Colorado cities want to tap into online sales revenue. That means the state’s messy sales tax system could get messier.
In South Dakota v. Wayfair, Supreme Court ruled online taxes can’t be “burdensome” for interstate sales, but Colorado’s complex system will put the ruling to the test
As state regulators scramble to expand online sales taxes in the wake of a landmark U.S. Supreme Court decision, Colorado’s largest cities could suddenly find themselves missing out on a new funding spigot worth millions of dollars each year.
But if they try to get their piece of a growing tax pie — Denver alone could reap more than $5 million each year — experts say they’re just as likely to find themselves in federal court.
The net result could be a hybrid system unlike any other in the country: one that would effectively require out-of-state businesses to collect some sales taxes but not others.
The U.S. Supreme Court in June overturned a de facto ban on interstate online sales taxes, ruling in South Dakota v. Wayfair that a state can require online retailers to collect and remit sales taxes regardless of whether they have a physical presence there.
The catch: states aren’t allowed to put an excessive burden on interstate businesses. And where South Dakota’s system was designed to be simple and user-friendly, Colorado’s is notoriously complicated and cumbersome — so much so that tax experts across the country believe it’s the most likely test case for the lingering question from the Wayfair case: What exactly constitutes an excessive burden?
The question has complicated Colorado’s efforts to expand online sales taxes to out-of-state retailers. And it has left top policymakers, advocacy groups and business coalitions urging patience.
A legislative task force is in the midst of a years-long effort to simplify the state’s sales tax collections, but the solutions being considered are still months or years away from coming to fruition.
So far, Colorado’s 71 home rule cities – which are independent bodies under the state constitution — that administer their own sales taxes are holding off. But state regulators are plowing ahead with plans of their own, holding an emergency hearing later this week on a major shift in sales tax rules that would pave the way for online sales taxes starting Dec. 1.
The new regulations would have ripple effects for many in-state businesses as well, adding another layer of complexity — and frustration — to sales tax collection in a state that is already infamous for it.
“We’re supposed to be trying to simplify our sales tax process,” says Tony Gagliardi, the Colorado state director of the National Federation of Independent Businesses. “And instead we’re just making it even more complicated.”
Why Colorado’s tax system is such a headache
Colorado certainly isn’t the only state with a complicated array of overlapping state and local sales tax requirements. But it’s the absolute hardest one for businesses to navigate, according to a 2018 analysis by the Council on State Taxation.
Between the hundreds of special districts that sit inside cities, which sit inside counties, which sit inside the state, Colorado at one point had a dizzying 756 possible combinations of sales taxes for businesses to collect depending on their physical location.
Most of these taxes are paid directly to the state, which then sends them along to local governments. But 71 home rule cities collect their own sales taxes, requiring companies to acquire separate tax licenses to do business there. In some cases the tax base can differ from one jurisdiction to the next, meaning a product that’s subject to taxes in one place may be exempt from taxes in another.
Further complicating matters: Different places don’t even agree on definitions for common terms like “groceries” or “computer equipment.”
Still, up until now, the state’s complicated tax code has not much of a problem for the typical mom-and-pop business on Main Street. Because taxes were based on the store’s physical location, it didn’t matter if a shop sold a product to someone who walked into the store or shipped it to Grand Junction — the business owner only paid taxes where the store was located.
That’s about to change – and only add headaches. Under the new rule, which takes effect Dec. 1, sales taxes will be applied wherever a product is delivered, not where it’s sold. The regulation applies to out-of-state tax collections, but also would affect in-state retailers that offer shipping.
The smallest out-of-state businesses get a pass. As long as they don’t sell more than $100,000 worth of goods or conduct more than 200 transactions in Colorado in a year, they’re exempt. But the in-state retailers have to follow the new rules, regardless of their size.
“It could be a total nightmare”
One silver lining that applies to all businesses: the Department of Revenue is delaying enforcement until the end of March.
Gagliardi, the Colorado NFIB director, says the extension offers some relief for businesses, but he thinks the state should push the whole endeavor back to March and re-evaluate it once the legislature’s in session.
“I’ve had accountant after accountant tell me there’s just no way to get a business into compliance by that first deadline of Dec. 1,” Gagliardi said.
Still, some small business owners say they aren’t too worried about it, thanks to new technology. Colin McIntosh, the CEO of Sheets & Giggles, a Denver-based online bedding retailer, says his company uses Shopify, a website platform for e-businesses with a built-in payment portal that calculates sales taxes automatically based on the buyer’s address.
But to use Shopify’s checkout system, an online business would have to set up their website through the company — and pay a monthly fee. Those who use another platform or built their own payment system have to figure out another way to calculate sales taxes for buyers across the state — and in the wake of the Wayfair decision, possibly across the country.
For a business that doesn’t already have a system like Shopify in place, McIntosh said, “it could be a total nightmare.”
Colorado lawmakers look for fixes
As interstate sales taxes become the norm, it’s reasonable to expect solutions like Shopify to proliferate. But while Colorado has wide latitude to require in-state businesses to keep up with its ever-changing tax policies, the U.S. Supreme Court has indicated there are limits to what a state can require of retailers based outside its borders.
“One of the factors that the court mentioned in Wayfair is that it not be burdensome,” said state Rep. Tracy Kraft-Tharp, D-Arvada, who chairs a legislative task force on sales tax simplification. “Colorado’s tax system is very burdensome.”
Broader reforms are in the works in Colorado, but they will take time — and the cooperation of home rule cities which have wide latitude under the state constitution to set their own tax policies.
The task force has proposed a bill that would establish a statewide clearinghouse for sales tax collections — effectively a one-stop shop for businesses as they navigate Colorado’s sales tax minefield. The hope is that a few home rule cities in Colorado will try it out, and the rest will follow voluntarily.
But first, the Colorado Municipal League is trying to get all 71 home rule cities to adopt the same tax base. It still wouldn’t match the state’s, which has adopted dozens of tax breaks for special interests, but it would be a big step toward simplification. So far 46 have signed on.
“We can get there as a state, and the 71 self-collecting home rule municipalities, but there are going to be some additional steps to be taken so we don’t end up being the poster child that some of the pundits thought we’d be for lawsuits,” said Kevin Bommer, the CML deputy director.
Theoretically, the state could step in and try to force every city in the state to adopt a uniform sales tax system like South Dakota’s. But it would almost certainly lead to a legal fight. Home rule cities — who could lose tax revenue if something they tax today was suddenly exempt – could sue the state to retain their constitutional autonomy. And taxpayer advocates could bring a challenge under the Taxpayer’s Bill of Rights if it results in new taxes without a vote of the people, either for the state or cities.
That leaves the focus, for now, on state regulators, who meet Nov. 30 on the rule change — a hearing that has tax experts and business advocates flying in from all over the country to testify.
“Everybody is watching,” Kraft-Tharp said. “Everyone knows that we have the most complicated, convoluted system. They’re all watching to see what are we going to do to make that easier.”