Sales Taxes: States Could Gain Revenue from Expanded Authority, but Businesses Are Likely to Experience Compliance Costs

Over the past two decades, e-commerce sales have grown rapidly, greatly expanding a category of sales known as remote sales. Under current law, states cannot require all businesses to collect taxes on remote sales. Congress has been considering proposals to change this. Little current, nationwide information exists to inform the debate.

In this report, GAO (1) estimated revenue states and localities could gain by being able to require businesses to collect taxes on all remote sales, and (2) described what is known about the related compliance costs and challenges to businesses, and administrative costs and challenges to states.

GAO estimated 2017 revenue gains to state and local governments based on actual and estimated sales data for remote sellers, excluding certain sales that were exempt from taxation or already collected by remote sellers with a substantial presence in a state. Ranges for GAO's estimates were based on a number of key assumptions that were varied based on available data. To describe related costs and challenges to businesses and states, GAO interviewed officials from state revenue agencies, subject matter specialists, and a wide variety of retailers with remote sales and the organizations that represent them.

GAO provided a draft of this report to subject matter specialists who agreed with the general approach that GAO followed in making its estimates.

Forty-five states and the District of Columbia levy taxes on the sale of goods and certain services, including those sold remotely, such as over the Internet. In 1992, the Supreme Court ruled in Quill v. North Dakota that a state can only require a business to collect and remit sales tax if the business has substantial presence, referred to as nexus, in that state. However, the decision stated that Congress could pass legislation to overrule this limitation. In general, under present law, if a seller does not have nexus in a state, and therefore does not collect tax, then a purchaser is required to pay a use tax in the same amount to his or her state government.

GAO estimated that state and local governments can, under current law, require remote sellers to collect about 75 to 80 percent of the taxes that would be owed if all sellers were required to collect tax on all remote sales at current rates. GAO found that the extent to which state and local governments can require businesses to collect taxes varies with the type of remote seller and by state.

GAO estimated that state and local governments could gain from about $8 billion to about $13 billion in 2017 if states were given authority to require sales tax collection from all remote sellers. This is about 2 to 4 percent of total 2016 state and local government general sales and gross receipts tax revenues.

Some businesses would likely see increases in several types of costs if required to collect taxes on all remote sales. These costs would be higher for businesses not currently experienced in multistate tax collection. Officials from state revenue departments told us that they generally do not anticipate major administrative costs or challenges if given the authority to require businesses to collect tax on all remote sales.

GAO is not making recommendations in this report.

Over the past two decades, electronic commerce (e-commerce) sales  have grown rapidly, but, under current law, states cannot require all   e-commerce businesses to collect taxes on sales to residents of their  states. Congress has been considering proposals that would allow this.  In 2000, when we last looked at remote sales, we found that the data  available at the time were not well suited to track rapidly evolving Internet  activity.

Today, even with better information on the potential revenue losses,  debate still exists over both estimates of lost revenue to states and on the  ability of all businesses—particularly small businesses and businesses in  states that do not have sales taxes—to collect and remit taxes to  jurisdictions across the country in a cost-effective way. There is also  uncertainty about the costs and other challenges of expanded collection  that could be incurred by state revenue agencies.

You asked us to review the effects on businesses and state revenue  agencies of legislation that would grant states the authority to require  businesses to collect and remit taxes on all remote sales. This report (1)  estimates how much revenue state and local governments could gain by  being able to collect taxes on sales made by all remote sellers, (2)  describes what is known about the costs and challenges remote sellers  experience in trying to comply with current state tax laws, and how those  costs and challenges might change if states were given the authority to  require businesses to collect on all remote sales, and (3) describes what  is known about costs and challenges states face in requiring remote  sellers to collect taxes.

To estimate the revenue that state and local governments could gain by  being able to collect taxes on all remote sales, we updated a model we  originally developed in 2000 to perform similar analyses. We used data— that we determined to be reliable—on the volume and composition of  Internet and other remote sales, the taxability of remote sales, and the  extent to which sellers already collect and purchasers already pay tax on  remote sales. Detailed information about our methodology, including the  data sources we used, is provided in appendix I.

To identify the types of costs and challenges that businesses will likely  face if required to collect and remit taxes on all remote sales, we  reviewed literature, conducted market research on software used by  businesses to facilitate tax collection, and identified knowledgeable  parties from whom we could solicit information. We interviewed  representatives from 12 legal, advocacy, or accounting groups and we  solicited them for contacts in the remote sellers’ business community  whom we could interview. We reviewed witness testimony before  congressional committees on the subject of remote sales to understand  the costs associated with sales and use tax collection as well as to  identify groups and individuals to interview. We interviewed a non- generalizable sample of more than 20 businesses or their  representatives. This includes businesses of different sizes, from different  industries, and included businesses with and without sales tax  obligations. We also attended conferences of the American Bar  Association and the American Catalog Mailers Association where the  topic of remote sales tax collection was discussed.

To describe what is known about costs and challenges that state revenue  agencies might face in requiring all remote sellers to collect taxes, we  interviewed representatives from the National Conference of State  Legislatures, the Federation of Tax Administrators, the Multistate Tax  Commission, and the Streamlined Sales Tax Governing Board. Between  February and October 2017, we monitored tax industry publications to  identify state actions to increase tax collections on remote sales, like bills  debated in state legislatures or administrative rules promulgated by state  revenue agencies. As state legislatures debated, and in some cases,  enacted these proposals, we reviewed revenue and cost estimates  developed by legislative budget offices or state revenue agencies to help  us identify the types of potential costs and challenges associated with  these new actions. For additional data and insights, we interviewed  officials from five state revenue agencies including three states that had  recent experience with changing their laws or regulations related to  remote sales tax collection.

We subjected our work to third-party review by noted specialists in the  field of tax policy. These experts agreed with the general approach that  we followed in making our estimates. The experts confirmed that  uncertainty surrounds many of these factors incorporated into the model.

We conducted this performance audit from September 2016 to November  2017 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

Forty-five states and the District of Columbia levy sales taxes on the sale  of goods and services. Of these, thirty-seven states also have local sales  taxes at the county or municipal level. Five states do not have statewide  sales taxes: Alaska, Delaware, Montana, New Hampshire, and Oregon.  Tax policy specialists have cited figures as high as 12,000 and as low as  10,000 for the number of tax jurisdictions in the United States—each with  potentially different tax rates, different rules governing tax-exempt goods  and services, different product category definitions, and different  standards for determining whether an out-of-state seller has a substantial  presence (referred to as nexus) in a state.

On average, states receive about one-third of their total tax collections  from general sales taxes. However, reliance on sales taxes varies  considerably across states. Five states that do not have a broad-based  individual income tax—Florida, Nevada, South Dakota, Tennessee, and  Texas—collect more than half their tax revenue from general sales  taxes. As of January 1, 2017, most state sales tax rates were about 6  percent, although analysis prepared by the Tax Foundation shows that  five states—Alabama, Arkansas, Louisiana, Tennessee, and  Washington—had average combined state and local tax rates close to or  above 9 percent.

Generally, businesses are required to collect sales taxes on goods and  services sold to in-state consumers at the time of the purchase, and remit  those taxes to the state, and sometimes local government, revenue  office. The growth of e-commerce has greatly increased the likelihood of  businesses selling to out-of-state customers. In 1992, the U.S. Supreme  Court ruled in Quill v. North Dakota that a state can only require a  business to collect and remit sales tax if the business has substantial  presence, referred to as nexus, in that state. However, the decision  stated that Congress could pass legislation to overrule the Quill decision.  Legislation has been proposed to expand states’ tax collection authority  to all remote sales, but no bill has received enough support to pass both  the Senate and the House of Representatives. Some of the legislation  has included provisions for small seller exemptions, free software, liability  protection, and transition periods.

In general, under present law in states with sales taxes, if the seller does  not have nexus in a state, and is therefore not required to collect tax, then  the consumer is required to pay a use tax in the same amount. Although  functionally similar to a sales tax, the use tax is a tax levied on the  consumer for the privilege of use, ownership, or possession of taxable  goods and services. However, consumer compliance rates for use tax  remittance are estimated to be very low.

With the growth in e-commerce, states have increased their enforcement  activities to collect sales tax from residents who make purchases from  out-of-state businesses. A few states have passed laws or changed  regulations that directly challenge or test the limits of the 1992 Quill v.  North Dakota decision—most notably, Alabama, Colorado, and South  Dakota—to increase tax collections on remote sales. In reviewing  testimony and tax industry publications, we found that states have also  sought additional revenue through more indirect approaches, such as  asserting jurisdiction on the basis of nexus to include “affiliate nexus” and  “click-through nexus.”

