  just as every employer is asked to withhold and remit tax on an employee’s income.  It just ensures that the tax that is due gets paid.  It’s good for everyone because it reduces the burden for all taxpayers.  People want lower taxes.  This will help to lower taxes. 

People have argued that the extra administrative work of collecting this tax for a small internet retailer would be an undue burden, costing them additional work and therefore money. (2) They ask that small retailers should be exempt from this burden, as it will put them out of business.  Sure it’s an additional cost, and I wouldn’t argue against a threshold, exempting businesses with minimal gross receipts, but let’s not forget that these small internet businesses don’t have showrooms in multiple states, and their customers might first be shopping in a competitor’s store, enjoying the assistance of that competitor’s employee.  Then the customer goes home and clicks on a website to save the Sales Tax! That doesn’t support business!

We know recordkeeping is a necessary burden on all businesses, and this burden changes with the times.  When Sales Tax nexus rules were written, there was no internet.  If a company sells something to be shipped out of state, there is no requirement to collect Sales Tax for that state if there is no nexus.  Years ago this was an insignificant part of business.  Prior to the internet explosion, this law only affected companies with catalogue sales.  In the Matter of Bellas Hess, and Matter of Quill, the Supreme Court found that these companies had no nexus in the challenging states, therefore they were not required to collect Sales Tax.  That was the correct result for that time.  Of course the tax was still due in the purchasers state, but due to the insignificance, it wasn’t missed much.  Now as we know, we have a day called cyber Monday, and December may come to be called Decyber, because of the amount of business transacted over the internet.  It’s quite a significant amount, and as the percentage of cyber revenues go up, Sales Tax collections go down. 

According to Senator Durbin of Illinois: States will lose an estimated $24 billion in 2012 because of uncollected sales taxes from Internet and catalog sales…(2)

How should the states recover that shortfall, by raising Income Tax rates?  That doesn’t make sense, because this shortfall is a result of tax revenue that is already due, but is not being paid.  It makes much more sense to collect the tax that is already due than to create new taxes.

Many large businesses already collect Sales Taxes on much of their internet sales because they have nexus in many states.  Small internet retailers already collect and remit sales tax in the state in which they are physically located (except in the five states that do not charge sales tax: Delaware, New Hampshire, Montana, Oregon and Alaska).  Is there an added cost to require businesses to collect Sales Tax for multiple states?  Sure there is – but not $24 billion per year. 

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(1) MELUGIN: Internet sales taxes attack states’ rights (Government intervention kills competition) By Jessica Melugin:     The  Washington Times Friday, November 30, 2012

(2) Tech Groups Oppose Internet Sales Tax Bill: By Grant Gross, IDG News Service: Aug 2, 2011

COUNTING THE DAYS (Help for NYS Residency Audits)

I will be discussing the confusion and complications involved in recordkeeping to meet your burden of clear and convincing evidence in a NYS or NYC Residency Tax Audit, as well as a promising solution.

State Residency has been a hot topic for some time now, and whether the issue is domicile or statutory residence, the amount of time spent in New York vs. another state is a prime concern. 

Domicile may be described as your primary residence - the place that you feel in your heart is your home.

Statutory Residence is defined in NYS and/or NYC as being domiciled in another state, having a permanent place of abode in NY and being present in NY for more than 183 days, or partial days.  A permanent place of abode is any suitable living quarters to which you have unrestricted access.  You may own it, rent it, or have some other arrangement.

Let’s focus on a particular case that is often discussed with regard to statutory residency.

The case is Matter of Avildsen.(1)  Avildsen is thought of as an important case because at the NYS Tax Appeals Tribunal, the point was made that credible oral testimony regarding the number of days spent in NY is sufficient to meet the burden of clear and convincing evidence.  This appears to contradict the regulations, which indicates the need for “adequate records to substantiate”.

The substance of NYS regulations 20 NYCRR Appendix 20, § 1-2(c) states:

Any person claiming to be a nonresident must have adequate records to substantiate the fact that he did not spend more than 183 days within New York. 

The standard is clear and convincing evidence.  Understanding and satisfying the requirements of clear and convincing evidence has been quite challenging.

Avildsen was a NYC case.  Taxpayers claimed that they were domiciled on Long Island.  NYC Audit Division determined that the taxpayers were domiciled in NYC and/or were statutory residents of NYC.

At the Administrative Law Judge hearing Mr. Avildsen’s secretary testified that she kept a contemporaneous diary of petitioner’s days in and out of NYC. A schedule of the days in and out was submitted, but not the diary itself due to the sensitive nature of its contents.  The schedule showed that Mr. Avildsen was not in NYC for more than 183 days.  Some airline tickets were submitted as corroboration for his travel days.

