Taxing Online Sales

Much to the chagrin of legislators supporting this movement, prominent online retailers Amazon.com and Overstock.com (among others) have begun canceling affiliate programs in affected states rather than submit to the requirements of the new laws. This trend, if it spreads among online retailers, will have important repercussions for online marketers with business models dependent on commissions from these programs. They must either relocate or suffer significant hits to their earnings, a result that undermines the revenue generation goal of these statutes. Moreover, while nobody expects online sales to diminish, current and future legal challenges to these statutes have the potential to redefine the online sales landscape.

Constitutional Background

Virtually all states (and the District of Columbia) impose a tax on retail sales of goods and certain services that is borne by the consumer but collected by the retailer and then remitted to the state. Most states also impose a parallel “use tax” for the privilege of using goods and certain services in the state that were not subject to local sales tax (e.g., because the goods were purchased out of state). Unlike sales tax, use tax is self-reported and paid by the consumer directly to the state.

Under the “dormant” Commerce Clause of the U.S. Constitution, a retailer located outside of the state, such as a mail order or online retailer, cannot be compelled by a state to collect sales tax if the retailer does not have “substantial nexus” with the state. In the 1992 case, Quill Corp. v. North Dakota, 504 U.S. 298, 314-15 (1992), the U.S. Supreme Court held that an out-of-state retailer has a “substantial nexus” with a state only if the retailer has a “physical presence” in that taxing jurisdiction. (Quill distinguished Due Process challenges from Commerce Clause challenges, as they differ in theoretical underpinning and the legal standards applied. While Due Process concerns the fundamental fairness of government activity and requires a defendant to maintain “minimum contacts” with a jurisdiction, the Commerce Clause prohibits state action that interferes with interstate commerce. Quill held that the defendant mail order company had maintained the requisite minimum contacts with North Dakota for purposes of the Due Process Clause, but held that there was not a “substantial nexus” to justify taxation under the Commerce Clause. Id. at 313.)

Although a brick-and-mortar location with employees would satisfy the Quill standard, courts have wrestled with cases that fall short of such physical presence. Court rulings have ranged from finding that mere advertising or shipping using a common carrier to a state is not enough to establish nexus, at one end of the spectrum, to finding that “continuous local solicitation” is sufficient to satisfy the standard even if the solicitation is done through independent contractors and agents, at the other end. See, Scripto, Inc. v. Carson, 362 U.S. 207, 210-12 (1960); Tyler Pipe Indus. v. Washington State Dep't of Revenue, 483 U.S. 232, 250 (1987). As one court has put it, physical presence “need not be substantial ' and it may be manifested by the presence in the taxing state of the vendor's property or the conduct of economic activities in the taxing state performed by the vendor's personnel or on its behalf.” Orvis Co. v. Tax Appeals Tribunal, 86 N.Y.2d 165, 178 (N.Y. 1995).

Use tax compliance is low, and enforcement is expensive and politically unpopular. As one alternative, several states (including Illinois) have amended their personal income tax returns to include an entry requiring self-reporting of use tax from online purchases. (For an example of such requirements, see, Illinois 2010 Form IL-1040 Instructions, available at www.revenue.state.il.us/taxforms/IncmCurrentYear/Individual/IL-1040-Instr.pdf. For more information on use tax self-reporting requirements among states, see, Nina Manzi, “Use Tax Collection on Income Tax Returns in Other States,” Minnesota House of Representatives Research Department, June 2010, available at www.house.leg.state.mn.us/hrd/pubs/usetax.pdf.)

However, as the effectiveness of such measures to enforce self-reporting and payment of the use tax is uncertain, states understandably have pursued various theories to compel out-of-state retailers to collect local sales tax. In the case of affiliate nexus statutes, such as the recent Illinois statute, states have focused on the “agency” aspect of physical presence ' i.e., do the actions of affiliates in the state give an out-of-state retailer sufficient nexus with the state to compel the retailer to collect sales tax (or, if the retailer has not collected the tax, to make the retailer primarily liable for the sales tax it should have collected and remitted to the state).

