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Colorado Wins Round Two on Use Tax Reporting Requirements for Remote Sellers

This article originally appeared in the April 2016 TaxStringer and is reprinted with permission from the New York State Society of Certified Public Accountants.

In 2010, Colorado enacted a law that imposes use tax reporting obligations on many remote sellers with no nexus to the state. This law does not require them to collectsales or use tax; it only requires them to report the sales information to both the purchaser and the state of Colorado, notifying them of a use tax liability. This can be equated to filing Form 1099 to ensure the reporting of income.

After an initial review in 2013, the U.S. Court of Appeals for the Tenth Circuit reviewed this case for the second time in February 2016 and ruled in Colorado’s favor again. This time, however, the court specified that the Colorado law does not discriminate against, nor does it unduly burden, interstate commerce.

This is an extremely significant decision: For the first time, a state will have a means to verify and enforce use tax filing by individuals. Use tax has been underreported for many years, and the amount of use tax on purchases by individuals has grown exponentially with the growth of Internet sales.

Background

For many years, states have addressed how to enforce payment of use tax on purchases from out-of-state locations. “Use tax” is loosely defined as sales tax due from a purchaser (user), when there was no requirement for the seller to collect sales tax. As the Supreme Court ruled in Quill Corp v. North Dakota, remote sellers with no physical presence in a state are not required to collect sales tax in that state. Since the rapid growth of Internet commerce, states have identified this lack of use tax payment as a significant cause of large shortfalls in tax collections. While tax professionals know that these out-of-state sales subject the purchaser to use tax, most citizens either do not know or choose not to comply, due to the difficulty in monitoring these transactions.

Sales tax previously collected at in-state locations is now lost due to the ease of Internet commerce with out-of-state sellers. This creates an unfair disadvantage to the in-state company who is losing business because it must charge customers sales tax, while the remote seller does not. While laws have been proposed to require remote sellers to collect use tax for states in which they have sales but no nexus, such proposed laws have been unsuccessful in Congress. These proposals are not popular for a couple of reasons. First, even though use tax laws already exist, it has the appearance of a new tax. The law would require remote sellers to collect tax that most people have not paid before. (It is estimated that only about 4 or 5% of personal use tax liability is paid.) In addition, the burden for small Internet businesses to begin collecting use tax in multiple states would be a recordkeeping nightmare.

History

Colorado comes through with a new concept. In 2010, Colorado enacted a law that imposes three obligations on retailers who have no obligation to collect sales taxes. It should be noted that retailers who made less than $100,000 in total gross sales in Colorado in the previous calendar year, and who reasonably expect gross sales in the current calendar year to be less than $100,000, are exempt from the notice and reporting obligations.

The requirements are: (1) to send a “transactional notice” to purchasers informing them that they may be subject to Colorado’s use tax; (2) to send Colorado purchasers who buy goods totaling more than $500 from the retailer an “annual purchase summary” with the dates, categories, and amounts of purchases, reminding them of their obligation to pay use taxes on those purchases; and (3) to send the Colorado Department of Revenue an annual “customer information report” listing their customers’ names, addresses, and total amounts spent.

The Direct Marketing Association (“DMA”), a group of businesses and organizations that market products, brought suit in federal court, claiming that the new law placed an undue burden on interstate commerce in violation of the Commerce Clause of the U.S. Constitution. The district court ruled in its favor, and placed an injunction against Colorado in enforcing its new law.

On August 20, 2013, the case went to the Tenth Circuit for the first time. Instead of ruling on the merits of the issue, the court held that the district court lacked jurisdiction to hear DMA’s challenge due to the Tax Injunction Act (TIA), which states that “the district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.” (28 USC 1341.) The Tenth Circuit remanded the case, ordering the district court to dismiss DMA’s claims and dissolve the permanent injunction.

In 2014, the case went before the Supreme Court on the issue of jurisdiction. Although the Court was not charged with ruling on the merits of Colorado’s law, and only whether or not the Tenth Circuit was correct in its ruling that the district court lacked jurisdiction, Justice Kennedy’s concurring opinion clearly sympathized with the state for its loss of revenue caused by purchases from remote sellers. He wrote that this “may well be a serious, continuing injustice faced by Colorado and many other States” and that “[t]he legal system should find an appropriate case for this Court to reexamine Quill.” [Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124, 1134 (2015) (Kennedy, J., concurring.)]

The Supreme Court held that federal courts do have jurisdiction, and that the TIA did not prevent the federal courts from hearing and ruling on this case. The Court remanded the case back to the Tenth Circuit for further proceedings. This time, the Tenth Circuit addressed the validity of Colorado’s law. The Tenth Circuit finally reversed the lower court’s decision, finding that the law was valid and did not violate the Commerce Clause. Quill, which required a seller’s physical presence in the state, addressed tax collection; this case, on the other hand, only addressesreporting obligations. Colorado may have found an answer to the use tax collection problem, at least from larger remote sellers with no presence in their state.

Will this mean another review by the Supreme Court? The Court may have some other cases to choose from. Alabama recently passed an economic nexus law for use tax collection, challenging the requirement under Quill for physical presence. Connecticut and Minnesota are right behind Alabama, as they have just proposed similar legislation. Are they taking Justice Kennedy up on his suggestion?

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