By Joseph H. Cucco, Albany Government Law Review
Since the internet first became a reality, there have been questions raised about how to ensure that online retailers—also called “e-tailers”—collect and pay their fair share of sales taxes. Defining what their fair share is however, has not been a simple matter, due to constitutional issues regarding limits on states’ ability to tax interstate commerce. Recently, states have begun enacting statutes designed to capture sales or use taxes from e-tailers. New York is one state which has imposed sales tax on internet purchases by passage of a statute dubbed the “Amazon Law.” Amazon.com is the largest e-tailer in the United States; until the Amazon law went into effect, Amazon.com did not collect any tax on sales to New York customers made on its website. New York’s law is evidence of an emerging trend—prompted in no small part by the staggering budget deficits many states have suffered in the economic crisis—towards treating internet sales essentially like those which occur in “brick-and-mortar” physical locations. Laws like this have given rise to numerous legal challenges by online retailers. The issue has gained much attention across the country as Senator Dick Durbin of Illinois, the second most senior Democrat in the Senate, recently announced he will propose federal legislation that requires e-tailers to collect sales tax from their customers.
These recent developments are the latest in the evolution of the issue of sales tax charged in out-of-state transactions. Since the 1940s, more than twenty cases hinging on this issue have been decided by the U. S. Supreme Court. These cases arise from a provision of the United States Constitution known as the Commerce Clause, which gives Congress the power to “regulate commerce . . . among the several states.” The U. S. Supreme Court has ruled that states can tax transactions arising through interstate commerce only if a “nexus” exists between the seller and the state. In cases such as Nelson v. Sears, Roebuck & Co. and Nelson v. Montgomery Ward & Co., the Supreme Court has held that mail-order businesses with a physical presence in the state consisting of retail stores or mail-order houses had sufficient nexus to be required to collect sales or use tax on all purchases made by state residents, regardless of whether a particular order went through a store or mail-order house within the state. To find nexus, the Court looked at the connection between the seller and the state, not to the mechanics of the individual purchase itself. In General Trading Co. v. State Tax Commissioner of Iowa and Scripto, Inc. v. Carson, the Court ruled that a company having salesmen in a state was a sufficient nexus to allow the tax. This was true whether the salesmen were regular employees, as in General Trading Co., or independent contractors, as in Scripto.
The purpose of the Commerce Clause, as explained by the Supreme Court in National Bella Hess Inc., v. Department of Revenue, was to “ensure a national economy free from such unjustifiable local entanglements” as would presumably ensue if “every . . . State, . . . every municipality, every school district, and every other political subdivision throughout the Nation with power to impose sales and use taxes” were to impose its own sales tax. The Court’s holding in Bellas Hess relied on both the Commerce Clause and the Due Process Clause of the Fourteenth Amendment. As Justice Stevens explained in Quill Corp. v. North Dakota, with reference to Bellas Hess, the Due Process Clause and the Commerce Clause do not impose identical restrictions: “while a State may, consistent with the Due Process Clause, have the authority to tax a particular taxpayer, imposition of the tax may nonetheless violate the Commerce Clause.” The only contacts the seller in Bellas Hess had with the state of Illinois were the United States mail or common carriers, which delivered its catalogs and merchandise. In Quill, the Court upheld Bellas Hess, saying that simply sending goods into the jurisdiction was not enough to trigger the sales tax. Its holding was based on a four-part test which was articulated in Complete Auto Transit v. Brady to determine if a state tax violates the Commerce Clause. That test required:
1) Nexus—a sufficient connection between the taxpayer (i.e., the retailer) and the state to warrant granting taxing authority;
2) Fair Apportionment—the state does not tax activities unrelated to activities carried on within the state’s borders;
3) Nondiscrimination—the state cannot treat non-resident taxpayers differently from resident taxpayers; and,
4) Related to services—the tax must be fairly related to services or benefits provided to the taxpayer by the state.
However, the advent of sales which occur over the internet, where the nexus between the seller and the state may exist only in cyberspace, has caused legislatures and courts to reevaluate the definition and application of nexus and thus states’ right to enforce collection of such taxes. The issue has become increasingly important in recent years, as commerce on the internet has become the fastest growing retail market in the modern world. Sales volume on the internet is expected to exceed $200 billion by 2013. Advocates of laws like New York’s Amazon Law maintain that failing to collect sales taxes that are legally due on online purchases costs states billions of dollars a year in lost revenue. The problem has been finding a strong enough nexus between e-tailers, like Amazon.com, and the states where its customers are located in order to satisfy constitutional requirements.
New York’s law and similar laws in other states find the required nexus in the fact that most major online retailers promote their sites with the aid of “affiliate programs.” Affiliate programs allow other websites to receive commissions by placing links on their web pages which take users to the site of retailers like Amazon. When a user clicks on the link and ultimately buys something from the retailer, the website is paid a commission. New York’s Amazon law imposes a presumption that an online retailer located outside of New York solicits business through an independent contractor or agent, such as an affiliate, if two conditions are satisfied. One is that the seller enters into an agreement with a New York resident which provides that the resident will receive compensation for referring potential customers to the seller. The second is that the seller earns at least $10,000 in sales as a result of these referrals from affiliates in New York during the preceding four consecutive quarters.