Colorado for instance enacted a law requiring retailers who do not collect  taxes on sales to Colorado customers to notify those customers of their  use tax obligations and send an annual report on customers’ purchases  to the state revenue agency. The revenue agency could then use this  information to identify which purchasers have a use tax obligation.

South Dakota took a different approach aimed at overturning the Quill  decision. In 2016, the legislature passed a law requiring out-of-state  businesses meeting certain criteria to collect and remit sales tax on  purchases made by South Dakota residents. The state supreme court  ruled on September 13, 2017, that the law violated Quill. On October 2,  2017, South Dakota filed a petition for a writ of certiorari with the U.S.  Supreme Court.

Alabama promulgated a regulation in September 2015 requiring out-of- state retailers who made $250,000 or more in sales to Alabama residents  annually, or who conducted one or more statutorily defined activities, to  collect and remit sales tax. A suit was filed with the Alabama Tax  Tribunal, but no decision has been made.

New York took a different route passing a “click-through” nexus law in  2008. Some out-of-state retailers enter into agreements with local online  retailers to advertise the local retailer’s merchandise on the out-of-state  retailer’s website. Because the agreement was with an in-state vendor,  the law defined that to be a sufficient nexus to impose sales tax on the  out-of-state-vendor. Several companies unsuccessfully challenged the  statute.

A few state governments have taken action to increase tax collection from  e-marketplace sellers. As of October 2017, two states (Minnesota and  Washington) had passed laws imposing new requirements on   e-marketplace companies to collect sales taxes on behalf of the sellers  using their e-marketplace platforms. Some states have asserted that the  warehousing of goods and fulfillment of orders from within a state is  enough to create nexus, and therefore a requirement to collect taxes on  sales to customers in that state. To enforce compliance, we found that  at least three state revenue agencies have been seeking sales, shipping  or location data about goods sold through e-marketplaces.

Taxes are Collected on Most Remote Sales, but States Could Gain Additional Revenue with the Authority to Require All Businesses to Collect Taxes

State and Local Governments Are Able to Collect Taxes on More Than Half of Sales

We estimate that state and local governments can, under current law,  require remote sellers to collect about 75 to 80 percent of the taxes that  would be owed if all remote sellers were required to collect tax on all  remote sales at current rates. We found that the extent to which state  and local governments can, under current law, require businesses to  collect taxes on remote sales varies with the type of remote seller (as  shown in table 1). For business-to-consumer (B2C) remote sales, we  found that the percentage of taxes already being collected by sellers  (which we call the “seller collection rate”) was generally higher for Internet  retailers than for other types of remote sellers like catalog retailers or   e-marketplaces.

Based on our analysis of nearly 1,000 Internet retail companies, we  estimate that about 80 percent of the potential revenue from requiring all  Internet retailers to collect is already collectible. Many of the largest  Internet sellers are established retail chains or consumer brands with a  physical presence, such as retail stores, in all, or nearly all, of the 45  states (plus the District of Columbia) that have a statewide sales tax. As  noted earlier, under current law, if a remote seller has a substantial  presence (referred to as nexus) in a state, the seller is required to collect  taxes on remote sales into that state. In addition, even without being  required to, some large Internet retailers have entered into agreements  with states to collect applicable taxes on all their Internet sales,  regardless of physical presence.

The rise of e-marketplaces, such as eBay, Etsy, and Amazon  Marketplace, has complicated nexus determinations. At these  marketplaces, sellers can access large customer bases and utilize the  marketing and distribution services of the marketplace platform, often for  a fee. Certain states can rely on inventory stored within their borders as  sufficient nexus to impose taxes. This has included sellers using a large  marketplace’s fulfillment services. As a result, to properly collect and  remit taxes, sellers using marketplace fulfillment services need  information on where their inventory is stored.

While we estimated the seller collection rate to be relatively high for the  category of Internet retailers (about 80 percent), we found it to be lower  for other types of B2C remote sellers. For example, we estimate that   e-marketplace sellers are currently collecting 14 percent of the taxes on  their sales, in our highest potential revenue gain estimate, to up to 33  percent, in our lowest potential revenue gain estimate. For other types of  remote retailers, such as mail-order companies, we estimate that they are  currently collecting tax on 58 percent of their sales in our highest potential  revenue gain estimate and up to 64 percent of their sales in our lowest  potential revenue gain estimate (as shown in table 1).

Although business-to-business (B2B) sales account for a larger share of  total e-commerce than B2C sales, potential state and local government  revenue gains from taxing all of these sales is less because fewer B2B  sales are taxable, and seller collection rates are higher (as shown in table  1). We estimate that about half of all wholesale e-commerce purchases  involve businesses purchasing raw materials or other intermediate goods  that are then manufactured or incorporated into a final product. These  purchases of intermediate goods are generally exempt from state and  local government taxes because only the final sale to the end consumer  would be taxable. For the remaining taxable B2B purchases, we  estimate that the seller collection rates are between 85 percent for those  sales in our highest potential revenue gain estimate and 94 percent in our  lowest potential revenue gain estimate.

Potential Revenue Gain across All States for 2017 is about $8 billion to $13 billion Based on our Low and High Scenario Estimates

Based on the seller collection rates we estimated using high and low  scenarios to illustrate the effect of underlying uncertainties, we  determined that state and local governments could potentially gain about  $8 billion based on our low scenario to about $13 billion, based on our  high scenario, in 2017 if they were given expanded authority to require  sales tax collection from all remote sellers. Table 2 presents our range of  estimates. Appendix II presents our range of estimates for each of the 45  states plus the District of Columbia that have a statewide sales tax. Our  estimates range from more than $1 billion for more populated states like  California and Texas to about $20 million for less populated states like  Vermont and Wyoming. The average gain is about $200 million.

In aggregate, our national estimate of about $8 billion (low scenario) to  about $13 billion (high scenario) represents about 2 to 4 percent of total  state and local government general sales tax revenues. According to data  from the U.S. Census Bureau, state and local governments in 2016  collected about $377 billion in general sales and gross receipts taxes.

Larger States Collect Taxes on a Greater Share of Remote Sales than Smaller States

We found that the extent to which state and local governments can  require remote sellers to collect taxes varies by state. Based on analyses  of remote sellers’ nexus locations, we estimate that some of the largest  states (in terms of population) can currently require sellers to collect  about 80 to 90 percent of the taxes these states could collect with  expanded authority on all remote sales. In contrast, we estimate that  some smaller states can only require sellers to collect and remit about 60  to 70 percent of the taxes they could collect on all remote sales. The  difference is based on the greater likelihood of Internet retailers having a  physical presence in larger states.

We researched store locations and sales tax policies for the largest 100  Internet retailers identified by researchers at Internet Retailer. We found  that about 85 percent of these Internet retailers had store locations in, or  stated on their websites that they were collecting sales taxes for,  California and New York. By contrast, about 55 percent of these large  Internet retailers had stores or were collecting in less populated states  like North Dakota and Wyoming.

For smaller Internet retailers with only one location, we also found that a  disproportionate share of them were located in larger states. Based on  our analysis of more than 400 Internet retailers with only one location, we  found that 19 percent were located in California and 12 percent in New  York. With Internet retailers and other remote sellers less likely to have a  physical presence in less populated states, smaller states are at a  disadvantage compared to larger states in their ability to require remote  sellers to collect taxes on all sales into their states.

About Half of Potential Revenue Gains Could Come from Tax Collections on E-Marketplace Sales

We estimate that nearly half of potential revenue gains to state and local  governments would result from collecting sales taxes on all e-marketplace  sales. To date, e-marketplaces have not been obligated to collect state  sales taxes on behalf of sellers. Instead, like with all remote sellers,  individual sellers who have title to the goods being sold through an   e-marketplace are required to collect tax on sales to states in which they  have nexus. However, we identified two states that have recently taken  action to attribute a collection obligation to the e-marketplace.

Through our review of tax industry publications and interviews with tax  practitioners, we learned that some individual sellers have difficulty  obtaining information from the e-marketplace companies on where their  goods might be stored. While the three large e-marketplaces that we  interviewed offer their sellers additional services that help sellers  calculate and collect sales taxes, not all sellers take advantage of this  service. None of the e-marketplaces that we interviewed could provide us  data on the extent to which their sellers currently collect sales tax. Given  the lack of available data, we made a conservative estimate of potential  revenue gains to states if given the authority to require all e-marketplace  sellers to taxes on all their sales. If e-marketplace sellers are currently  collecting less tax than we assume in our model, the actual potential  revenue gain to states would be higher than the estimate we provide in  this report.

