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Why Your State Thinks You're a Tax Cheater

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TaxesMost people pay their taxes voluntarily. With at least one type of tax, though, millions of Americans break the law every year -- and many of them probably never realize it. And now, states in desperate need of more tax revenue are trying to do something about that.

Online shopping has become one of the fastest-growing parts of the retail industry. Over the past holiday season, online sales rose 15% to a whopping $37.2 billion, according to comScore, setting an all-time record. On 10 separate days, sales online hit or exceeded $1 billion.

Savings and convenience were definitely two of the biggest reasons why shoppers stayed in front of their computers instead of taking to the malls during November and December. However, a big part of the price advantage that drives customers to Amazon.com (AMZN) and other online retailers comes from the fact that in many states, online retailers don't collect sales tax. That gives them an advantage over brick-and-mortar retailers in the state, an advantage that many increasingly see as unfair. That's what's behind the drive to force Amazon and others to start collecting sales taxes from customers no matter where those customers live.

States are focusing their attention on online retailers because it's easier to go after the big fish. But in reality, when you make an online purchase, you're typically breaking the law of your state if you don't report it and pay whatever use tax may apply.

Getting More Use

The 45 states that impose sales taxes all also have what's known as use tax provisions. Basically, the use tax is meant to cover for cases where the state didn't get to collect the appropriate sales tax. So if you go out-of-state to buy something -- perhaps to one of the five sales-tax-free states -- you technically owe use tax on your purchases.

As a practical matter, it's always been hard to enforce use taxes. One report from Orange County, Calif., revealed that 99.7% of residents failed to pay use tax on products that they bought out of state.

But in recent years, many states have added lines on their income tax returns covering uncollected sales and use taxes. In total, 26 states include a declaration of use-tax liability on their returns -- meaning that if you fail to mention such a liability, your signed return can be used against you on an audit.

More interesting, however, are some creative provisions that a few states are using to boost revenues. Rather than expecting you to keep track of all your online purchases over the course of the year, some states offer taxpayers so-called "safe harbor" provisions for meeting their use tax obligations.

California, for instance, lets taxpayers pay 0.07% of their adjusted gross income -- amounting to $70 for someone earning $100,000 in a given year. Michigan uses a similar approach based on 0.08% of income, but it expressly doesn't apply for purchases of more than $1,000, for which taxpayers have to pay additional tax on top of the calculated amount.

Will You Volunteer to Pay?

Given the difficulty that state tax agencies would have in enforcing even these beefed-up use tax provisions, you can expect most of the focus to remain on finding ways to force businesses to collect sales tax on the states' behalf. The big question then will be whether losing what often amounts to a 5% to 10% "discount" on online purchases pushes shoppers back toward traditional retail stores.

Nevertheless, if states do decide to make examples of individual taxpayers, not knowing about the use tax laws won't be any defense. With interest and penalties potentially applying, you might prefer to take advantage of the safe harbor provisions that some states are offering rather than rolling the dice.

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Motley Fool contributor Dan Caplinger loves all things tax-related, for some bizarre reason. You can follow him on Twitter here. He doesn't own shares of Amazon.com, but The Motley Fool does. Motley Fool newsletter services have recommended buying shares of Amazon.com.



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