Back in March of last year, Illinois joined a small cadre of states putting a new tax on online sales into law. Backed by Gov. Quinn (D-Ill.), the law was designed to force out-of-state retailers who advertise in Illinois to collect and pay sales taxes. Yesterday, however, a Cook County Circuit judge rightly ruled the law violated the Commerce Clause of the U.S. Constitution.
The Supreme Court ruled in 1992 that states can not force out-of-state companies to collect and fork over sales taxes levied on in-state consumers, unless they have a physical presence in the state. That landmark case, Quill v. North Dakota, not only set a bright line rule, but also the stage for a push over the last three years to circumvent the Supreme Court’s ruling. The aim of Internet tax advocates is not only to raise taxes, but also to dissolve the physical presence standard.
Illinois’s law was the most frequently enacted by primarily liberal states, like New York, California, and Connecticut. Dubbed the “affiliate nexus tax,” it required online retailers who advertise on “affiliated” websites in the state to start charging the state’s sales tax. Not only did Cook County Circuit Judge Robert Lopez Cepero rule that a stretch under the Commerce Clause, he found it ran afoul of the federal Internet Tax Freedom Act, which prevents discriminatory taxation of e-commerce.
Almost immediately upon passage last year, the affiliate tax started to wreak havoc. Internet advertisers found their business relationships cut from major online retailers like Amazon.com, who were left with little choice after being handed an unconstitutional requirement. Since online ad contracts were severed, affiliate advertisers closed up shop and fled Illinois altogether. With no more online ads in the state, the law became moot. The only thing it accomplished was putting 9,500 of their own residents out-of-business. Not only did this mean the tax hike failed to raise revenue, but it lost the state an estimated $22 million from income taxes on businesses that no longer existed.
The problem is not unique to Illinois; advertisers in every other state where the law was passed were also put out of work. This led online affiliates to band together under the Performance Marketing Association to challenge the law, and they started with a great success in Illinois.
The win in Illinois is not the first time taxpayers have watched such unconstitutional Internet tax bills go down. Earlier this month, the U.S. District Court of Colorado finalized a permanent injunction against a different type of tax. Colorado’s “reporting requirements” law forced online retailers to tell the Department of Revenue who it’s customers were and what they purchased. That way the state could go after their own residents for “use tax” collection. Use tax is owed when a consumer buys something elsewhere and brings it in-state, but it goes largely uncollected. Like in Illinois, the court determined the law violated the physical nexus standard set in the Commerce Clause and Quill case. Another court found a similar law in North Carolina also violated the First Amendment, since consumers have a right to purchase goods anonymously to the state.
To be sure, this is not the end of the affiliate nexus Internet tax. The court’s ruling will be challenged up to the highest court possible. But let this be a shot across the bow to politicians in other states considering such taxes. This ruling is a monumentally important step in the fight against higher taxes online. It also helps preserve the critical physical nexus standard that prevents tax collectors from reaching across their borders to raid the wallets of residents in other states.