Compliance with Use Tax on Most Remote Purchases is Low for Individual Taxpayers, but High for Businesses

Because state and local governments currently do not have the authority  to require businesses to collect tax on all remote sales, states generally  require taxpayers who were not charged a tax on their purchases from  out-of-state vendors to pay a use tax on those purchases. However,  with the exception of purchases that are required to be registered with the  state, such as vehicles, voluntary compliance is generally thought to be  extremely low. For those states that permit taxpayers to report use taxes  on their income tax returns, it is estimated that only about 1 to 2 percent  of returns include use tax payments. Unlike estimates for individual  compliance with use tax, estimates for business compliance are high,  ranging from 70 to 90 percent. Some tax practitioners we interviewed  told us that businesses routinely retain records of their taxable and tax- exempt purchases, including remote purchases, and are more likely to be  compliant with any use taxes.

We identified at least four states that have begun implementing new laws  intended to increase consumer use tax compliance. Under these “notice  and reporting” laws, remote sellers not collecting taxes on out-of-state  sales are required to notify customers that they may be liable for use  taxes to their home state. The states are also requiring remote sellers to  send their out-of-state customers an annual summary of all purchases for  which sales tax was not collected. Data from these annual summaries are  shared with state revenue agencies that can use this information for  enforcement purposes. Data were not yet available to estimate the  revenue effects of these new programs. As we have previously reported,  tax compliance is generally much higher when there is third-party  reporting of information to the revenue agency. We expect that state  collection of third-party information will achieve similar results.

Some Businesses Would Likely Incur Several Types of Costs If Required to Collect Taxes on All Remote Sales

We identified various costs associated with typical steps involved in  multistate sales tax collection. We group these costs into three broad  categories: software related costs, audit and assessment compliance  costs, and costs associated with research and liability. We found that  businesses with limited experience in multistate tax collection and those  that lack software systems designed to facilitate multistate tax collection  would incur the highest costs under such a scenario.

Representatives from a large national chain and a trade group  representing retailers told us that, generally speaking, larger retailers and  those that primarily engage in brick-and-mortar retailing believe that  expanded state authority would end the unfair advantage that remote  retailers gain by not collecting sales tax on their out-of-state sales. Those  familiar with multistate collection explained that because the software  used for multistate collection is easily scaled up, retailers already using  such systems, would incur few challenges to adapt to this expanded  authority. Further, larger retailers that already collect in many states  would already have the systems in place for collection under expanded  authority. We also identified state and national efforts for simplifying tax  collection for businesses. These efforts show potential for mitigating the  expected costs, but much depends on the specifics of any legal changes.

Our research found that a number of commercial software offerings are  available to assist businesses with collecting sales taxes in multiple  states. Two people familiar with the use of tax software told us that  although many standard business software products generally include  some sales tax functionality, these systems do not always fully support  businesses selling in multiple tax jurisdictions. As a result, sellers with  more widespread collection obligations typically use specialized multistate  sales tax software. A representative from a Certified Public Accounting  (CPA) firm explained that costs are incurred both when businesses collect  sales tax from customers, and when they remit the tax to the appropriate  state revenue department. In some instances, there are also start-up  costs that businesses incur prior to tax collection, as well as audit or  assessment costs that occur after tax collection. Figure 1 summarizes  these steps and can help inform the discussion of the specific costs.

Businesses Selling Remotely May Incur High Upfront Costs to Establish Software for Multistate Tax Collection

The cost of both collecting and remitting sales tax rises with increased  exposure to tax jurisdictions. As the number of jurisdictions for which a  business collects taxes increases, the amount of administrative work also  increases. Businesses will have to prepare and file a greater number of  returns, license more functionality from the collection software they use,  and collect tax on a greater number of sales. All of these actions add  additional costs to a business’s operations.

While all sellers would incur these additional costs, costs will be highest  for those that do not already use software for multistate tax collection.  This is especially true for those selling goods treated differently by  different states and those that do not use easily-integrated software.  Costs for collection software include, start-up costs, licensing fees,  administrative costs, and options for premium services, such as preparing  or automatically filing sales tax returns. Start-up costs are the costs  associated with setting up the software for first use.

Tax practitioners told us that software is necessary for multistate  collection because of the complexity created by unstandardized  requirements across jurisdictions. As we note above, tax policy specialists  have cited figures as high as 12,000 and as low as 10,000 for the number  of tax jurisdictions in the United States. In addition to differences that exist  among the tax codes of the 45 states and the District of Columbia with  statewide sales taxes, many local bodies have the power to impose  additional sales taxes on purchases within their jurisdictions.

Some tax practitioners that we interviewed said that mapping and system  integration related to the necessary software for multistate collection are  the most costly of the start-up activities. Mapping requires coding all of a  business’s product offerings to the taxation categories used by the  software. One software provider told us that generally, these software  products do not require businesses to research the legal categorization in  each state’s laws; however, it does require businesses to categorize  products with sufficient precision for the software to assign its tax status  based on state laws. For example, apparel is treated differently across  states. Pennsylvania exempts clothing, except for formal apparel; items  made of real, imitation, or synthetic fur; and athletic apparel. Across the  border, New York State exempts clothing sold for less than $110;  however, some jurisdictions do not apply these exemptions and charge a  local sales tax on these items.

The initial product mapping required before using multistate tax software  can be labor intensive. As such, we expect that businesses setting up  software for the first time, and selling goods which states treat differently  will have more labor-intensive product-mapping work. Some software  providers offer consulting services to assist businesses with mapping  their offerings. Software providers, however, treat these services as a  premium option so businesses will generally incur extra costs for using  these services.

Several people familiar with the use of sales tax software said that errors  in mapping products can expose businesses to liability in the form of  uncollected taxes. Recognizing the wide variations in sales tax laws, a  group of states launched the Streamlined Sales Tax Initiative in 1999.  The initiative was designed to standardize these variations and provide  software assistance to make it easier for businesses to comply with state  and local sales and use tax laws. This initiative sought to shield  businesses from liability by directing software providers participating in  the effort to complete mapping for businesses and assume liability for  errors. However, more recent changes allow software providers to  negotiate these issues directly with their business clients. According to a  representative of the Streamlined Sales Tax Governing Board, 24 states  have passed legislation to conform to the Streamlined Sales and Use Tax  Agreement. These states account for a third of the United States  population, but many of the largest states (in terms of population) are not  fully participating.

Software integration, or establishing a connection between existing  business software and the new multistate tax software, will be required for  businesses that begin to use multistate tax software. Two software  providers we spoke with said that they have already created integration  modules for the most common business software packages in use today.  One explained that integration with these common business systems is  generally the least expensive and may come at no cost to the business.  However, businesses using customized software or software that is not in  common use may see higher costs to integrate these systems. Some  businesses may need to integrate several systems with the collection  software. This integration may be required for transactions such as  processing sales through different retail channels or ensuring that  merchandise returns are removed from existing collections.

Businesses will also face additional costs to license the necessary  software functionality from the provider. A public accounting firm told us  that these on-going licensing fees are generally lower in the first year,  than the one-time costs associated with mapping and integration.  Licensing costs generally are a function of the volume of information  requests sent to the tax database maintained by the software provider.

In estimating costs to license multistate collection software, online  businesses must consider both the number of completed transactions  they anticipate as well as the browsing behavior of those using their  websites. A CPA firm we interviewed explained how these software  packages work. Whenever a business website calculates a sales tax  amount, it does so by sending an information request to a rate and  address database maintained by the software provider. Importantly, this  process is often an automated function of the “shopping cart” system,  which may calculate a sales tax amount whenever a customer changes  the goods in the shopping cart, even in the absence of a completed sale.  As such, businesses must account for both completed transactions as  well as how often customers change the bundle of goods in the online  shopping cart. For example, customers may use shopping carts while  comparison shopping on different websites. Our market research found  licensing costs as low as $12 per month for up to 30 information requests  each month, and as high as $200,000 per year for unlimited information  requests.

Businesses and others familiar with sales tax software told us that  licensing fees are only one of multiple costs required to collect sales  taxes in multiple states. As such, simplification proposals that include  provisions for states to pay these licensing fees may not mitigate  significant costs to businesses transitioning to software assisted  multistate collection. Businesses will still incur start-up costs and  additional administrative costs, even when states pay the licensing fees  on the use of the software. Even under such proposals when software  comes with no licensing fees, mapping can be labor intensive for  businesses selling products that state tax laws treat differently, and  integration can create costs for businesses using custom software or  software that is not widely used. Further, for software to reduce  administrative costs, it must be integrated with more than just a  business’s shopping cart system. However, simplification proposals that  only cover software licensing costs and integration with the shopping cart  system may leave businesses with the costs of a more extensive  integration. Businesses would either have to incur additional costs to  better integrate sales tax software with existing business information  systems (such as a general ledger accounting system), or regularly  reconcile receipts and records manually to prepare sales tax returns for  all states where it makes sales.

