American consumers have long enjoyed a nifty tax break that often helps offset those pesky shipping charges when they buy online. If the online seller doesn't have a storefront or a warehouse in their state, they don't pay sales tax.

But that free ride, rooted in a nearly 2-decade-old U.S. Supreme Court decision, may be coming to an end. Online sellers like Amazon.com are facing mounting pressure across the country to collect sales taxes as government officials and brick-and-mortar retailers alike complain that they're being cheated.

The latest sign of the sea change is a deal hatched in California with Amazon in which the online behemoth agreed to drop its multimillion-dollar referendum campaign and commit to collecting sales tax a year from now unless Congress imposes new national rules.

"It's really kind of significant because it's an agreement by Amazon to do what it's refused to do all across the country," said Danny Diaz, spokesman for the Alliance for Main Street Fairness, a Washington, D.C.-based coalition of large and small retailers trying to close the online sales tax loophole.

While Seattle-based Amazon is hardly the only online retailer, it's the big fish in the Internet commerce pond, with 33,700 employees and 2010 sales of $34.2 billion. Founded in 1994, Amazon has aggressively fought efforts to collect sales taxes in states where it has no on-the-ground presence.

But with hard times cutting into state budgets and traditional retailers' balance sheets, a growing number of states have been eyeing the Internet and catalog retail industry -- with some 16,000 companies driving $235 billion in sales -- as a source of lost revenue. Closing the online sales tax loophole could deliver $23 billion in additional tax revenue to the states, according to Americans for Tax Reform.


California is a latecomer to the close-the-loophole party. New York required online retailers to collect sales tax four years ago, and Amazon has been collecting the levies and putting them in an escrow account while battling the Empire State in court. States such as Illinois, Arkansas, Connecticut, North Carolina and Rhode Island have taken similar steps, and even low-tax Texas is toying with the idea.

California's effort to crack down on what it considers online sales-tax cheats came in June after Democratic Gov. Jerry Brown and the Democratically controlled Legislature were unable to secure Republican support to extend higher sales and income tax rates.

Amazon fired back by dropping its 10,000 California affiliates, whose "physical presence" state officials were using to justify the sales tax requirement. It then began collecting signatures for a ballot measure to overturn the online sales tax law.

Lawmakers fought back by threatening to replace the law with an "urgency measure" that couldn't be repealed by initiative. But eventually all sides agreed to a compromise measure that passed the Legislature Friday night. And Brown is expected to sign it.

Some have questioned the Amazon deal as yet another sales-tax dodge. But Larry Levin, spokesman for state Sen. Loni Hancock, D-Oakland, a key legislative sponsor of bills to require online retailers to pay sales tax, said the company's pledge to collect sales taxes in a year is a milestone.

"For the first time," Levin said, "Amazon acknowledged a responsibility to pay the state sales tax."
Amazon hailed the agreement as a "bipartisan win-win." But the company's deal with the state hasn't sat well with other online businesses.

"We're surprised that Amazon's doing it because the California law in our view is unconstitutional," said Jonathan Johnson, president of O.co (also known as Overstock.com), the Utah-based online retailer with 1,500 employees and 2010 sales of $1 billion. "There's no reason to acquiesce to enforcement of it now or a year from now."

The compromise also frustrated Loren Bendele, CEO of Savings.com, a Los Angeles-based affiliate marketer for online bargains. The firm was dumped by Amazon and other online retailers after California passed the new law.

Bendele said getting the business back from Amazon isn't much help if the other online firms don't take Amazon's lead.

But those who have followed the online sales tax saga say this year's actions in California and other states are making it harder for Congress to ignore the issue, raising prospects for a national policy that even online retailers say would be better than the current patchwork of state rules.

"I'm hopeful that today represents a shift," said Joe Henchman, vice president of state projects for the Tax Foundation, a Washington, D.C.-based nonprofit think tank. "Everybody's no longer talking past each other and instead talking about how we make sure everyone who has to pay sales tax is paying in a way that doesn't burden interstate commerce or treat brick-and-mortar differently from online."

The current online sales tax rules stem from a 1992 U.S. Supreme Court decision, Quill Corp. v. North Dakota, which held that forcing a company with no physical presence in the state to pay sales tax violated constitutional provisions barring interference with interstate commerce.

But that decision predates Amazon, O.co and other online retailers, and critics say it's ripe for reconsideration in the 21st century.

Technically, consumers are on the hook to pay "use" taxes on purchases in which the state sales tax wasn't collected. But government officials acknowledge the futility of trying to go after consumers for that cash.
Johnson and other online retailers hope Congress reaffirms the Quill ruling and puts a quick end to state-by-state efforts to tax their sales.

He argues that a store owner in San Jose relies on the city's firefighters to protect his store from fires -- and must pay taxes to support that service. But if his Salt Lake City company caught fire, no California firefighters would come to his aid.

But he and other online retailers say if they have to pay sales tax, they would prefer that Congress establish a national policy. How long that might take is anybody's guess. Henchman noted that "Congress is kind of busy with a lot of stuff these days," adding that there "really isn't a good proposal out there."

One proposal, the Main Street Fairness Act by U.S. Sen. Dick Durbin, D-Ill., would require online retailers to collect sales tax regardless of whether they have a physical presence in the buyer's state. It's tied to an effort to establish more uniform sales tax definitions among the states to make it easier for interstate merchants to collect the tax.

Henchman said the complexity of local sales tax schemes has worsened since the Quill decision -- from 6,000 sales tax jurisdictions nationwide two decades ago to more than 9,600 today. It was considered a major accomplishment, he added, when the streamlined sales tax effort agreed to "a uniform definition of candy."

While the National Retail Federation and even Amazon have indicated support for the Main Street Fairness Act, it has drawn opposition from political conservatives. Grover Norquist, president of Americans for Tax Reform, calls it a "massive" money grab sought by leaders in high-tax states.

Bendele noted that the Main Street Fairness proposal has been floated in the past and failed to gain traction, but he believes it or something similar will happen sooner or later.

"It's inevitable," Bendele said.