Online Tax Laws

When New York enacted the first “Amazon.com tax” in 2008, it was mindful of the physical presence requirements of Quill and established a rebuttable presumption that if an out-of-state online retailer maintains commission agreements with New York residents or businesses which collectively generate over $10,000 in New York sales annually for the retailer, then that out-of-state retailer has a “physical presence” in the state. See, N.Y. Tax Law '1101(b)(8)(vi) (2008). New York asserts that the physical presence of these affiliates in the state, coupled with the contractual commission relationship with the out-of-state retailer, creates the “physical presence” nexus required to impose sales tax collection obligations, while the $10,000 threshold helps to establish the substantial nature of that presence. An out-of-state retailer can rebut this presumption by offering evidence that the affiliate engages in mere advertising rather than solicitation of business. Other states that have proposed or passed online sales tax legislation have studied, and in some cases emulated, New York's model when structuring their own legislation:

• Rhode Island and North Carolina have implemented online sales tax laws paralleling New York's tax, although Rhode Island's gross minimum revenue threshold for affiliates is only $5,000. See, R.I. Gen. Laws '44-18-15 (2009); N.C. Gen. Stat. '105-164.8(b)(3).
• Colorado's online sales tax law adopts a different approach from the New York model. The Colorado law applies to any “retailer that does not collect Colorado sales tax,” defined as any retailer that doesn't collect sales or use tax but sells goods to Colorado purchasers. Such retailers are required to: a) notify their Colorado consumers that they are obligated to self-report and pay the use tax; and b) file with the Department of Revenue a list of all customers who have purchased goods for shipment to Colorado, presumably to provide the state with the means for enforcement of use tax obligations directly against the consumers. See, Act, 1 Colo. Code Regs. '201-1:39-21-112.3.4 (2010). In 2011, the Direct Marketing Association obtained a preliminary injunction against the Colorado law on the grounds that it violates consumer privacy. See, Direct Marketing Association v. Huber, No. 10-cv-01546-RED-CBS (D. Colo. Jan. 26, 2011).
• Illinois' version of the law amended the state's existing statutory definition of “retailer maintaining a place of business in the state” to include any retailer holding a contract with an Illinois business or individual on which they pay commissions based upon the sale of property. See, 35 Ill. Comp. Stat. 105/2 (2011). Illinois' law also requires that such contracts exceed $10,000 annually. However, unlike New York, Illinois' law does not provide a mechanism for retailers to rebut the presumption that they engaged in solicitation rather than mere advertising.
• Several other states have proposed online sales tax legislation, including: Arizona, Arkansas, California, Connecticut, Hawaii, Iowa, Maryland, Massachusetts, Minnesota, Mississippi, New Mexico, South Carolina, Tennessee, Texas, Vermont, Virginia and Wisconsin, in each case following similar models. See, Daniel Tyler Cowan, “Recent Development: New York's Unconstitutional Tax on the Internet: Amazon.com v. New York State Department of Taxation & Finance and the Dormant Commerce Clause,” 88 N.C.L. Rev. 1423, 1429-30 (2010); Casey Ross, “Patrick Wants Net Sales Tax Created,” Boston Globe, Jan. 6, 2009, available at www.boston.com/business/taxes/arti cles/2009/01/06/patrick_wants_net_sales_tax_created; “Amazon v. the States,” The New York Times, March 17, 2011, available at www.nytimes.com/2011/03/18/opinion/18fri3.html; Betty Beard and Ronald J. Hansen, “Internet Sales Tax Eyed for Arizona,” The Arizona Republic, July 18, 2010, available at www.azcentral.com/businessarticles/2010/07/18/20100718biz-internet-sales-tax-eyed-for-Arizona0718.html; Max Brantley, “Amazon's Fight Against Tax on Internet Sales,” Arkansas Times, March 14, 2011, available at www.arktimes.com/ArkansasBlog/archives/2011/03/14/amazons-fight-against-tax-on-internet-sales.
  [ Editor's Note: On May 31, 2011, the California State Assembly approved legislation to require online retailers to collect state sales and use tax with the passage of AB 155 . Sponsored by Assemblyman Charles Calderon (D-Whittier), the measure extends the statewide sales tax to purchases made from online retailers that have a presence in the state, including those that work with sister companies with offices in California. The state Board of Equalization estimates that unreported sales and use taxes total more than $1 billion annually, the Associated Press reports, but that figure might also include uncollected sales and use taxes from purchases made out-of-state by California residents. The bill passed 47-16 with the support of one GOP lawmaker and now heads to the state Senate.]