Additional costs for software include administrative costs associated with  use of the software. These costs are incurred because even automated  software requires some administrative work by staff. The use of optional  premium services offered by software providers may further reduce these  administrative costs, but increase software costs in the process.  Administrative costs tend to be highest, as a proportion of taxes collected,  for the smallest sellers. Some businesses told us that collecting sales tax  in all jurisdictions where they have customers would increase staffing  costs, even when collection is facilitated by software. Premium services  commonly offered by software providers assist businesses with preparing  and filing tax returns. While electing to use these services may save  businesses labor costs, they incur additional fees to use these premium  services.

We interviewed several businesses based in states that do not collect a  sales tax. They told us that they are already researching software options  should the need to collect sales tax on all remote sales arise. These  businesses told us that they have little experience with collecting sales  tax. As reported above, in the first year, start-up costs for the software are  much higher than the on-going licensing fees. Businesses that do not  need to collect sales tax in their own state may be less likely to already  have multistate tax collection software or in-house expertise.

Businesses May Incur Increased Audit and Assessment Costs as Exposure to Collecting Jurisdictions Grows

If states are allowed to require businesses to collect tax on all remote  sales, businesses we spoke with expect audit and assessment related  costs to rise because of increased exposure to more tax jurisdictions.  Attorneys told us that state revenue departments also employ other low- cost enforcement tools that create compliance costs. Officials from three  state revenue departments that we spoke with said that they primarily  focus their audits on large businesses because audits are resource  intensive. Officials from one agency acknowledged that other  enforcement tools, such as a letter audit, require fewer resources to use.

Some businesses told us that they already expend significant resources  responding to audits on sales tax collection and remittance. These costs  include making staff available, developing justification for tax claims, and  complying with document or information requests. A representative from  the tax department of one company with nexus in most states said that  auditors return every few years to audit the company and that they are  currently contending with 8 to 10 audits from different tax authorities.  They expect audit related costs to grow with exposure to more  jurisdictions and that will require hiring additional staff. Another business  we spoke with said they had just dealt with an expensive audit that lasted  3 years. They reported that they do not have the resources to comply with  similar audits from other jurisdictions.

We interviewed 11 businesses, attorneys, or representatives from the  business community who said that fear of increased audits, should states  gain expanded authority to tax remote sales, is a legitimate concern for  businesses. Attorneys we spoke with offered several reasons that small-  and medium-sized businesses will be audited should states gain the  authority to tax remote sales. One explained that sales tax audits of small  businesses often identify non-compliance and produce revenue. Another  said that assessments prepared by revenue offices generally carry a  presumption of accuracy. In practice, this places the burden of proof on  the retailer to rebut claims made by revenue offices. However, some state  revenue departments we spoke with said that they do not expect their  audit resources to increase and therefore would be spread more thinly if  states are allowed to require businesses to collect tax on remote sales.  Two state revenue offices explained that this change would mean they  have a much larger universe of businesses from which to select. As such,  it is unknown how frequently businesses might have to contend with  concurrent audits in different states.

Travel to, and securing counsel in, remote jurisdictions would create  additional costs for audited businesses that would not occur in the current  environment. A business representative explained that the CPAs and  attorneys they employ, or have on retainer, may not be able to represent  the business in an out-of-state venue. As such, businesses would need to  retain counsel qualified to practice in the assessing jurisdiction.

Two business representatives also told us that businesses may be less  successful at challenging tax assessments in out-of-state courts. This  may prompt them to settle claims in an out-of-state court that they might  litigate in their home state. Further, the federal Tax Injunction Act restricts  businesses’ ability to seek relief in federal court for matters related to  state taxes.

In addition to audits, state revenue departments have many low-cost  enforcement tools at their disposal. One example is the letter audit. An  attorney we spoke with explained that in this process, a revenue office  sends a letter to a business stating that the office suspects they owe  sales taxes. The business incurs costs to prove the state wrong to avoid  the assessment. In some cases, states bypass the assessment process  and sue the business—arguing that the business has nexus in the state  and owes tax. In conducting interviews, we found that states also send  information requests and questionnaires to businesses designed to  uncover whether they have nexus obligations. One representative from a  trade group we spoke with said that a business will normally be  responsive in order to remain in compliance with the law, despite potential  uncertainty about the state’s authority to collect.

Businesses we spoke with in states that do not collect a sales tax  generally were not collecting sales taxes for other states, so they had little  experience with a sales tax audit. Further, some businesses in these  states were not tracking the legal requirements on businesses imposed  by out-of-state jurisdictions. Businesses located in states without a sales  tax also may incur costs to alter business practices after initial exposure  to sales tax audits. This might happen because the procedures they  currently use may not withstand the taxing states’ scrutiny.

Businesses Incur Costs to Stay Current with Legal Requirements in Multiple Jurisdictions, but are Still Exposed to Risk

If states gain the authority to require businesses to collect tax on remote  sales, businesses will have to incur costs to understand their new  compliance obligations, which can differ by state or tax jurisdiction. The  related liability cost increases along with an increase in exposure to more  tax jurisdictions. These costs will likely increase the most for businesses  that do not have established legal teams, software systems, or outside  counsel to assist with compliance related questions. We identified three  areas, based on interviews with businesses, where these costs are most  likely to occur. First, businesses expressed concern that changes in legal  precedent could expose businesses to liability for past sales. Second,  some businesses reported paying assessments based on contestable  laws. Third, some businesses reported instances where businesses’  actions created nexus that led to an unforeseen liability.

The U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota  constrained states’ ability to tax sales originating from outside the state.  We identified four states that recently changed their laws in an attempt to  re-litigate this decision. A representative from the business community  told us that the effect of the U.S. Supreme Court potentially overturning  the Quill decision may allow laws that are on the books in many states to  be enforced. For example, Alabama’s Department of Revenue told us that  they have asserted jurisdiction over remote sellers under a previously  unenforced law to further litigation challenging the Quill decision. They  acknowledged that this action has the potential to allow retroactive  enforcement, should the challenge succeed. However, they said the state  was most interested in prospective compliance. Some businesses worry  that, if legal arguments like these prevail, states will not confine  themselves to prospective enforcement efforts. They fear that states  could decide that businesses owe taxes from years when enforcement of  the law did not impose collection obligations on out-of-state businesses.

Risk of Overpayment Due to Compliance Culture

State revenue departments mail assessments, questionnaires, and other  correspondence to out-of-state businesses. These may direct businesses  to provide information, pay taxes, or register to collect sales taxes. In  some cases, the Quill decision protects businesses from obligations to  comply with these directives. Nevertheless, some businesses have  complied. One representative from a trade organization representing  remote businesses said that the natural tendency for a business is toward  compliance. This may lead them to pay or comply without thoroughly  examining the strength of their legal position. He cited a state that mailed  around two hundred demand notices to out-of-state businesses for  unremitted sales tax. Even though he said that these businesses did not  have nexus in the state, more than half of businesses remitted payment.  Another business told us that they registered to collect in a state that was  attempting to challenge the Quill decision because they judged that the  cost of challenging the state’s new law was likely to exceed any increased  compliance costs. This business said that collecting the tax, but waiting to  remit it pending the results of a legal challenge, would expose the  business to penalties and interest.

Because state tax laws are complex and subject to change, businesses  may not always be aware of their obligations under state law. Our  research revealed cases where businesses incurred collection obligations  unknowingly. One lawyer, whose practice represents several businesses  in sales tax related issues, described a business that was contacted by a  nearby state’s revenue office and asked to provide information on its use  of fulfillment services from a popular marketplace provider. The business  downloaded a report from the marketplace provider and sent it to the  revenue office. The business said that the marketplace provider had  formatted the information in a way that made it uninterpretable without  knowledge of the location codes it contained. The state revenue office  was able to use the report to show that the marketplace’s fulfillment  services stored the business’s property in the state. Stored property  suffices to create a nexus obligation and the business received an  assessment for back taxes, interest, and penalties dating back to when  the property was first stored in the state. The lawyer we spoke with has  seen six similar cases since that one and said that the addition of interest  and penalties often doubles the amount of taxes owed.

Active monitoring of sales tax laws across the country can help  businesses ensure they are compliant with all of their legal obligations.  Businesses we spoke with differed in the way they conducted this  research. Some undertook the research in-house. Others used software  that provides updates when laws change. Some said that they require  outside legal counsel to resolve difficult questions. In all cases, this  research imposed additional costs on businesses.

