A Colorado law requiring out-of-state retailers to remind residents of their use tax liabilities has been ruled unconstitutional.
The law, originally passed in February 2010, required retailers outside Colorado that sell $100,000 or more worth of products to Colorado residents to provide notices to these customers. The notices state that the buyer is obligated to self-report and pay use tax on their purchases.
Under the law, retailers also had to provide the Colorado Department of Revenue with an annual report listing the names, addresses, and total purchases for all Colorado customers. In addition, if a customer spent more than $500 a year with the retailer, the retailer had to inform that customer about the annual report to the state.
Rather than creating laws requiring out-of-state retailers to collect sales tax from Colorado customers as other states have, the Colorado legislature opted to strengthen their ability to enforce existing use tax laws. However, according to the Colorado U.S. District Court, the state overstepped its bounds.
According to an article published in Journal of Accountancy, the court ruled that the law violated the Commerce Clause of the United States Constitution. In the court's opinion, the law treated out-of-state retailers differently than in-state retailers, which interferes with the out-of-state retailer's ability to participate in interstate commerce.
Additionally, the court believes that the law is unnecessary because the state could have implemented "nondiscriminatory alternatives" to enforce use tax collection. For example, the plaintiff on the case, The Direct Marketing Association (DMA), recommended instead outlining residents' use tax obligations on the state sales and use tax return.
The DMA, a trade association representing direct marketers, originally filed for an injunction against the law when it was first passed. A U.S. District Judge granted the preliminary injunction in January 2011. This new ruling makes that injunction permanent.
At the heart of the matter is the increasing use of e-commerce. As more residents buy goods online, states are seeing less in the way of tax revenue. While buyers are supposed to self-assess use tax on out-of-state purchases, most do not. The Colorado law was an attempt to give the state's use tax laws some teeth.
However, this ruling will likely permanently kill the legislation, meaning Colorado will have to find another way to ensure residents pay tax on internet purchases. As several other states have already done, Colorado may consider expanding the definition of nexus to include affiliate-marketing agreements. These laws broaden nexus rules to the point where many online retailers would have to begin collecting sales tax.