Cover Story

Did you forget anything?

Taxpayers breathing a sigh of relief that tax day has come and gone may be surprised to learn of a little-known levy that a growing number of states are starting to enforce

Issue: "Tax man's terror," April 14, 2001

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.

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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.

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