Four businesses in states without sales taxes told us that they have  incomplete research or a lack of familiarity with recent changes to state  laws that impose obligations on out-of-state businesses. Businesses like  these may encounter additional costs in the form of unforeseen liabilities  or costs to conduct research.

Strategies Show Some Potential for Containing Risks

In the course of our research, we identified strategies with the potential to  mitigate the concerns laid out above. However, much would depend on  the specifics of any legal changes. These strategies include: simplification  rules for collection and remittance in multiple states, small business  exemptions for businesses under a certain size, transition periods for  businesses to come into compliance, and limitations on lookback periods.

Simplification Rules May Help Businesses Understand Collection  Obligations  Simplification rules for remote sellers could provide businesses with a  single compliance requirement instead of varied requirements from the  jurisdictions with the authority to assess sales tax. These rules could  lower research and compliance costs, and leave businesses less  exposed to hidden liabilities. One multistate effort has created a set of  simplified rules for collection and remittance. However, one attorney we  spoke with said that the rationale for including and excluding certain items  in the classification is unclear, and this leaves room for states to interpret  the taxability in different ways. Further, some of the simplifications  proposals we analyzed do not apply to state definitions of nexus. As such,  it is possible that businesses might be aware of and compliant with the  simplification rules, but unclear on how to structure their operations to  avoid the less simple rules that come from acquiring nexus. These cases  might require additional research costs and legal services to resolve and  may expose a business to unforeseen liability.

Small Business Exemptions May Help Small Businesses Avoid  Additional Costs  Small business exemptions would ensure that businesses with sales  below a specified threshold would not be liable for taxes to remote  jurisdictions. This could reduce research and liability costs for small  businesses because these businesses would only have to verify that their  sales were below the threshold that requires collection. However, some  business representatives we spoke with said that the thresholds  contained in many proposals were too low.

The Small Business Administration defines a small business as one with  $32.5 million in annual sales for electronic shopping retailers, and $38.5  million for mail-order houses. Federal legislation allowing states to tax  remote sales have included a variety of small business exemptions. For  example, one proposal would initially exempt small business with annual  sales below $10 million, but that exemption would decline and eventually  expire after 3 years. Another proposal would set a permanent exemption  of $1 million in annual sales. New state laws and administrative  regulations require out-of-state sellers to collect taxes. We identified small  seller exemptions in some of these laws and regulations as low as  $10,000 and as high as $500,000 in annual sales into the state.  However, one business owner said that $25 million in annual sales is still  a small business. The owner explained that such businesses can quickly  go bankrupt and have little capital to survive downturns in the business  cycle. Business representatives said that business models which  emphasize low margins and high sales volume are common in remote  sales. These businesses may have limited resources for additional  compliance obligations.

Transition Periods Can Help Businesses Prepare for Collection  Obligations  Transition periods may give businesses time to examine their legal  obligations and secure tools, such as software or legal counsel, to  facilitate compliance but can prompt increased demand for assistance  and services. Our work has shown that sometimes tax system transition  deadlines are likely to prompt a large volume of requests from taxpayers  for compliance assistance from taxing authorities. Because businesses  reported that additional software or legal services would be required to  transition to new collection obligations, we expect demand for such  services to increase before transition deadlines.

Limits to Lookback Periods May Protect Newly Registered  Businesses  Limited lookback periods restrict how far back a state revenue agency  can examine a business’s records after that business registers to collect  taxes. Attorneys that we interviewed said that registering to collect with a  state can trigger an examination of that business’s records with an eye to  discovering if the business owes taxes for sales prior to the registration.  They explained that if businesses are not protected by limitations to  lookback periods upon registration, this may inhibit registering to collect in  new states. One business owner told us that the risks of additional  scrutiny and unforeseen liability have prevented him from registering to  collect in a nearby state where he would like to do more business.  Limitations to lookback periods would give businesses more confidence in  registering to collect because they would be less likely to incur additional  scrutiny or an unforeseen liability as a result of the registration.

States Generally Do Not Anticipate Major Administrative Costs or Challenges If Given the Authority to Require Businesses to Collect Tax on All Remote Sales

Actions by state and local governments to increase tax collections on  remote sales could require additional government resources to administer  sales taxes. State revenue agency officials, as well as representatives  from the Federation of Tax Administrators and other state government  organizations we interviewed, did not identify any major increases in  administrative costs or significant administrative challenges if states were  given the authority to require businesses to collect taxes on all remote  sales.

In the absence of congressional action to grant states expanded tax  collection authority on all remote sales, state legislatures have recently  considered, and in some cases enacted, new laws designed to increase  tax collections on remote sales. As these proposals were being  considered, we identified five revenue agencies or legislative budget  offices that had estimated the costs to implement and administer these  new programs. For example, one state’s analysis concluded that  current state revenue agency resources were sufficient to implement and  administer the new program, and another state’s analysis determined that  the program would have only a moderate effect on the state revenue  agency.

Other state analyses that estimated additional annual costs varied widely,  from a few hundred dollars to up to $4 million. While these estimates  varied widely, we found that this information helped to illustrate potential  challenges and costs state and local governments could face in trying to  collect taxes from all remote sellers. Interviews with three state revenue  agency officials who had already implemented, or were beginning to  implement, new programs also provided us further information on  potential administrative costs and challenges.

Sales Tax Administration Activities  Registration of vendors. States need to  process registration forms from new vendors,  including out-of-state vendors. States also  need information to help identify unregistered  vendors.  Returns processing. States require  resources to process sales tax returns,  including returns from out-of-state vendors.  States typically capture data in information  systems, and identify and process over- or  underpayments.  Enforcement efforts. Audit resources are  needed to verify vendors’ total taxable sales.  When auditing out-of-state vendors, state  revenue departments may face higher travel  costs.  Collections. States send delinquency notices  to vendors for late, miscalculated, or  underpaid collections.  Taxpayer services. States provide education  efforts and taxpayer assistance to improve  voluntary compliance.

We previously reported that the following state functions are typically  associated with administering sales taxes: identifying and registering  vendors; returns processing; enforcement; collections; and taxpayer  services (see sidebar titled “Sales Tax Administration Activities”).

If remote sellers were required to collect state taxes regardless of nexus,  states may need to process an influx of new registration forms from out- of-state vendors. State revenue agency officials as well as  representatives from the Federation of Tax Administrators told us,  however, that they did not anticipate that registering new out-of-state  vendors and processing additional returns would pose major challenges  to state agencies. They explained that state revenue agencies already  process a large volume of registration changes annually as new  businesses are created or existing businesses fail. As a result, they  expected that new registrations from out-of-state sellers would not  represent a significant strain on current resources.

Potential increases in new out-of-state vendor registrations could be  lessened by states’ small seller exemptions. Some state proposals for  increasing tax collections on remote sales have exempted smaller out-of- state sellers with annual sales less than a certain dollar amount, or  annual transactions less than a certain number, into a state. Recent small  seller exemptions have set annual sales exemption thresholds ranging  from $10,000 in Washington State to $500,000 in Massachusetts. One  revenue agency official from Alabama, which began enforcing a new  remote-seller regulation in 2016 that has a $250,000 small seller  exemption, told us that the approximately 100 newly registered out-of- state sellers is an extremely small share of the state’s total 40,000  registered sellers.

States may need additional resources to process new tax returns from  out-of-state vendors and to verify out-of-state vendors’ total taxable  remote sales into a state. However, as tax administrators noted above  with regard to new vendor registrations, any increase in out-of-state  returns processing may be minimal when compared to the volume of  routine in-state returns. When processing new out-of-state returns, states  may need to decide whether to capture the same amount of data from  out-of-state filers as they currently do for in-state filers in order to limit  errors and required resources for follow-up.

Depending on whether and how some states choose to centralize  registration and reporting for out-of-state vendors, some administrative  costs and burdens associated with these functions might be reduced or  mitigated. For example, a revenue agency official from Alabama told us  that implementation of its new administrative rule (requiring out-of-state  vendors to collect taxes on sales to Alabama customers) has been  facilitated by having its state revenue department serve as a centralized  collection point on behalf of local tax authorities.

Thirty-seven states, like Alabama, have local sales taxes in addition to  statewide sales taxes. Some of these local taxes are already centrally  collected by a state revenue agency, but in some states, local authorities  collect them. States that are members of the Streamlined Sales and Use  Tax Agreement have agreed to allow centralized state registration and  reporting for out-of-state vendors. Louisiana, another state with many  local sales tax jurisdictions, recently enacted a new law creating a sales  tax board for promoting “uniformity and efficiency” of local sales and use  tax administration. The law also created an independent agency within  the state’s Department of Revenue for administering and collecting state  and local taxes related to remote sales.

