How better data can help states improve online sales tax collection

In 2020, e-commerce grew by 32.4% over the previous year, and it’s still rising. E-commerce was 7.7% higher in the first quarter of 2021 compared to the fourth quarter of 2020, according to the Census Bureau. Most states, however, are struggling to ensure that businesses comply with sales tax laws, which negatively impacts revenue.

In 2018, the Supreme Court’s Wayfair decision allowed states to require remote – online -- sellers to collect and remit sales tax, but states still lack an effective way of making sure businesses comply, said Scott Peterson, vice president of U.S. tax policy and government relations at Avalara, a provider of tax-compliance software.

“States need to develop more real-time pictures of their economies,” Peterson said. “All the information that exists on how the economy is doing is reported to governments on a very infrequent basis. If you’re a governor, at best you learn once a month how the retailers in your state are doing.”

“Surveying State Leaders on the State of State Taxes,” a report by the Tax Policy Center released last month, found it surprising “that states are largely unable to determine what share of sales taxes is coming from online sales, especially if sales transactions are from companies with an in-state physical presence. Although technology could help better differentiate these sales, part of the uncertainty is because of the way revenues are remitted to the state. And improving or changing technology doesn’t seem to be a priority among most states.”

Understanding the differentiation between sales tax revenue from in-state brick-and-mortar stores vs. online sellers is important to finding tax evaders or business owners who simply aren’t aware of the requirements, Peterson said.

“It goes to your ability to predict,” he said. For example, without accurate data, states couldn’t truly understand how the pandemic would affect their tax revenues and appropriately plan for last year’s recession.

In fact, “states’ ability to tax online sales transactions helped support state revenues,” the report found. “The pandemic and the renewed importance of e-commerce led all three states without legislation in place [Florida, Louisiana and Missouri] to pass such laws.”

About half of survey respondents said they track online sales tax collections separately. For example, respondents from Maryland indicated that some online sales tax revenue is tracked separately because it is dedicated to education funding (according to rules that were part of the legislation expanding online sales tax collection). However, officials can’t track all online sales tax receipts because companies with brick-and-mortar stores within the state co-mingle their in-store and online remittances.

In Wisconsin, the Department of Revenue established a system to estimate sales tax collections resulting from the Wayfair decision and from online marketplaces, but these are estimates based on new filers before and after the passage of the state’s Wayfair-related and marketplace facilitator taxation laws.

Respondents in 10 states said they had invested in the past three years in technology to differentiate between brick-and-mortar and online business sales taxes. Two of them plan to invest in more solutions in the next three years, but respondents in 16 states said they had not made any investments and 13 of those don’t plan to.

One state actively leveraging technology is Colorado. Its new Sale and Use Tax System is a “one-stop portal” for businesses to collect and remit retail sales tax, according to the report. It can look up sales- and use-tax rates by address, calculate tax rates on items with differing tax rates in the same jurisdiction, and provide a uniform remittance form.

Some states are outsourcing compliance work. Just as companies that handle payroll for agencies automatically withhold income taxes, states can contract vendors to do the same for e-commerce sales taxes. That would increase compliance -- and revenues -- Peterson said.

Another approach is data sharing. Although it’s not new, its importance has changed since states began trading tax information. “A data-sharing agreement today is immensely more valuable than it’s ever been,” Peterson said. “Back in the day, 30 years ago, when I ran the South Dakota sales tax, knowing that a New York business was making sales in South Dakota was virtually worthless” because taxes could only be collected on businesses with an in-state presence, he said.

Today, however, state revenue secretaries want that interstate sales information. The Federation of Tax Administrators, the trade association for state tax collection agencies, has had an information-sharing agreement in place for decades, but the level of cooperation varies among states, Peterson said.

The federation’s Southeast region has a data hub that collects sales tax data from states and shares it among members, but there is no such thing available at a nationwide scale, he added.

Data mining is another long-time standard practice for revenue departments seeking tax evaders, and today’s computing capabilities make it easier than ever to do. For instance, when he was sales tax director, Peterson said that when he wanted data analyzed, he had to put in an order for it and wait for another department or office to return the results.

“With the speed and power of the average laptop today, you can do and everybody in your office can do what it took a mainframe computer to do 20 years ago,” he said. “The data is there. They just need to figure out how to get it.”