Not surprisingly, Amazon challenged New York’s law. Amazon claimed that the law violated the Commerce Clause and federal and state Due Process and Equal Protection Clauses because the tax collection obligations it required were based on activities that were insufficient to create a substantial nexus. At the trial court level, Judge Eileen Bransten of the New York Supreme Court granted the State of New York’s motion to dismiss Amazon’s complaint, stating flatly, “Amazon is wrong.” Amazon appealed, joined by Overstock.com, which had lost in a separate declaratory judgment challenge to the law, and several other organizations which filed amicus curiae briefs. The Appellate Division found that Amazon “failed to establish the existence of a viable equal protection claim.” The court did find that “further discovery is necessary before a determination can be rendered as to the as-applied Commerce and Due Process Clauses claims” and remanded the case back to the trial court. It is likely that another appeal will be forthcoming, and possible that the case could eventually end up before the U. S. Supreme Court.
Amazon terminated its affiliate relationships in North Carolina and Rhode Island to avoid collecting sales tax in those states, which have recently enacted their own internet sales tax laws, and threatened to terminate affiliates in other states that are contemplating similar legislation. As of March of 2011, twelve states have bills pending that are similar to New York’s Amazon law. It is probably only a matter of time before all states which have sales or use taxes enact some sort of similar legislation. Proponents of such laws argue that they help states regain lost revenue; that they reduce the competitive disadvantage incurred by brick-and-mortar retailers who must collect sales taxes; and that they reduce the disproportionate impact of sales taxes on purchasers in the lower-income brackets, who often do not have internet access, or cannot use forms of payment accepted online, like credit cards. If Senator Durbin’s proposed law eventually passes, states will not need to pass their own New York-style Amazon laws to ensure that their sales taxes are paid. States will, however, need to simplify and harmonize their sales tax laws to avoid the “unjustified local entanglements” foreseen by the Court in Bella Hess. Ultimately, the law will have to catch up to the technology. Until then, uncertainty will haunt cyberspace and the inevitable lawsuits will follow.
Dawn Kawamoto, States, E-Tailers Clash Over Sales Tax, Daily Finance, March 14, 2011, available at http://www.dailyfinance.com/2011/03/14/states-hope-to-force-e-tailers-to-collect-sales-tax-from-online/?icid=sphere_copyright.
 N. Y. Tax Law § 1101(b)(8)(vi) (Mckinney Supp. 2011).
Verne G. Kopytoff, Amazon Pressured on Sales Tax, N.Y. Times, March 13, 2011, available at http://www.nytimes.com/2011/03/14/technology/14amazon.html.
Press Release, Statement of Joseph Henchman, Tax Counsel & Director of State Projects, Tax Foundation, New York Court Sends “Amazon Tax” Case Back for More Information (November 4, 2010) available at http://www.taxfoundation.org/research/show/26829.html.
 Declan McCullagh, Democratic Senator Wants Internet Sales Taxes, CNet News, April 12, 2011, available at http://news.cnet.com/8301-31921_3-20052999-281.html.
James G.S. Yang, The Current Development of Internet Commerce Taxation, 29 J. State Tax’n 49 (2011).
 U.S. Const. art. I, § 8, cl. 3.
 Henchman, supra note 5.
 Nelson v. Sears, Roebuck & Co., 312 U.S. 359 (1941).
 Nelson v. Montgomery Ward & Co., 312 U.S. 373 (1941).
 Yang, supra note 7.
 Gen. Trading Co. v. State Tax Comm’r of Iowa, 322 U.S. 335 (1944).
 Scripto, Inc. v. Carson, 362 U.S. 207 (1960).
 Yang, supra note 7.
 Nat’l Bellas Hess, Inc. v. Dep’t of Revenue of Ill., 386 U.S. 753, 759-60 (1967).
 Id. at 759.
 U.S. Const. amend, XIV, § 1.
 Quill Corp. v. North Dakota, 504 U.S. 298, 305 (1992).
Joshua Sibble, Recent Developments in Internet Law, 23 Intell. Prop.& Tech. l.j. 12 (2011).
 Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
 Chris Atkins, Important Tax Cases: Complete Auto Transit v. Brady and the Constitutional Limits on State Tax Authority, tax foundation, May 19, 2005, available at http://taxfoundation.org/blog/show/490.html.
 Yang, supra note 7.
 Mazerov, supra note 3.
 Andrew Swain, Is New York’s Amazon Tax Law the First of Many? A New York Tax Practice Insight, 2009 Emerging Issues 4432.
 Amazon.com LLC et al., v. New York State Dep’t of Tax’n and Fin., 877 N.Y.S.2d 842 (Sup. Ct. N.Y. Co. 2009).
 Id. at 848.
 Amazon.com, LLC v New York State Dept. of Tax’n & Fin. , 81 A.D.3d 183 (1st Dep’t 2010).
 Id. at. 206.
 Sibble, supra note 20.
 Kawamoto, supra note 1.
 Those states are Arizona, California, Connecticut, Hawaii, Illinois, Massachusetts, Minnesota, New Mexico, Rhode Island, Tennessee, Texas, and Vermont.
 Mazerov, supra note 3.