Short-Term Impact:
Online Retailers Void
Affiliate Relationships

In theory, under these new tax laws, out-of-state online retailers would collect and pay over to the state sales tax on online purchases made by resident consumers, thereby recapturing what proponents view as lost tax revenues. In Illinois, for example, legislators estimate that the proposed legislation could generate over $150 million in new revenue for the state. In practice, however, online sales tax laws have thus far failed to live up to the promise of increased sales tax revenues, while at the same time bringing negative consequences to in-state business owners contracting with these online retailers.

As mentioned earlier, Amazon.com and Overstock.com already have stopped operating affiliate programs in Rhode Island, North Carolina, Colorado, and now Illinois, in an effort to end their “physical presence” in those jurisdictions and maintain their ability to offer sales-tax free purchases to consumers. (In light of the pending legal challenge, Amazon did not terminate its affiliate program in New York and collects sales taxes on online purchases.) While these moves may protect the online retailers from sales tax collection obligations, it also harms the in-state individuals and businesses that rely upon those marketing commissions.

Of the states that have rejected online sales tax legislation, several point to the withdrawal of online retailers or harms to small business as a primary concern. (Governor Schwarzenegger vetoed California's proposed sales tax measure in 2009, citing potential job loss and an announcement by Overstock.com to terminate affiliate agreements. In Virginia, proposed legislation was vetoed at the committee level after the Department of Taxation concluded that such laws could actually decrease tax revenue for the state, concluding: “by [Amazon] ending the affiliate program with Virginia vendors, such vendors would likely lose business and remit less Retail Sales and Use Tax to Virginia.” Virginia Department of Taxation, 2010 Fiscal Impact Statement SB 660, available at http://leg1.state.va.us/cgi-bin/legp504.exe?101+oth+SB660F161+PDF.)

Opponents of these laws argue that the actual economic effect of such a law contradicts the legislative intent in two ways. First, the state fails to collect additional sales taxes as online retailers terminate affiliate programs in the state. Second, local e-commerce businesses at best suffer reduced revenues or, at worst, go out of business or relocate their operations to a state that has no such law. When state businesses lose revenue and jobs, the state's taxable income base shrinks. The net result, the opponents argue, is that the affiliate nexus laws, rather than creating the multi-million dollar returns promised by lawmakers, will actually diminish state tax revenues.

Long-Term Impact:
Amazon.Com v. New York

In 2008, Amazon.com and Overstock.com sued the State of New York, alleging that third-party contractual relationships are not enough to constitute “physical presence” in New York for purposes of taxation. In previous catalog and mail-order cases, courts have found that commissioned sales brokers under the facts of those cases may be sufficient to create a “physical presence” under the substantial nexus standard, as they play a pivotal role in the retailers' ability to “establish and maintain” their market in the taxing jurisdiction. See, Scripto, 362 U.S. at 210; Tyler Pipe, 483 U.S. at 250; Orvis, 86 N.Y.2d at 181. Online retailers argue, however, that the Internet is a fundamentally different commerce structure. Online retailers don't need a physical presence to “establish and maintain” a market in any location, and the activities of affiliates are aimed at funneling traffic to the retailer's own site ' a function that online retailers would argue is much more akin to advertising than to solicitation. Further, any sales facilitated by affiliates are as likely to come from outside the affiliate's home state as within it, making the affiliate's physical location a misleading indicator of in-state activity by the retailer. The characterization of online retailers' affiliate relationships as either advertisement or solicitation will be a critical determinant of the law's constitutionality.

As of the date of this writing, that question remains unanswered. In 2009, the lower state court in New York dismissed Amazon.com's complaint seeking a declaratory judgment, holding that the affiliate relationships are enough to constitute a “substantial nexus” with New York, based on the fact that the law requires agreements with New York residents and businesses, and that the $10,000 minimum ensures that those contracts are substantial. See, Amazon.com, LLC v. N.Y. State Dep't of Taxation & Fin., 877 N.Y.S.2d 842, 847-48 (N.Y. Supp. Ct. 2009). In November 2010, the Supreme Court of New York Appellate Division upheld the law as constitutional on its face, but reinstated the case for further proceedings to determine whether the law, as applied to Amazon.com, violates the Commerce and Due Process Clauses. See, Amazon.com, LLC v. N.Y. State Dep't of Taxation & Fin., 913 N.Y.S.2d 129, 143-44 (N.Y. App. Div. 2010). The court ordered additional discovery to determine whether in-state affiliates constitute a “substantial nexus” in New York, and specifically to establish whether affiliates solicit business essential to Amazon or merely engage in passive advertising. Id. at 145-46.