When allocating enforcement and collections resources, state  administrators may need to weigh trade-offs between pursuing incidences  of noncompliance (typically higher among small filers) against potential  revenue effects (greatest among large filers). Representatives from the  Federation of Tax Administrators did not anticipate significant increases in  enforcement costs because they said most sales tax noncompliance is  detected not through intensive audits but through less costly automated  matching of electronic data such as credit card sales receipts with  business-reported sales. They also said that most noncompliance issues  are resolved via automatically-generated correspondence with taxpayers.  That is, most taxpayers resolve additional amounts owed or other  noncompliance matters after receiving notification letters from state  revenue agencies.

One state revenue agency official told us that his agency may experience  higher travel costs associated with audits of out-of-state vendors. The  same official believed, however, that this might merely require re- allocating current travel expenses from in-state audits to out-of-state  audits rather than requiring an increase in travel budgets. The Oklahoma  legislature recently authorized the state revenue agency to create an out- of-state sales tax enforcement division. While the final bill provided the  state agency with flexibility to staff this division using existing resources,  the original proposal would have mandated opening a new office outside  the state and staffing it with a minimum of five employees at an estimated  annual cost of $450,000.

Finally, state revenue agency officials and representatives from the  Federation of Tax Administrators told us that they anticipated some  additional resources may be needed for taxpayer assistance such as  providing increased telephone assistance or publishing guidance for new  out-of-state vendors. Demand for taxpayer assistance is likely to be  higher from smaller out-of-state vendors with less experience in collecting  and remitting taxes to other states. The complexity of a state’s sales tax  laws, such as rules for when to exempt a certain type of product based on  how it is used, are also likely to affect levels of taxpayer service  requested by new out-of-state vendors.

States Implementing Notice and Reporting Requirements May Experience Difficulties Matching Sales Data to Taxpayer Information

We identified at least four states that have enacted new “notice and  reporting” laws in attempts to increase tax collections from remote sales.  Under these laws, if an out-of-state seller chooses not to collect taxes on  sales into a state, then the seller is required to notify its customers of  state use tax obligations, send customers annual summaries of their  purchases, and share that information with state revenue agencies. One  state’s fiscal analysis of its new notice and reporting law estimated that  out-of-state retailers will decide to collect the tax rather than comply with  notice and reporting requirements. The handful of new notice and  reporting laws that we identified have only recently become effective, so it  is unclear to what extent this has or will occur.

We found two recent estimates of costs to implement and administer  these new notice and reporting laws. The Louisiana Legislative Fiscal  Office estimated that the state revenue agency would incur costs of  $90,000 annually to administer a new notice and reporting law. By  contrast, the Washington Department of Revenue estimated that it would  cost about $4 million annually to administer the state’s new notice and  reporting law. Washington revenue officials told us that most of these  costs come from hiring new staff. They explained that increased costs are  common when they must enforce new provisions of the tax code because  it is not easy to reassign tax staff.

State revenue agencies implementing new notice and reporting laws may  experience difficulty matching sales information from out-of-state retailers  with taxpayer data. Revenue officials from Colorado told us that the  annual sales reports remote sellers are required to send to their  customers and share with state revenue agencies, will not contain unique  taxpayer identification data like Social Security numbers. Without these  data, these officials explained that revenue agencies will need to use  customers’ names and addresses to match with taxpayer returns. If  buyers with similar names make use of the same delivery address, this  may complicate efforts to identify a taxpayer’s use tax obligation.

Colorado and Washington officials also told us that once their revenue  agencies begin sending letters to taxpayers with estimated use tax  obligations, they anticipate significant increases in phone calls and other  requests for taxpayer assistance. In order to manage expected increases  in call volumes and control costs, Colorado officials said they plan to be  selective about sending notices in the first years.

Officials from Washington’s Department of Revenue told us that one part  of their new notice and reporting law applied to e-marketplaces rather  than sellers. Officials told us that it is easier for states to enforce  compliance against one large entity (the e-marketplace company) instead  of the thousands of smaller sellers that sell through the e-marketplace’s  platform. Washington’s notice and reporting law requires e-marketplace  companies to comply with the notice and reporting requirements if the   e-marketplaces choose not to collect and remit taxes on behalf of their  individual sellers.

In August 2017, the Multistate Tax Commission began offering a general  sales tax amnesty program for e-marketplace sellers. During the amnesty  period, the commission would accept applications from qualifying remote  sellers. The sellers would affirm in their applications that their only  connection with the participating state or states is through inventory  housed in an e-marketplace’s warehouse or fulfillment center. In  exchange, one group of participating states would agree to waive back  tax liabilities for sales and use taxes, as well as for income and franchise  taxes, including penalties and interest, without regard to any lookback  period. At the time of our report, 24 states and the District of Columbia  were participating. The program was set to end in November 2017.

As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the appropriate Senate  and House committees. We will also send copies of the report to the  Secretary of the Treasury and other interested parties. In addition, the  report will be available at no charge on the GAO website at  http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-9110 or mctiguej@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made contributions to this  report are listed in appendix III.

Appendix I: Methodology for Revenue Gain Estimates

To address our objective on estimating how much revenue state and local  governments could gain by being able to collect taxes on sales made by  all remote sellers, we updated a model we used to prepare similar  estimates in 2000. The sidebar titled “Steps Involved in Estimating  Potential Revenue Gains” summarizes the steps in our methodology.

Compared to when we did similar analysis in 2000, there are some areas  where we have better data, but a single point estimate is still not possible  because of uncertainty surrounding estimates of several key inputs to our  model. In our 2000 report, there were few reliable data sources on which  to base our calculations and adjustments. We noted then that projections  of sales were particularly difficult to make given the rapidly changing   e-commerce environment. Today, there are more data sources available  on current and future e-commerce sales.

In addition to the past uncertainty regarding the magnitude of remote  sales, we reported in 2000 that there was considerable uncertainty about  the amount of tax that state and local governments were already  collecting from these remote sales. Today, data are more easily available  on where e-commerce companies have a substantial presence (referred  to as nexus) in states. Some research companies track this information,  and more companies are explicitly stating on their websites in which  states they collect sales tax. Still, we had to make several broad  assumptions about the volume of e-marketplace sales, including the  extent to which e-marketplace sellers were already collecting sales taxes.

As states continue to research tax losses associated with e-marketplace  sales and pursue increased enforcement actions, we believe that more  data could help improve the accuracy of our estimates. Additional data  from e-marketplace companies about the extent to which their sellers are  collecting sales taxes through the e-marketplace optional tax services  would also help improve further analysis in this area.

The Volume and Composition of Internet and Other Remote Sales

To obtain sales estimates, we reviewed academic, government, and  private-sector studies. We also contacted these authors and other  specialists in this field to identify other potential sources of sales  estimates. Some state revenue agencies and other researchers who have  estimated tax revenue losses from remote sales have used data from the  U.S. Census Bureau to derive their base estimates of total Internet and  other remote sales. While we did use some Census data in our analyses,  we primarily relied upon data from Forrester Research (a research  company whose data we had used in our 2000 report) to arrive at low and  high scenario estimates for total sales volumes for different types of  remote sales as shown in table 3. We chose not to provide a single point  estimate, because the low and high scenarios illustrate how the numbers  can vary—sometimes non-trivially—depending on reasonable  assumptions about the underlying uncertainties.

Forrester Research’s estimates of business-to-consumer (B2C)   e-commerce sales for the years 2016 to 2021 presented data on 31  different product categories to which we could then apply specific state  sales tax rates and exemptions. By contrast, similar Census data were  more limited in that: the data contained fewer categories (13 merchandise  lines plus non-merchandise receipts); the most recent data were for the  year 2015; and the data did not include e-marketplace sales. Forrester  Research’s total online retail forecast for 2016 was about $400 billion and  nearly $450 billion for 2017. We reduced this total by about $20 billion by  removing sales for two product categories (movie tickets and event  tickets) that were more akin to services industry (rather than retail)  activities.

Unlike Census data, Forrester Research included sales from   e-marketplaces in its e-commerce forecasts. Sales tax losses associated  with e-marketplace sales have become an increasing area of focus for  state revenue agencies, and so it was important to include in our analysis.  To separate e-marketplace sales from the sales of other Internet retailers,  we analyzed data from the annual reports of three leading e-marketplace  companies and data we obtained from Internet Retailer. We estimated  the value of merchandise being sold on these three leading   e-marketplaces to be about $110 billion in 2016. However, some of  these are sales by other Internet retailers using the e-marketplaces to sell  their goods. That is, some retailers operate stores and their own websites  but also sell their goods through “storefronts” on the e-marketplaces. We  adjusted our total e-marketplace sales estimate to avoid double-counting  retailers’ Internet sales in our analysis. In the end, we estimated that   e-marketplace sales (excluding the sales of Internet retailers using   e-marketplaces) accounted for 20-25 percent of total 2017 online retail  sales ($85 billion to $106 billion).

