How fair is the Marketplace Fairness Act?

The debate over the Marketplace Fairness Act (MFA) of 2013 is starting to heat up. It’s already cleared the Senate hurdle and is expected to wind its way through the House of Representatives by the start of the fall. The stakes are huge: if passed, the law would redraw the sales tax landscape and affect just about every company, either directly or indirectly.

Companies are anxiously awaiting the outcome. ‘In its current version, we think the MFA is terrible for us and for small businesses across the country,’ says Jonathan Johnson, executive vice chairman of the board of directors of Overstock.com, an online discount retailer. ‘It creates a huge administrative burden that will be very difficult for small businesses to meet. That said, if the MFA becomes law, we will comply.’

The MFA’s central aim is to level the playing field for all businesses, irrespective of size or location. Advocates of the law argue that out-of-state and online vendors should have to remit the same sales-and-use taxes as bricks-and-mortar businesses. 

‘The biggest upside is to local stores that don’t sell online,’ says Vladimir Gendelman, president of Company Folders, an online service that creates folders and other print marketing materials. Phil Rooke, CEO of Spreadshirt, an internet company offering custom T-shirts, clothing and other products, notes that although there will be initial price increases, the MFA will be good news for customers, because a fair system for commerce will lead to greater choice for consumers.

Cash-strapped states that are eager for additional sources of revenue to refill their drained coffers will also benefit. ‘States have been unable to establish an efficient and reliable process to collect taxes from residents on internet and catalog sales,’ says Brian Murphy, national managing partner of state and local tax services for Grant Thornton. ‘The MFA will change the legal standards in all states and provide the authorities with a means to collect more than $23 billion in annual sales-and-use taxes from residents that have previously gone unpaid (according to a 2012 estimate from the National Conference of State Legislatures).’

In order to collect taxes from online and remote companies, however, states would be required to provide firms with taxability and exemption information, as well as free software that would calculate transaction-level taxes, file sales-and-use tax returns and be regularly updated to reflect rate changes. Only remote sellers with $1 million or less in annual remote sales would be exempt from the law. All other companies should consider what they would need to do to comply.

Simple, or simply too much?

For businesses, says Murphy, the MFA is intended to provide some level of sales tax simplification in an effort to make it easier for remote sellers to comply with the collection and remittance process. Some of the MFA simplification provisions include single-entity administration of all state and local sales-and-use taxes, a single administering entity, a uniform sales-and-use tax base among the state and local taxing jurisdictions, and destination sourcing for all remote sales, he adds.

The reality is that things aren’t likely to be that simple. Companies will have to deal with substantially different sales tax bases and questions of taxability from state to state, as well as different filing platforms. When combined with the sheer number of sales tax filings in comparison to what these companies may have been used to filing, the effect of the MFA could be overwhelming over time, Murphy notes.

In a prepared statement, Michael Fuljenz, president of Universal Coin & Bullion, expresses his frustration: ‘As a small business owner, I may now be severely limited in doing business in some states as I could be swamped by paperwork [and] be subjected to hundreds of taxing authorities’ demands for records, audits and other demands. The time, expertise or legal ability to respond to or defend these issues would be prohibitive to me and other small, lower-margin businesses.’

The investment to comply with the MFA won’t be cheap. According to Gendelman, some of the costs would include ‘new accounting systems to track taxes, investing in new website functionality that can handle the complexity of 9,600 tax jurisdictions – to say nothing of the time and challenge of upgrading these crucial systems – and hiring and training additional employees to manage new tax processes, whether or not the business supports additional hires. Companies will take on new costs and open themselves to new risks, including audits from far-away states. This will result in a sizable increase in the cost of goods purchased online, which may affect the business model of online merchants. This price increase will alter customers’ buying habits.’

Gendelman says the MFA will have a lower impact on larger companies because Amazon and others like it have millions of customers, so the per-customer increase will be minimal. For small internet businesses with only a few thousand customers, however, the additional charge per customer will be much more substantial. ‘The MFA could be the straw on the struggling camel’s back that pushes some small online firms to consider going out of business,’ Gendelman warns.

Developing a game plan

Until the final bill is passed, it’s hard to know the depth and scope of what may become reality. How then to develop a game plan? ‘Any company that buys and/or sells taxable goods and services remotely needs to review its internal sales-and-use tax systems and processes to make certain they are able to comply with the MFA if it becomes law,’ says Jeffrey Saviano, partner and leader of the indirect, state and local tax practice at Ernst & Young.

‘Prepare for change,’ recommends Carla Yrjanson, vice president of tax research and content for indirect tax at Thomson Reuters. ‘Governments are hungry for revenue, and taxation of online goods and services is a very likely candidate to help them shore up their budget deficits.’ 

The collection of the sales-and-use tax begins 180 days after the state publishes notice of its intent to exercise authority (but no earlier than the first day of the calendar quarter that is at least 180 days after the legislation is enacted). There is nothing worse, however, than scrambling at the last second, not knowing where and how all the pieces fit together or how this will affect the company’s bottom line and resource allocation, says Gendelman. 

That’s all the more reason not to wait for the software provided by the states. Focus on compliance issues now, says Ed Zelinsky, a law professor at Yeshiva University’s Cardozo Law School. There are already a number of solution providers like Avalara and TaxCloud that offer software that can calculate, collect and remit sales tax to all the relevant states, says Rebecca Madigan, executive director of the Performance Marketing Association, which supports the MFA. ‘They provide little widgets that get added to check-out pages – it’s as easy as including credit card processing software,’ she notes. 

Rooke’s company already pays sales taxes in 16 countries and three US states. ‘Once the processes are set up, the work is automated,’ he says. ‘Our accountant maintains an annual audit to ensure everything is working properly in order to troubleshoot future problems.’ 

Thinking through the details

Murphy highlights a few questions companies will need to answer. Do the accounting and tax information systems required to be compliant with the new standards exist? Will the company’s existing sales-and-use tax software work sufficiently? Does the sales-and-use tax function have the ability to determine the taxability of goods and potentially some services in all of the states? Can the company handle an increased number of state audits? ‘Companies need a general game plan and cost estimate of complying with this bill,’ Gendelman says. ‘They need to know how much they will need to raise prices in order to be compliant.’

‘Keep it simple for the customer,’ says Rooke. ‘Concentrate on the value, services and choices you deliver. This is what makes winning companies in booms, recessions or taxation changes. This will help you survive and thrive despite the MFA.’ 

‘Board members should get informed about the requirements and implications of the act so that a preliminary assessment can be made as to its potential impact on the company’s business model, cash flow and financial statements,’ says Loren Chumley, KPMG’s national practice leader for indirect taxes. 

The board should have a sense of how many states could audit the business and what the company can do to mitigate concurrent audits. Board members need to be apprised of management’s plans for potential implementation so they can assess the relative risks to the company, making sure all affected aspects of the business are discussed, says Chumley. 

The biggest mistake, says Andrew Johnson, partner with the accounting firm Peisner Johnson, is to ignore the MFA and to ignore the sales tax nexus generally. ‘The big risk is that companies have nexus, and they sell taxable goods, but fail to collect the appropriate tax at the time of the sale,’ he explains. ‘Later they are found to have nexus and they’re assessed for the tax. The tragic result is that instead of the sales coming out of their customers’ pocket, it ends up coming out of theirs. Figure 8 percent to 10 percent on top of all sales, and that can add up to substantial liabilities. If you fail to collect tax, the state can get it from you – and will add on penalties and interest. That’s a big problem.’