Conclusion

Amazon.com is likely to appeal any decision upholding the law to New York's Court of Appeals and possibly to the U.S. Supreme Court. If the New York law is upheld, it will undoubtedly continue to inspire similar laws throughout the country, and may dramatically alter the e-commerce landscape for businesses and consumers: Either consumers will lose the opportunity to make sales-tax free (but not use-tax free) online purchases, or Amazon.com and other online retailers will cease or modify their affiliate programs in an effort to remain free from state tax collection obligations.

If these laws are held unconstitutional, it will be a victory for online retailers, but may come too late for in-state affiliates who have already suffered from the termination of affiliate programs. With Illinois joining the online sales tax movement, and on the heels of Amazon.com v. New York, time will tell whether online tax laws are economically and constitutionally sustainable.

On March 10, 2011, Illinois Governor Patrick Quinn signed the “Main Street Fairness Act,” 35 Ill. Comp. Stat. 105/2 (2011), into law, making Illinois one of a growing number of states seeking to collect sales tax revenues from a retail market traditionally beyond their reach ' the world of online commerce ' by focusing on the role of local online marketing affiliates. Given Illinois' $13 billion budget deficit, the measure is hailed by supporters as a means for the state to collect taxes on online purchases ' and to help local brick-and-mortar businesses compete with online retailers. At the same time, the measure has been harshly criticized by online merchants who contend that it is an unconstitutional intrusion on interstate commerce, and by policy analysts who question its ability to raise tax revenues.

The 'Amazon.com Tax'

In 2008, New York began this trend by passing legislation requiring certain out-of-state online retailers to collect state taxes on purchases by resident consumers. N.Y. Tax Law '1101(b)(8)(vi) (2008). Under New York's law, dubbed the “Amazon.com tax” due to an ongoing challenge by the online retail giant ( see , Amazon.com, LLC v. New York State Depart. of Taxation & Fin. , 877 N.Y.S.2d 842 (N.Y. Supp. Ct. 2009), aff'd in part, modified in part , 913 N.Y.S.2d 129 (N.Y. App. Div. 2010)), online retailers who contract with in-state individuals and companies (known as “affiliates”) under certain marketing commission agreements are subject to sales-tax collection obligations. Since then, 12 states have proposed similar tax legislation targeting online retailers, and three states (Rhode Island, Colorado and North Carolina) already have enacted their own laws. With the passage of the Main Street Fairness Act, Illinois became the fifth state to enact such legislation.

Much to the chagrin of legislators supporting this movement, prominent online retailers Amazon.com and Overstock.com (among others) have begun canceling affiliate programs in affected states rather than submit to the requirements of the new laws. This trend, if it spreads among online retailers, will have important repercussions for online marketers with business models dependent on commissions from these programs. They must either relocate or suffer significant hits to their earnings, a result that undermines the revenue generation goal of these statutes. Moreover, while nobody expects online sales to diminish, current and future legal challenges to these statutes have the potential to redefine the online sales landscape.

Constitutional Background

Virtually all states (and the District of Columbia) impose a tax on retail sales of goods and certain services that is borne by the consumer but collected by the retailer and then remitted to the state. Most states also impose a parallel “use tax” for the privilege of using goods and certain services in the state that were not subject to local sales tax (e.g., because the goods were purchased out of state). Unlike sales tax, use tax is self-reported and paid by the consumer directly to the state.

