California 'Amazon tax' kicks in – and local businesses could be losers

A new California law, taking effect Friday, requires large, out-of-state retailers to collect sales taxes on Internet purchases by California customers. The Golden State is the seventh, and most populous yet, to pass such a law.

Called the “Amazon tax,” the law was signed Wednesday by Gov. Jerry Brown (D) in hopes of raising an estimated $317 million annually to help close a yawning budget gap. At least 10 other cash-strapped states want to do the same.

But California’s new law has plenty of critics, including local business owners who may end up taking a big hit.

“We’re going to have to leave the state,” says Keith Posehn, who operates a website with his wife in San Diego.

California – like New York, Illinois, Arkansas, Connecticut, North Carolina, and Rhode Island before it – is trying to get around a 1992 US Supreme Court ruling that holds sellers can’t be forced to collect sales taxes unless they have a physical presence in the state.

“States in search of revenues try to find ways to establish that out-of-state retailers do have a presence or nexus,” says Stephen Liedtka, associate professor of accounting at Villanova University in Pennsylvania.

Indeed, California has come up with its own way of defining an online retailer’s physical presence in the state. This definition has everything to do with local affiliates, or businesses, that refer customers to the online retailers.

If such referrals result in substantial sales for an online retailer, then the retailer is considered to have a physical presence in California.

“The out-of-state retailer will have to collect tax if it pays commissions to people or businesses in California that refer buyers to the online retailer, and it makes more than $10,000 in sales on those referrals and it has more than $500,000 in total sales in California,” explains Daniel Schibley, senior state tax analyst at CCH, in an e-mail. CCH publishes tax information.

Mr. Posehn is one of at least 25,000 local affiliates affected by the new law. In 2008, he and his wife created Zorz.com – a website that helps clients develop online advertising campaigns. Until now, when his business referred a customer to an online retailer like Amazon or Overstock.com – and the customer made a purchase there – he was paid a commission. But now the online retailers are cutting off such payments, in a bid to erase their connections to California.

Posehn says that 35 percent of his business is evaporating without the commissions.

Looking for a state that is friendlier to tech-firm start-ups, Posehn says his next stop is Washington, Texas, or Utah. “We can either stay here and remain a target for a state that is hostile to the core of its own economy, or go to a state that is more supportive and open to tech and small business,” he says.

Mr. Schibley explains just how a referral to an online retailer works. He gives as an example a person who sells sewing supplies out of his home via a website. The website might include a notice that says, “Click here to shop for sewing machines.” That click would take the buyer to an Amazon site. If the buyer then purchased a sewing machine from Amazon, Amazon would pay the website operator a commission on that sale.

Not surprisingly, Amazon and other online retailers object to California’s new law. “We oppose this bill because it is unconstitutional and counterproductive,” Amazon says in an e-mailed letter that explains the termination of its affiliate advertising program.

Supporters of the law say they are just trying to level the playing field. Online sellers, they say, have turned local retail stores into places where shoppers go to examine merchandise – before buying it online.

“You can’t give one segment of retail a 10 percent discount every day. It’s just not fair,” Bill Dombrowski, president of the California Retailers Association, told the Los Angeles Times.

In the end, California’s hope that the law will produce more tax revenue may not become reality. In North Carolina and Rhode Island, tax revenues actually decreased after similar laws were enacted, according to the Tax Foundation in Washington.

That’s because the small businesses are crushed, says Rebecca Madigan, executive director of the trade group Performance Marketing Association in Camarillo, Calif. “Their only option is to move out of state and take their employees with them,” she says.

Ms. Madigan surmises that it is big-box stores like Wal-Mart and Costco that lobbied and sold lawmakers on the legislation in their own efforts to wipe out their online competition.

Her organization is suing Illinois over the law, and Amazon is suing the State of New York.