Technology Team Newsletter: Taxation by Association: Law and State Taxation of Internet Sales

Internet retailers sell goods online to buyers all over the world. It is not uncommon for Internet retailers to have "associate programs" that allow persons to maintain links to Internet retailers on their own Web sites. The Internet retailers, in turn, pay an associate a percentage of the sale proceeds generated through the special links.

Historically, Internet retailers have not collected state and local sales taxes on sales made through an associate program, provided the Internet retailer itself does not have a sales force or store in a particular state. Warning: The days of relying on this exemption may be numbered. A New York tax law enacted in 2008 (commonly called the " law") provides that an Internet retailer is considered a New York "vendor" and must collect New York sales tax on sales into New York if: (a) it enters into commission agreements with New York residents and compensates them for referring customers to its Web site; and (b) gross receipts from aggregate commission sales exceed $10,000 annually. The law essentially treats the associates as an Internet retailer's New York sales force requiring it to collect New York sales tax on its sales into New York.

This law was recently challenged in two separate court actions by and based on various constitutional grounds. However, in January 2009, a New York trial court upheld the law, finding that it did not violate either the New York or U.S. Constitution. It is widely anticipated that or, or both, will appeal the decision. If the New York law is ultimately upheld, its impact across the country could be significant. Since the January decision, California, Connecticut, Hawaii, Maryland, Minnesota, Rhode Island, and Tennessee have introduced bills modeled after the law in New York. While the number of bills is small (and some appear to have already lost traction in the relevant state legislature), this development is sending shockwaves throughout the business and legal communities.

Those in favor of the bills claim that the increased sales tax revenue would help strained state budgets. Proponents also claim that these bills would level the playing field between traditional brick and mortar businesses, which must collect sales tax in states where they are located, and out-of-state Internet retailers. Critics argue that having multiple states with their own law will only add unnecessary complexity and increase costs in complying with an already complicated patchwork of state and local tax rules. Opponents also point out that the bills have prompted Internet retailers, such as and, to suspend their associate programs in those states and that such action directly hurts smaller Internet retailers who depend on the associate programs as a source of revenue.

It remains to be seen whether the law in New York is ultimately upheld and other states enact similar laws. We will keep you updated on this and other developments in future newsletters from the Technology Team.