Data sources on other remote sales like mail-order catalogs or television  shopping channels are more limited, compared to available data on   e-commerce sales. A representative of catalog companies we interviewed  told us that it is becoming increasingly difficult to attribute retail sales to  particular sales channels. For example, many catalog retailers also have  websites or sell their goods in retail stores or via e-marketplaces. We  decided the best available estimates could be derived by separating out  aggregate Census data on Electronic Shopping and Mail-Order Houses  into separate e-commerce and mail-order components. We first  estimated that the mail-order portion of the top-line Census category to be  about $150 billion in 2016, but then removed about $95 billion in  estimated mail-order prescription drug sales because nearly all states  exempt prescription drugs from sales taxes. Using data on historical  growth rates for the mail-order catalog industry, we then estimated the  range of other remote sales for 2017 to be from $58 billion to $61 billion.

Forrester Research’s estimates of business-to-business (B2B)   e-commerce wholesale trade for the years 2016 to 2021 presented data  on 11 different product categories to which we could then apply specific  state sales tax rates and exemptions. While similar Census data  included 19 different product categories, the most recent Census data  was only for year 2015. Forrester’s estimates exclude sales via  electronic data interchange networks which accounts for some of the  difference with Census’ larger e-commerce estimate. Forrester  Research’s total B2B forecast was about $825 billion for 2016 and about  $885 billion for 2017. We removed about $125 billion in petroleum and  petroleum products sales because these sales would generally be subject to excise (not sales) taxes and, furthermore, these sales would be taxed  on volume (not dollar value) and we lacked volume data, such as gallons  sold. We also lowered the value of the motor vehicles and parts  category by 40 to 60 percent under the assumption that most vehicles are  taxed when registered with state motor vehicle agencies and sales and  use tax compliance is considered generally high.

To estimate the amount of tax due on remote sales, we apportioned a  share of total e-commerce and other remote sales to each state (and the  District of Columbia) and then applied each state’s tax exemptions and  rates to those sales. We allocated sales across states by assuming that  each state’s share of sales to individual consumers is proportionate to the  state’s share of U.S. disposable personal income, and that each state’s  share of sales to businesses is proportionate to the state’s share of U.S.  gross domestic product. We made this allocation for each of the B2C  and B2B product categories. We then determined which categories of  products and services are taxed by state and local governments and at  what rates.

Our main sources for state and local rates and exemptions were CCH’s  State Tax Guides and Multistate Quick Answer Charts, Federation of Tax  Administrators’ summary tables, and the Tax Foundation’s 2017 State  Business Tax Climate Index. Eight states plus the District of Columbia  do not have additional local sales tax rates levied by cities, counties, or  other special taxing districts. For the other 37 states with both statewide  and local tax rates, we used weighted average local rates as estimated by  the Tax Foundation after first comparing and testing these rates with  similar data published by the Washington State Department of  Revenue.

For B2B e-commerce wholesales, we made additional adjustments to  reflect the fact that many B2B sales are exempt from tax based on the  type of purchaser or the type of use. These purchaser and use  exemptions are important for estimating the proportion of B2B sales that  are exempted as raw materials or as inputs incorporated into a final  product. Our sources of sales estimates did not disaggregate them by  type of purchaser or types of use. In order to estimate the percentage of  business-to-business sales that would be exempt, we used input-output  account tables prepared by the Department of Commerce’s Bureau of  Economic Affairs. These tables show the inter-industry transactions of  the U.S. economy for 2015 and provide detailed information on the  composition of inputs and the distribution of outputs of all major U.S.  industries. On the basis of our analysis of the input-output data, we  excluded a range from 50 to 60 percent of all B2B e-commerce  wholesales from our model (see row titled “less exempt intermediate  goods” in table 3).

The Extent to Which Remote Sellers Already Collect Taxes

Seller collection rates represent the share of taxes on remote sales that  state and local governments can currently require remote sellers to collect  due to remote sellers’ substantial presence (referred to as nexus) in a  state. To estimate seller collection rates for selected categories of e- commerce and other remote sales, we followed an approach similar to  that in our 2000 study. We made separate estimates for Internet retailers,  e-marketplaces, other remote retailers, and merchant wholesale e- commerce sales because a different population of firms dominates in  each group. Again, we chose not to use a single point estimate, because  the low and high alternatives illustrate how assumptions made about  collection rates can vary our model output—sometimes non-trivially. The  ranges of our estimates are shown in table 4.

To make our estimate for Internet retailers, we analyzed data from  Internet Retailer’s 2017 list of the leading 1,000 U.S. companies to  determine the states in which they collect sales taxes. We first used data  from company financial reports to adjust Internet Retailer’s 2016 global  sales figures for the top 100 companies to reflect only U.S. Internet  sales. We also used company annual reports and a smaller list of  leading Internet retailers from eMarketer to test the accuracy and reliability of Internet Retailer’s data, which we found to be sufficiently  reliable for our purposes.

We then verified Internet Retailer’s data on the states where each of the  top 100 companies were collecting sales taxes by comparing it to sales  tax collection policies published on companies’ websites or lists of  companies’ physical locations (such as retail stores, warehouses, or  company headquarters). We performed our research on companies’  collection policies and nexus from May to June 2017. During this period  some companies’ collection policies or nexus changed from the date  when Internet Retailer published its Top 1000 list in April. For example,  the largest Internet retailer completed agreements with the remaining few  states where it was not previously collecting sales tax. As of September  2017, the company stated on its website that it collects taxes on sales of  all its products sold to customers in the 45 states (plus the District of  Columbia) with statewide sales taxes.

For 27 of the top 100 companies, Internet Retailer did not report any data  on states where the companies were collecting sales taxes, so we used  the results of our own nexus research. For the remaining states where we  could do comparisons, we found Internet Retailer’s data on companies’  nexus to be sufficiently reliable for our purposes. On the basis of our  nexus research, we found that about 40 percent of the top 100 companies  were collecting in all 45 states (plus the District of Columbia) with  statewide sales taxes, and three-quarters were collecting in at least half  the states. Only 2 of the top 100 companies were only collecting in, or  only had nexus, in one state.

To estimate the percent of sales on which Internet retailers were currently  collecting taxes, we first allocated each company’s total sales to states  based on each state’s share of national disposable personal income. We  then multiplied each state’s share of sales by the combined state and  local government weighted average tax rate to estimate the total tax  dollars that could be collected on all sales regardless of nexus. We then  used our nexus data for each company to estimate the tax dollars  companies were already collecting. The ratio of these two estimates (total  taxes collectible under current law, divided by total taxes that could be  collected if states had expanded authority) is our estimated “seller  collection rate.” For the top 100 companies on Internet Retailer’s list, we  estimated this seller collection rate to be from 87 to 96 percent.

We then extended our research of companies’ nexus to the remaining  900 companies on Internet Retailer’s top 1000 list. These remaining 900  companies accounted for about 20 percent of the total dollar sales  volume for all 1,000 companies on Internet Retailer’s list (after we had  adjusted global sales to U.S.-only sales for the top 100). For about one- third of these 900 companies, Internet Retailer did not report any nexus  data so we did our own research. For the other two-thirds, we relied on  Internet Retailer’s nexus data because we found it sufficiently reliable  based on our analysis of first 100 companies listed. Compared to the top  100 companies, these remaining 900 companies were far less likely to  have nexus (or said they were collecting) in all or most states. About half  the remaining 900 companies only had nexus (or said they were  collecting) in one state. In terms of tax dollars, we estimated that these  900 Internet retailers were already collecting from 44 to 49 percent of the  potential taxes that states and local governments could require to be  collected if given expanded authority on all remote sales. For all 1000  Internet retailers, we adjusted our estimates of dollars currently being  collected by plus (+) and minus (-) 5 percent, which gave us a range of  overall estimated collection rates from 78 to 86 percent for the category.

The wider range of our estimates on seller collection rates for   e-marketplace sales is because less data were available on the extent to  which these types of sellers already collect sales taxes. We could not find  sufficiently reliable data on the physical locations of sellers who use   e-marketplaces. The three major e-marketplaces (that we analyzed to  estimate total e-marketplace sales) offer their sellers additional services  that help sellers calculate and collect sales taxes, but not all sellers take  advantage of this service. None of the e-marketplaces that we  interviewed were able to provide us data on the extent to which their  sellers currently collect sales tax. We found limited data on the extent to  which e-marketplace sales include sales taxes. Two studies estimated  that sales taxes were more likely to be collected by larger sellers like  other retailers using e-marketplaces to sell some of their products. As we  noted above when describing our methods for estimating total e- marketplace sales, we estimated that about 40 percent of Internet  retailers sell their products not only via their own stores and websites, but  also offer their products for sale on e-marketplace sites.