The ALJ found this and other testimony to be credible, and found that taxpayers were not domiciled in NYC, however, the ALJ found that the taxpayers were statutory residents of NYC, because the regulation requires that adequate records must be submitted for substantiation of the 183 day rule.  The ALJ stated:

The evidence presented by petitioner is not sufficient to sustain his burden. There is no question that a business diary bolstered by credible testimony and other documents may be sufficient to substantiate the number of days spent in New York (see, Matter of Moss, Tax Appeals Tribunal, November 25, 1992). However, in this instance, in order to accept petitioner's argument, one is forced to accept testimony as to what those diaries show. Such testimony, although credible (emphasis added), is not sufficient to meet the "adequate records" requirement of 20 NYCRR Appendix 20, § 1-2(c) (see, Matter of Feldman, supra).

The taxpayer took the case to the Tax Appeals Tribunal.  The Tribunal reversed the decision of the ALJ and determined that the Avildsens were not statutory residents.

Why did the Tribunal reverse?  Don’t the regulations require “adequate records”?

Look at the ALJ’s comments very carefully.

Such testimony, although credible (emphasis added), is not sufficient to meet the "adequate records" requirement…

What does this mean?  “Such testimony, although credible”…

It appears that the ALJ believed the testimony to be truthful.

The crux of the matter is, that according to the Tribunal, since the ALJ stated that the testimony for the taxpayer was credible (truthful), then the taxpayer should prevail.  The law does not require records at hearing.  This is what leads to confusion or misinterpretation of this case.  The Tribunal did not say the testimony was credible.  The Tribunal said that the ALJ found it to be credible. 

The Tribunal went on to further state:

“Obviously, any taxpayer who attempts to sustain his burden of proof solely on testimonial evidence runs a very great risk that he will not prevail at the hearing because the Administrative Law Judge will determine that the testimony is not credible to establish the necessary facts.”

Did the ALJ really believe the testimony to be truthful?  I don’t know.  He found against the taxpayer.  Wasn’t he really saying in his commentary above that he didn’t accept petitioner’s argument?

“However, in this instance, in order to accept petitioner's argument, one is forced to accept testimony as to what those diaries show.”

If the ALJ did not state “although credible…”, but stated it differently such as:

“Without the actual diary, testimony wasn’t sufficient to be credible”, we would have had a different Tribunal result.

So what can we learn from this?  Should someone as a result of this case expect to prevail on oral testimony alone?  No!  How should someone prepare to file as a nonresident of NY and expect to be successful on audit?

In order to be clear and convincing, we should be better prepared than to go in with oral testimony and a few documents.  A detailed contemporaneously kept diary should be the starting point.  This should be bolstered by documents such as credit card receipts, travel records, and any other document which indicates someone’s location on a particular date which support the entries in the diary.  Once documentary evidence is found to be credible, oral testimony is more likely to also be found credible if there is a question on some undocumented days.  See Matter of Robertson. (2)

Unfortunately, many taxpayers have failed to adequately maintain their diary.  See Matter of Holt (3) where the diary was a poor photocopy.

Solution for the 21^st century:

Have you heard of a company called MONAEO? (4) 

MONAEO is software that is installed on your smartphone, which tracks your whereabouts like an electronic diary. It keeps track of your days in a potential tax jurisdiction, and even warns you when you are getting close to the residency limit such as the 183 days in New York.

Really?  Yes! 

Too often, people go into court rolling the dice hoping their documents will be accepted.  I was involved with residency cases for over 20 years for the NYS Tax Department.  I’ve seen diaries in a wide range of quality and accuracy.  I’ve seen this new product and was so impressed that I agreed to become a special advisor to the company.  If used properly it is 100% accurate and not subject to human error.  You don’t have to remember to make entries.  It does that automatically based on your location.  You will know exactly how many days you were present in New York or other taxing jurisdictions.  Based on my years of experience with NYS Audit Division I know the State will look at it with the proper amount of skepticism, but it will prove to be reliable.

If you’ve been involved in a State residency audit, you know that this could make your life a lot easier.  This will save you time, energy, and maybe a lot of tax money.  Stay Tuned.

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1 Matter of Avildsen, N.Y. Tax Appeals Tribunal (May 19, 1994) DTA No. 809722
2 Matter of Robertson, N.Y. Tax Appeals Tribunal (September 23, 2010) DTA No. 822004

3 Matter of Holt, N.Y. Tax Appeals Tribunal (July 17, 2008) DTA NO. 821018

4 Visit www.monaeo.com for more information.