It's April the 16th, and you're feeling good. Once again, you managed to round up your receipts, balance the books, and interpret an instruction manual written by accountants, for accountants. You signed your federal return, signed your state return, signed your checks, and got everything in the mail before the stroke of midnight turned you into a late-payment pumpkin. You are officially a Good Citizen, complying faithfully even with those laws you find odious.
But put the medal polish away. You may have skeletons in your closet you don't even know about. Or at least a shirt. Did you remember that $30 pinpoint oxford you mail-ordered from Maine? What about the $50 waffle iron you found on the Web? In most states, failure to report such out-of-state purchases doesn't just make you a bad citizen-it makes you a tax cheat.
Thanks to a slowing economy and a tighter-fisted federal government, many states are beginning to fear a budget squeeze. Governors and state legislatures are desperate for new revenues, but fearful of the political price they might pay for pushing new taxes. Instead, they're blowing the dust off the law books and ramping up enforcement of an obscure little tax that almost everyone is supposed to pay, but almost no one actually does.
It's called the use tax, and in some states it's been on the books since the 1930s. According to the Constitution, states are not permitted to tax interstate commerce, or business conducted across state lines. At the time the Constitution was written, the state line could be several days' journey by horseback, so interstate commerce was relatively rare. But in an age of automobiles, jets-and especially the Internet-billions of dollars worth of interstate sales can be tallied up in single day. Eager to get their hands on a share of that money-but forbidden by the Supreme Court to impose an out-of-state sales tax-states invented a way to tax items used within state lines but purchased elsewhere.
Like the familiar sales tax, use taxes claim a percentage of every sale for state coffers. But while businesses wrestle with the paperwork nightmare of the sales tax, individual consumers are expected to track and remit their own use taxes to state authorities. Again, the reason is constitutional: The Supreme Court has ruled that state governments cannot force out-of-state businesses to collect the use tax for them, unless the business has a "nexus," or physical presence, in the state. Because mail-order merchants and Internet retailers don't collect a sales tax, most Americans assume such purchases are tax-free. Only Alaska, Delaware, Montana, New Hampshire, and Oregon have no use taxes, but if the 45 use-tax levying states have their way, millions of taxpayers may soon find out just how wrong they are.
Huey Mills, pastor of the Fellowship Bible Church in Lancaster, S.C., already learned about use taxes the hard way. When state officials notified him in January that they intended to audit his church school, Carolina Christian, he told his bookkeeper, "Don't worry, we have nothing to hide. We follow the law."
So confident was Mr. Mills that when the auditors asked for three years' tax records, he instead turned over everything he had for their inspection. "We wanted to demonstrate openness and cooperation," he explains now, somewhat ruefully. "We're very conscientious as law-abiding citizens. We teach the children in our school to respect government, and I wanted to demonstrate the greatest respect possible for the state and its laws."
Respect can be costly, Mr. Mills discovered. Since 1996, Carolina Christian had expanded twice, erecting new classrooms and other facilities for a growing student body. With each building program, Mr. Mills drew up a list of the new classroom furniture that would be needed and put it out for bids. He insists he wasn't going outside the state in order to avoid paying sales tax. South Carolina simply has no manufacturing companies that specialize in classroom furniture, so he looked elsewhere. He found a low bidder in New York, paid the invoices they presented to him, and forgot about it-until the auditors showed up. After two weeks of poring over his books, they presented Mr. Mills with a list of furniture and supplies on which he'd failed to pay the 5 percent use tax. They also presented him with a bill: $12,000 in back taxes, plus interest, plus 25 percent for failing to file and another 25 percent for failing to pay. Altogether, Carolina Christian took a $20,000 hit, though state officials have since promised to back off the punitive portions of the tax bill.
Mr. Mills says the whole experience, which garnered statewide media coverage, was not only expensive, but embarrassing. He insists he didn't know about the use tax, and statistics indicate he's hardly the only one. Though the tax has been on the books in South Carolina since 1951, last year the state took in only $72,000 of the estimated $40 million its citizens owed. Officials at the Department of Revenue say they're trying to spread the word through brochures and advertisements aimed at professional tax preparers. This year, for the first time, there's even a use-tax line on South Carolina's individual income tax return. That will make it easier for the Department of Revenue to make the case that nonpayment is the result of fraud rather than ignorance.
But even those who know about the tax may be ill-equipped to understand it. Taxpayers are required to pay the prevailing rate for their home address, but that's not as easy as it sounds, since tax rates vary not only from state to state, but county to county. In California, for instance, sales and use taxes range from 7 percent in Amador County to 8.25 percent in San Francisco. Many counties even have "special administrative districts," small enclaves where tax rates are higher than the county as a whole. In Los Angeles County, for example, residents of the town of Avalon pay half a percentage point extra to fund their municipal hospital.
Beyond the dizzying variety of tax rates-some 7,000 separate tax districts spread out across the nation-individual taxpayers also must grapple with a bewildering list of products and services subject to the use tax. In Ohio, use taxes have been around since 1936, though few taxpayers have heard of them. State officials believe they're being cheated out of some $200 million a year in nonpayment, so Ohio, too, has put a line for use taxes on its individual income tax returns. But Ohioans may find that a little knowledge can be a dangerous-or expensive-thing, as they try to understand arcane reporting rules. Computers ordered through the mail are subject to the use tax, for instance, unless the purchaser is a teacher who is using the computer to prepare lectures and lesson plans. Bottled water is exempt, but sparkling water is not. Insulin is exempt, but ibuprofen is not.
And it gets worse. Mr. Mills at Carolina Christian has spent the last two months appealing the auditors' conclusions line by line. In the process, he's learned more about the use tax than he'd ever care to know. He now knows that the plates he buys for his lunchroom are tax exempt, but forks and spoons are not. Likewise, he doesn't have to pay taxes on the shortening he buys to make cookies, but any shortening used to grease the cookie sheet is taxable. And aluminum foil? If it's used to wrap a potato for baking, it's taxable. If it's used to wrap and serve the potato, it's tax exempt. Small wonder that the public school district in Lancaster has a CPA on staff to comply with the labyrinth of sales- and use-tax laws-a luxury that Carolina Christian School can ill afford.
Naturally, Congress is finding it hard to resist wading into the use-tax mess. The push for greater enforcement, after all, is largely the result of the explosion in e-commerce. To protect the nascent Internet industry, Congress passed a moratorium on new Internet taxes, making it impossible for states to get their slice of a multibillion-dollar pie.
But by dusting off the old use-tax laws, states are simply making an end-run around the moratorium. And some lawmakers-mostly from Southern and Midwestern states without a significant Internet presence-are trying to help. In March, the Senate Commerce Committee took up debate on a bill that would require online merchants to collect use taxes for every state, just as they do sales taxes for states in which they have a physical presence. Industry officials insist that's simply impossible, but senators behind the legislation-including Republicans like George Voinovich of Ohio and Tim Hutchinson of Arkansas-say they'll require states to standardize their tax laws to make collection easier.
Still, proponents admit that such standardization is probably years away-and even then, the new law might not pass muster with the Supreme Court. In the meantime, cash-starved states continue to go it alone, stepping up enforcement and trying to make it impossible for taxpayers to claim ignorance. But even including a line on individual tax returns is unlikely to coax cash from taxpayers who realize that there's almost no way for state authorities to catch cheats as long as businesses aren't required to report interstate sales. Instead, taxpayers with a conscience will grit their teeth and "render unto Caesar," while their less forthcoming neighbors simply dare the taxman to catch them.