New York's Latest Internet Tax Grab Costs Businesses and the State

There were two predictable fallouts from New York State’s move to force online companies to collect state sales tax: There would be a lawsuit. And some online merchants would cut off their affiliates in the state.

Amazon filed suit against the state late last month. Now Overstock.com has become the first major Internet retailer to cancel its relationship with affiliates in New York. Affiliates are Web site owners who get commissions for referring customers to an online store. They are important because New York State is requiring any company that has an affiliate in the state to collect sales taxes on its behalf. Until now, companies had to collect taxes only if they had a physical presence, such as an office or factory, in the state.

“We believe the law is unconstitutional and won’t stand the test of the courts, but in the meantime we have been very careful to keep our footprint just in Utah,” said Jonathan Johnson, Overstock’s senior vice president for corporate affairs. “We can’t afford to have our New York affiliates up online if it subjects us to New York sales taxes.”

Overstock has dropped its New York affiliates so as to avoid New York tax obligations. That's roughly 3,400 entities affected. Some are substantial in size, but many are small businesses that rely on an affiliate system to operate. So far, Amazon.com will not drop its New York affiliates.

It's a question of what the state will consider nexus with the state for applying sales tax.

The new law is based on a novel definition of what constitutes a presence in the state: It includes any Web site based in the state that earns a referral fee for sending customers to an online retailer. Amazon has hundreds of thousands of affiliates—from big publishers to tiny blogs—that feature links to its products. It says thousands of those have given an address in New York State, although it does not verify the addresses.

The state law says that if even one of those affiliates is in New York, Amazon must collect sales tax on everything sold in the state, even if it is not sold through the affiliate. This is an extension of an existing rule that companies that employ independent agents or representatives to solicit business must collect sales taxes for the state.

By that definition, a single sale through ads posted on my blog could result in Cafepress, PJ Media, or Google, respectively being obligated to collect tax for New York if I lived there. It's also an issue that flies in the face of the Streamlined Sales Tax Project, which tries to harmonize state sales tax so that it's easier for businesses to comply with state laws by using consistent definitions. New York is definitely pushing the envelope, and I suspect it will backfire badly.

How much tax revenue is the state going to lose because those affiliates are no longer bringing in sales and the hoped for sales tax revenues? How many jobs could be lost as a result of lower sales? How will that affect New York personal income tax revenues?

In the quest to obtain more taxes from more sources, New York is driving away businesses that do business here. That means that the state will end up with a net loss on trying to impose taxes on Internet sales.

So, why did the state pursuing this course of action? The state hoped the new legal interpretation would bring in $50 million a year to help close New York’s budget gap.

Here's a novel idea for the state to try - cutting spending instead of raising taxes or imposing taxes on services. They might actually find that revenues will increase among businesses because a more favorable tax climate will encourage more people to live, work, and spend their hard earned money in the state.