Under the “dormant” Commerce Clause of the U.S. Constitution, a retailer located outside of the state, such as a mail order or online retailer, cannot be compelled by a state to collect sales tax if the retailer does not have “substantial nexus” with the state. In the 1992 case, Quill Corp. v. North Dakota , 504 U.S. 298, 314-15 (1992), the U.S. Supreme Court held that an out-of-state retailer has a “substantial nexus” with a state only if the retailer has a “physical presence” in that taxing jurisdiction. (Quill distinguished Due Process challenges from Commerce Clause challenges, as they differ in theoretical underpinning and the legal standards applied. While Due Process concerns the fundamental fairness of government activity and requires a defendant to maintain “minimum contacts” with a jurisdiction, the Commerce Clause prohibits state action that interferes with interstate commerce. Quill held that the defendant mail order company had maintained the requisite minimum contacts with North Dakota for purposes of the Due Process Clause, but held that there was not a “substantial nexus” to justify taxation under the Commerce Clause. Id. at 313.)

Although a brick-and-mortar location with employees would satisfy the Quill standard, courts have wrestled with cases that fall short of such physical presence. Court rulings have ranged from finding that mere advertising or shipping using a common carrier to a state is not enough to establish nexus, at one end of the spectrum, to finding that “continuous local solicitation” is sufficient to satisfy the standard even if the solicitation is done through independent contractors and agents, at the other end. See , Scripto, Inc. v. Carson , 362 U.S. 207, 210-12 (1960); Tyler Pipe Indus. v. Washington State Dep't of Revenue , 483 U.S. 232, 250 (1987). As one court has put it, physical presence “need not be substantial ' and it may be manifested by the presence in the taxing state of the vendor's property or the conduct of economic activities in the taxing state performed by the vendor's personnel or on its behalf.” Orvis Co. v. Tax Appeals Tribunal , 86 N.Y.2d 165, 178 (N.Y. 1995).

Use tax compliance is low, and enforcement is expensive and politically unpopular. As one alternative, several states (including Illinois) have amended their personal income tax returns to include an entry requiring self-reporting of use tax from online purchases. (For an example of such requirements, see, Illinois 2010 Form IL-1040 Instructions, available at www.revenue.state.il.us/taxforms/IncmCurrentYear/Individual/IL-1040-Instr.pdf. For more information on use tax self-reporting requirements among states, see, Nina Manzi, “Use Tax Collection on Income Tax Returns in Other States,” Minnesota House of Representatives Research Department, June 2010, available at www.house.leg.state.mn.us/hrd/pubs/usetax.pdf.)

However, as the effectiveness of such measures to enforce self-reporting and payment of the use tax is uncertain, states understandably have pursued various theories to compel out-of-state retailers to collect local sales tax. In the case of affiliate nexus statutes, such as the recent Illinois statute, states have focused on the “agency” aspect of physical presence ' i.e., do the actions of affiliates in the state give an out-of-state retailer sufficient nexus with the state to compel the retailer to collect sales tax (or, if the retailer has not collected the tax, to make the retailer primarily liable for the sales tax it should have collected and remitted to the state).

Online Tax Laws

When New York enacted the first “Amazon.com tax” in 2008, it was mindful of the physical presence requirements of Quill and established a rebuttable presumption that if an out-of-state online retailer maintains commission agreements with New York residents or businesses which collectively generate over $10,000 in New York sales annually for the retailer, then that out-of-state retailer has a “physical presence” in the state. See, N.Y. Tax Law '1101(b)(8)(vi) (2008). New York asserts that the physical presence of these affiliates in the state, coupled with the contractual commission relationship with the out-of-state retailer, creates the “physical presence” nexus required to impose sales tax collection obligations, while the $10,000 threshold helps to establish the substantial nature of that presence. An out-of-state retailer can rebut this presumption by offering evidence that the affiliate engages in mere advertising rather than solicitation of business. Other states that have proposed or passed online sales tax legislation have studied, and in some cases emulated, New York's model when structuring their own legislation:

• Rhode Island and North Carolina have implemented online sales tax laws paralleling New York's tax, although Rhode Island's gross minimum revenue threshold for affiliates is only $5,000. See, R.I. Gen. Laws '44-18-15 (2009); N.C. Gen. Stat. '105-164.8(b)(3).
• Colorado's online sales tax law adopts a different approach from the New York model. The Colorado law applies to any “retailer that does not collect Colorado sales tax,” defined as any retailer that doesn't collect sales or use tax but sells goods to Colorado purchasers. Such retailers are required to: a) notify their Colorado consumers that they are obligated to self-report and pay the use tax; and b) file with the Department of Revenue a list of all customers who have purchased goods for shipment to Colorado, presumably to provide the state with the means for enforcement of use tax obligations directly against the consumers. See, Act, 1 Colo. Code Regs. '201-1:39-21-112.3.4 (2010). In 2011, the Direct Marketing Association obtained a preliminary injunction against the Colorado law on the grounds that it violates consumer privacy. See, Direct Marketing Association v. Huber, No. 10-cv-01546-RED-CBS (D. Colo. Jan. 26, 2011).
• Illinois' version of the law amended the state's existing statutory definition of “retailer maintaining a place of business in the state” to include any retailer holding a contract with an Illinois business or individual on which they pay commissions based upon the sale of property. See, 35 Ill. Comp. Stat. 105/2 (2011). Illinois' law also requires that such contracts exceed $10,000 annually. However, unlike New York, Illinois' law does not provide a mechanism for retailers to rebut the presumption that they engaged in solicitation rather than mere advertising.
• Several other states have proposed online sales tax legislation, including: Arizona, Arkansas, California, Connecticut, Hawaii, Iowa, Maryland, Massachusetts, Minnesota, Mississippi, New Mexico, South Carolina, Tennessee, Texas, Vermont, Virginia and Wisconsin, in each case following similar models. See, Daniel Tyler Cowan, “Recent Development: New York's Unconstitutional Tax on the Internet: Amazon.com v. New York State Department of Taxation & Finance and the Dormant Commerce Clause,” 88 N.C.L. Rev. 1423, 1429-30 (2010); Casey Ross, “Patrick Wants Net Sales Tax Created,” Boston Globe, Jan. 6, 2009, available at www.boston.com/business/taxes/arti cles/2009/01/06/patrick_wants_net_sales_tax_created; “Amazon v. the States,” The New York Times, March 17, 2011, available at www.nytimes.com/2011/03/18/opinion/18fri3.html; Betty Beard and Ronald J. Hansen, “Internet Sales Tax Eyed for Arizona,” The Arizona Republic, July 18, 2010, available at www.azcentral.com/businessarticles/2010/07/18/20100718biz-internet-sales-tax-eyed-for-Arizona0718.html; Max Brantley, “Amazon's Fight Against Tax on Internet Sales,” Arkansas Times, March 14, 2011, available at www.arktimes.com/ArkansasBlog/archives/2011/03/14/amazons-fight-against-tax-on-internet-sales.
  [ Editor's Note: On May 31, 2011, the California State Assembly approved legislation to require online retailers to collect state sales and use tax with the passage of AB 155 . Sponsored by Assemblyman Charles Calderon (D-Whittier), the measure extends the statewide sales tax to purchases made from online retailers that have a presence in the state, including those that work with sister companies with offices in California. The state Board of Equalization estimates that unreported sales and use taxes total more than $1 billion annually, the Associated Press reports, but that figure might also include uncollected sales and use taxes from purchases made out-of-state by California residents. The bill passed 47-16 with the support of one GOP lawmaker and now heads to the state Senate.]

Short-Term Impact:
Online Retailers Void
Affiliate Relationships

In theory, under these new tax laws, out-of-state online retailers would collect and pay over to the state sales tax on online purchases made by resident consumers, thereby recapturing what proponents view as lost tax revenues. In Illinois, for example, legislators estimate that the proposed legislation could generate over $150 million in new revenue for the state. In practice, however, online sales tax laws have thus far failed to live up to the promise of increased sales tax revenues, while at the same time bringing negative consequences to in-state business owners contracting with these online retailers.

As mentioned earlier, Amazon.com and Overstock.com already have stopped operating affiliate programs in Rhode Island, North Carolina, Colorado, and now Illinois, in an effort to end their “physical presence” in those jurisdictions and maintain their ability to offer sales-tax free purchases to consumers. (In light of the pending legal challenge, Amazon did not terminate its affiliate program in New York and collects sales taxes on online purchases.) While these moves may protect the online retailers from sales tax collection obligations, it also harms the in-state individuals and businesses that rely upon those marketing commissions.

