Most states impose a sales tax upon retail sales of tangible personal property within the state. Where sales tax is not collected on the sale, most states require the purchaser to pay an equivalent “use” tax upon the purchase. However, many purchasers fail to comply with the use tax statutes that require payment of taxes on online purchases, and states historically have had limited resources to collect use taxes on online purchases.

As state and federal revenue has decreased in light of the economic downturn, governments of all levels have taken steps to fill their budget gaps. One such step is the enactment of laws commonly referred to as “Amazon laws” in an attempt to increase states’ ability to collect taxes on online sales.  

Legislation at the State Level

The “Amazon” laws are generally based on two approaches. The first approach is commonly referred to as “click-through nexus,” which generally expands current law to require a retailer to collect sales tax from customers in situations in which the retailer does not have a physical presence in the state. The second approach imposes increased reporting requirements to enhance use tax compliance.

Click-Through Nexus. Under the click-through nexus approach, states attempt to impose a collection obligation in certain situations in which a retailer does not have a traditional physical presence. Specifically, these laws provide that retailers will be deemed to have a physical presence in states where agents solicit business on their behalf. Under a click-through nexus statute, a retailer without traditional physical presence in the state will be considered to have physical presence if it does business with a company that has physical presence in that state and has a website that directs online users to the retailer’s website in exchange for compensation. For example, if a business has physical presence in all fifty states and its website has a click on referral for a retailer, that retailer could be considered to have physical presence in each such state and be required to collect sales or use taxes on all of its online sales in the states that have a click-through nexus statute (as opposed to only being required to collect taxes on sales generated by the click-on referral in such states).

New York was the first state to adopt the click-through nexus approach in 2008. Other states that have enacted a similar approach include Arkansas, California, Connecticut, Illinois, North Carolina, Rhode Island and Vermont. Click-through legislation has been proposed in a number of other states as well, including Arizona, Massachusetts, Minnesota, Tennessee and New Mexico.  

Use Tax Reporting. The use tax reporting statutes require retailers to apprise customers of the need to report and pay a use tax and often attempt to require retailers without a taxable nexus to file a tax return. Statutes requiring retailers to report to the state of residence of the customer the total amount of the online purchases made by the customer will do so regardless of whether the retailer has a physical presence in the state. Colorado is an example of a state that enacted a use tax reporting statute.

Constitutional and Other Legal Challenges. Both the click-through nexus approach and use tax reporting approach enacted by states have faced constitutional challenges, some of which have been successful.14 For example, a click-through law in Illinois was deemed unconstitutional in May 2012.15 The Illinois Cook County Circuit Court held that the law violated the dormant Commerce Clause and was preempted by the federal Internet Tax Freedom Act, which prohibits multiple or discriminatory taxes on e-commerce. In 2012, a federal court held that the use tax reporting law in Colorado was unconstitutional as it violated the dormant Commerce Clause.16

Proposed Legislation at the Federal Level

Because Congress has the authority to grant states the power to regulate interstate commerce, Congress could enact legislation that requires retailers to collect sales or use taxes on online sales and remit the taxes to the state of the purchaser even when a retailer lacks physical presence in that state. Legislators in Congress have proposed several different laws that would give states the power to tax sales by online retailers. The proposed laws include the Main Street Fairness Act (H.R. 2701 and S. 1452), the Marketplace Equity Act of 2011 (H.R. 3179) and the Marketplace Fairness Act (S. 1832).

“…the enactment of laws commonly referred to as “Amazon laws” [is] an attempt to increase states’ ability to collect taxes on online sales.”

Main Street Fairness Act. The Main Street Fairness Act would permit each state to require remote sellers to collect sales or use tax if the state is a member of the multistate Streamlined Sales and Use Tax Agreement (“SSUTA”). The SSUTA sets out guidelines to simplify and conform state-level tax systems. The Main Street Fairness Act also provides for a governing board to resolve any issues arising under the SSUTA, and gives to the United States Court of Federal Claims exclusive jurisdiction to review the governing board’s decisions.

Marketplace Equity Act. The Marketplace Equity Act would permit a state to require remote sellers to collect sales or use taxes on sales in that state upon the implementation of a simplified tax administration system. The Marketplace Equity Act differs from the Main Street Fairness Act as it (i) sets out its own guidelines for states rather than depending on an independent agreement (i.e., the SSUTA) and (ii) does not create an independent board to resolve conflicts arising thereunder. Under the Marketplace Equity Act, a state’s sales and use tax system must meet minimum requirements relating to streamlined return filing, have uniform tax base and exemptions throughout the state, and implement the sales and use tax rate structure in order to impose collection duties. In addition, a state must refrain from holding remote sellers responsible for collecting the tax until it publishes a notice about the new law for at least six months.

Marketplace Fairness Act. The Marketplace Fairness Act is a hybrid of the two proposed laws mentioned above. Under the Marketplace Fairness Act, a state can impose a duty on remote sellers to collect sales or use taxes on sales to customers in that state if the state meets one of two requirements: (i) if it is a member of the SSUTA or (ii) if it has implemented a simplified tax administration system.

Industry Reaction to Legislation

Online retailers have historically fought against legislation that would require collection of sales or use taxes in states in which they do not have physical presence. As a result, they have fought the constitutionality of the state statutes and generally resisted the enactment of federal statutes. However, the stance of the largest player in online retail is changing. Amazon recently entered into settlements with various states, including California, Pennsylvania and New Jersey, in which it agreed to collect sales or use taxes in return for such states foregoing uncollected taxes on past sales. In addition, in August, a representative of Amazon endorsed the Marketplace Fairness Act at a Senate Commerce, Science, and Transportation Committee hearing.


State governments’ attempts to collect sales tax have created a general unease for online retailers who have historically avoided these taxes. In light of the above, private equity investors considering an investment in such retailers should analyze the impact of sales and use taxes on profitability of the online retail model.