In our calculations, we assumed that from 10 to 30 percent of   e-marketplace sales were made by large sellers that collected taxes in  most states (either due to nexus or collection agreements with states).  After allocating those sales to states based on share of disposable  personal income, we assumed that these large sellers collected taxes at  the same rates we had estimated for the top 100 Internet retail  companies. We assumed that the remaining e-marketplace sales (from  70 to 90 percent) were made by smaller sellers with only one nexus, and  that these small sellers were geographically located similar to other  Internet retailers with only one nexus. After allocating those sales to  states, we assumed that these small sellers collected taxes only in their  home state. Our resulting seller collection rates for all e-marketplace  sellers ranged from 14 to 33 percent.

Due to a lack of sufficiently reliable data, we did not consider what  percentage of e-marketplace sales are used items. According to one   e-marketplace company, about 20 percent of items listed on their site are  used. According to information from one tax software company, the  taxability of used items for sale varies by state.

We could not find data that listed the leading mail-order catalog  companies, and in which states they have nexus and are collecting taxes.  However, 116 of the companies in Internet Retailer’s 2017 Top 1000 list  were classified by Internet Retailer as “Catalog/Call Center” companies.  These companies had from $5 million to $5 billion in 2016 Internet sales  to U.S. customers and were distributed similarly to the full population of  all 1000 companies. Since we had already estimated their collection rates  as part of our analysis on Internet retailers, we re-calculated an aggregate  collection rate for these 116 companies. We adjusted our estimates of  dollars currently being collected by plus (+) and minus (-) 5 percent, which  gave us a range of overall estimated collection rates from 58 to 64  percent.

B2B E-Commerce Wholesalers Collection Rates

We followed a similar approach for estimating seller collection rates for  business-to-business e-commerce wholesalers. We identified 106  companies on the Internet Retailer’s 2017 Top 1000 list with significant  B2B sales. Some of the companies appeared to sell exclusively to  businesses whereas others had both significant consumer and business  sales. These companies had 2016 Internet sales to U.S. customers  ranging from $5 million to $10 billion, and the subpopulation was  distributed similar to the overall Top 1000 population. The 106 companies  were more likely to come from Internet Retailer’s categories of:  automobile parts, computers/electronics, hardware/home improvement,  and office supplies. Comparatively fewer were in Internet Retailer’s  categories of apparel/accessories, food/drug, health/beauty, or  housewares/home furnishings. Because we had already estimated their  collection rates as part of our analysis on Internet retailers, we   re-calculated an aggregate collection rate for these 106 companies. We  adjusted our estimates of dollars currently being collected by plus (+) and  minus (-) 5 percent, which gave us a range of overall estimated collection  rates from 85 to 94 percent.

The Extent to Which Purchasers Already Pay Tax

According to data we found, consumer and business use tax compliance  rates have not changed significantly since we did similar analyses in  2000. As we reported then, consumer use tax rates are estimated to be  very low whereas business use tax compliance rates are estimated to be  very high. The most widely-cited study we found on consumer use tax  compliance was prepared by the Minnesota legislature in 2015. The  study reported that for those states that allowed taxpayers to report use  taxes on their state income tax returns, the percentage of returns  including use taxes ranged from a low of 0.2 percent in Rhode Island to a  high of 10.2 percent in Maine. We used the various rates from the study  in our calculations. For those states not listed in the Minnesota legislature  study, we used a default median rate of 1.2 percent. We had more to up- to-date data for California, Mississippi, and Vermont, which we used in  our calculations. We then adjusted the total dollar amount of use taxes  paid by consumers from 0 to 10 percent to provide us a range of inputs  for our model. Making these adjustments had little to no effect on the final  results. For business use tax compliance rates, we found data from five  states that estimated business use tax compliance to be from 70 percent  to 90 percent. In our model, we applied both these figures to give us a  range of estimated use tax dollars paid by businesses.

Table 5 shows the potential revenue gains for 2017 that we calculated  using various combinations of low and high estimates for sales and  sellers collections rates described above. Here too, we chose to not  provide a single point estimate because the low and high scenarios for  potential revenue gains illustrate how the many underlying uncertainties  affect potential revenue gains.

By adjusting various model inputs we produced some lower estimates  resulting from the following assumptions and adjustments: (1) decreasing  our estimated e-marketplace and other remote retailer sales; (2)  increasing our estimated seller collection rate for all types of remote  sellers; (3) increasing our estimated consumer and business use tax  compliance; and (4) increasing our estimates of tax-exempt business  inputs (intermediate goods). The higher estimate results from: (1)  increasing our estimated e-marketplace and other remote retailer sales;  (2) decreasing our estimated seller collection rates for all types of remote  sellers; (3) decreasing our estimated consumer and business use tax  compliance rates; and (4) decreasing our estimates of tax-exempt  business purchases (intermediate goods).

Including Additional Factors in Our Model Would Likely Lower Our Overall Estimates of Potential Revenue Gains

We lacked sufficient data on four additional factors that, if we had  included in our model, would likely reduce our estimates of state and local  government revenue gains.

We lacked sufficient data on the extent to which requiring all remote  sellers to collect sales taxes on all sales (regardless of a sellers’ nexus)  would raise final prices to consumers and thus lower demand for goods  sold remotely. Facing higher final prices, some online or other remote  shoppers might shop instead at traditional brick and mortar retailers, or  place orders with non-U.S. remote sellers. A representative from one  major Internet retailer we interviewed believed that its customers placed  higher value on the convenience of shopping online and were less likely  to change their shopping behavior if previously untaxed sales now  included sales taxes. Some economists have concluded that consumers  alter buying decisions when remote retailers begin to collect sales  taxes. However, one of the tax policy specialists who reviewed our  report noted a lack of consensus on this topic.

We lacked sufficient data on what portion of e-commerce sales included  in our model might be tax exempt digital downloads of software, music,  books, and games. Some states consider digital downloads to be a  service (not a physical good) and therefore exempt from sales taxes. The  variations in state laws governing the taxability of digital downloads were  too numerous for us to reliably include in our model. Assuming that states  do not change their laws to make these purchases taxable, it is likely that  our estimates of potential revenue gains would be lower.

We were unable to factor in the extent to which some small remote sellers  might be exempt from sales tax collection requirements even if states had  expanded authority over all remote sales. Recent state laws and  regulations regarding taxes on remote sales have included small seller  provisions that exempt sellers who make less than a specified dollar  amount of sales or a number of transactions annually into a state.  Proposed federal legislation granting states expanded taxing authority on  all remote sales also includes different nationwide dollar amount  exemptions for small sellers. We could not find sufficiently reliable data  to estimate how many businesses or what dollar volume of sales might be  exempt either at the state or federal level. As a result, our final estimates  most likely overstate the total potential revenue gains for some, or all,  states depending on what types of small seller exemptions might be  enacted at either the state or federal level, or both.

Sales to Tax Exempt Entities  We lacked sufficient data on what share of remote sales are made to tax  exempt entities. In our 2000 report, we were also unable to identify any  estimates of sales by taxable versus tax-exempt purchaser. Officials from  one state revenue agency we interviewed estimated that the percent of  purchases made by tax-exempt entities or persons to be extremely low.  Our final estimates of potential tax gains would be lower for states if we  had included an estimate in our model.

Appendix II: State and Local Government Potential Revenue Gains

Appendix III: GAO Contact and Staff Acknowledgments

James R. McTigue, Jr. (202) 512-9110 or mctiguej@gao.gov.

In addition to the contact named above, Tara Carter (Assistant Director),  Mark Kehoe (Analyst in Charge), Brett Caloia, and Christine N. Dickason  made key contributions to this report. Anne Stevens, A.J. Stephens,  Cynthia Saunders, JoAnna Berry, Stewart W. Small, Donna Miller,  Andrew Emmons and Andrew Howard also provided key assistance.

When consumers order goods remotely, such as from a website or mail-order catalog, states have limited ability to collect taxes on the sale. Under current law, a state cannot require a remote seller to charge sales taxes unless the seller has a substantial presence, such as a store or warehouse, in the state.

Congress has been considering legislation to expand states' authority to collect taxes from remote sellers. We found that state and local governments could gain billions of dollars in additional revenue if given this authority, but some businesses would likely see increased costs to comply with the tax laws of multiple states.