Of the states that have rejected online sales tax legislation, several point to the withdrawal of online retailers or harms to small business as a primary concern. (Governor Schwarzenegger vetoed California's proposed sales tax measure in 2009, citing potential job loss and an announcement by Overstock.com to terminate affiliate agreements. In Virginia, proposed legislation was vetoed at the committee level after the Department of Taxation concluded that such laws could actually decrease tax revenue for the state, concluding: “by [Amazon] ending the affiliate program with Virginia vendors, such vendors would likely lose business and remit less Retail Sales and Use Tax to Virginia.” Virginia Department of Taxation, 2010 Fiscal Impact Statement SB 660, available at http://leg1.state.va.us/cgi-bin/legp504.exe?101+oth+SB660F161+PDF.)

Opponents of these laws argue that the actual economic effect of such a law contradicts the legislative intent in two ways. First, the state fails to collect additional sales taxes as online retailers terminate affiliate programs in the state. Second, local e-commerce businesses at best suffer reduced revenues or, at worst, go out of business or relocate their operations to a state that has no such law. When state businesses lose revenue and jobs, the state's taxable income base shrinks. The net result, the opponents argue, is that the affiliate nexus laws, rather than creating the multi-million dollar returns promised by lawmakers, will actually diminish state tax revenues.

Long-Term Impact:
Amazon.Com v. New York

In 2008, Amazon.com and Overstock.com sued the State of New York, alleging that third-party contractual relationships are not enough to constitute “physical presence” in New York for purposes of taxation. In previous catalog and mail-order cases, courts have found that commissioned sales brokers under the facts of those cases may be sufficient to create a “physical presence” under the substantial nexus standard, as they play a pivotal role in the retailers' ability to “establish and maintain” their market in the taxing jurisdiction. See, Scripto, 362 U.S. at 210; Tyler Pipe, 483 U.S. at 250; Orvis, 86 N.Y.2d at 181. Online retailers argue, however, that the Internet is a fundamentally different commerce structure. Online retailers don't need a physical presence to “establish and maintain” a market in any location, and the activities of affiliates are aimed at funneling traffic to the retailer's own site ' a function that online retailers would argue is much more akin to advertising than to solicitation. Further, any sales facilitated by affiliates are as likely to come from outside the affiliate's home state as within it, making the affiliate's physical location a misleading indicator of in-state activity by the retailer. The characterization of online retailers' affiliate relationships as either advertisement or solicitation will be a critical determinant of the law's constitutionality.

As of the date of this writing, that question remains unanswered. In 2009, the lower state court in New York dismissed Amazon.com's complaint seeking a declaratory judgment, holding that the affiliate relationships are enough to constitute a “substantial nexus” with New York, based on the fact that the law requires agreements with New York residents and businesses, and that the $10,000 minimum ensures that those contracts are substantial. See , Amazon.com, LLC v. N.Y. State Dep't of Taxation & Fin. , 877 N.Y.S.2d 842, 847-48 (N.Y. Supp. Ct. 2009). In November 2010, the Supreme Court of New York Appellate Division upheld the law as constitutional on its face, but reinstated the case for further proceedings to determine whether the law, as applied to Amazon.com, violates the Commerce and Due Process Clauses. See , Amazon.com, LLC v. N.Y. State Dep't of Taxation & Fin. , 913 N.Y.S.2d 129, 143-44 (N.Y. App. Div. 2010). The court ordered additional discovery to determine whether in-state affiliates constitute a “substantial nexus” in New York, and specifically to establish whether affiliates solicit business essential to Amazon or merely engage in passive advertising. Id. at 145-46.

Conclusion

Amazon.com is likely to appeal any decision upholding the law to New York's Court of Appeals and possibly to the U.S. Supreme Court. If the New York law is upheld, it will undoubtedly continue to inspire similar laws throughout the country, and may dramatically alter the e-commerce landscape for businesses and consumers: Either consumers will lose the opportunity to make sales-tax free (but not use-tax free) online purchases, or Amazon.com and other online retailers will cease or modify their affiliate programs in an effort to remain free from state tax collection obligations.

If these laws are held unconstitutional, it will be a victory for online retailers, but may come too late for in-state affiliates who have already suffered from the termination of affiliate programs. With Illinois joining the online sales tax movement, and on the heels of Amazon.com v. New York, time will tell whether online tax laws are economically and constitutionally sustainable.