Affiliate Nexus Overreach

Shortsighted and poorly managed legislation is hurting small Internet sites

Original: 2/20/2012

You'll probably note that I've removed all B&H links on this site, the ones that provided my a small amount of consistent revenue due to your use of them. This is because the state in which I live, Pennsylvania, has issued a press release indicating that the state is simply going to change its interpretation of law. Essentially, the state has decided that affiliate programs like the one B&H uses to reward sites that send them traffic (much like advertising, only its paid on successfull order rather than on click), are actually a nexus.

Nexus has a legal definition established by the Supreme Court. We've argued about this before, back when mail order companies didn't collect sales tax in states in which they weren't located. In Quill versus North Dakota, the Supreme Court declared that a company must have a physical presence in a taxing location before it was required to collect tax. What my state just declared, via a press release, is that the presence of a link (on a server not in Pennsylvania, by the way) establishes such physical presence. Their claim, rejected previously in plenty of court decisions, is that a PA resident collecting link income acts as an agent to the outside company and thus is a "physical presence."

A company like B&H doesn't have a lot of choice in this matter. The press release also says that, if ignored, it has the right to audit three years worth of transactions of the infringer. Even if B&H thought that they could successfully defend a suit brought by the state, the sheer level of paperwork that could be required of them in such a suit would be costly and time-consuming. It's easier for them to terminate relationships with affiliates, which is what they've now done with bythom.com and why I've begun removing their links.

So why is PA doing this? Because someone at the Department of Revenue under the direction of our recently elected Republican governor came up with a funny number to help balance the budget: US$40 million. That's what PA thinks they're going to collect in new income by using this reinterpretation. That ignores what's happened in other states that passed laws that tried the same thing (and again, PA did not pass a law, they simply decided to reinterpret the existing law in a way that directly contradicts the Quill v. North Dakota decision). It started in New York, but has expanded to North Carolina, Illinois, Colorado and others: every time a state makes a nexus claim on affiliate programs, affiliate programs get cancelled in that state. This means that not only does the state not get the sales tax revenue it thought it would, but it gets less income tax, as well, as the sites that were getting such income no longer receive it and thus their reported income goes down.

The correct solution to the problem has been and remains: a single national sales tax collection agency that distributes money to the appropriate jurisdictions. Why is that the answer? Because there are over a 1000 different taxing agencies in the US. I live in only one of them (B&H has a physical presence in two of them). Companies cannot be expected to generate reports and checks to that many entities--many of which have differing collection rules and payment dates. Moreover, this is another form of taxation without representation, something that our country had something to say about during its founding. That's why the decision in Quill was what it was: if you don't have a presence and a vote in a jurisdiction, then there is no legal obligation to that entity's laws.

If you'd like to read a longer article that is reasonably well reserched on the subject of nexus as it applies to sales tax, and what states have been doing, click here. I note that another of the other better researched articles by a legal authority states that "several lower court decisions that have considered (and rejected) the [affiliate nexus] theory." That doesn't do me any good, obviously, as until the subject of nexus gets reviewed by the Supreme Court (again), states will continue to act as they have.

So why are states doing this? Several reasons:

  • Pressure. The local retail lobby, especially headed by Walmart, has been trying for several years to put a dent in Amazon's growth. Their claim is that they can't be competitive because Amazon doesn't charge sales tax in most jurisdictions (Amazon only has warehouses in a few states, and has tended to avoid states that make nexus reach claims).
  • Recession. The states are hurting for revenue, because all forms of their revenue collection is down.
  • Balanced Budget. All states have some form of balanced budget requirement. Unfortunately, you can "balance" a budget by using projected numbers, even when those numbers aren't likely to be realized, like sales tax collection due to affiliate nexus. That's why I call it "funny money": it's as real as Monopoloy money is.
  • Failure to collect Use Tax. Most states, including my own, have Use Tax laws, which says that a citizen needs to pay sales tax on things they order from out of state. I actually do that. I submit Use Tax every month with my Sales Tax collections. Virtually no one else does. But the states are afraid to police Use Tax (they could simply audit any tax statement from someone that doesn't declare any, on the assumption that most people have bought something from the Internet). That's because they'd get voted out of office almost immediately. Even though the voters are actually shirking the law (again, I'm not).

I should point out that I'm not against collection of sales taxes. I pay sales tax on everything I buy, regardless of where I buy it. I try to lead an ethical and moral life and follow the law as best I can (it's not always possible to figure out what the law actually means, or even know about every law, though).

There is a possible solution. It's called the SSUTA, which is basically is a centralized system to which all Internet and Mail Order companies would submit reports and collected taxes. You see, it isn't the myriad of tax rates that's the issue for companies like B&H. After all, you can easily build a tax code table based upon ZIP Code. The problem is over a thousand agencies you'd have to keep track of and report to and pay on different schedules. It's an accounting nightmare, and would put companies like mine completely out of business if we had to submit tax forms to over a 1000 agencies and submit to their laws. The SSUTA has been proposed many times at the federal level, and almost half the states support some form of it. It is currently being considered by Congress under the name Main Street Fairness Act. Personally, I support a well-written version of the SSUTA, as should most reasonable folk: this notion that because you order out of state you don't have to pay sales tax (or use tax) is actually legally incorrect almost everywhere in the US, and it does change the dynamics of how business is done. "Cheaters" basically get a discount, then justify the cheating because of the discount. Very circular logic, and ethically not supportable.

Unfortunately, the PA press release means big changes for me. I was using the money collected via affiliate programs to pay for my site's costs, plus start building a small sum that would allow me to hire some additional help in keeping the site active and up-to-date. That money is now threatened (and about half is already gone due to the loss of one of the two programs I was using). I'm now faced with a problem. The solutions I see are:

  • Spending less time on my sites. Why? Because I will eventually need to replace that income. Even though it's not a huge amount of money, it's significant enough that it impacts my thinking.
  • Adding advertising to the site. Replace the affiliate programs with advertising. This is a niche site, so advertising rates will never completely replace affiliate income, unfortunately. Not unless I clutter the site with lots of ads. Ads mean everyone will get tracked, you'll see animated things blinking on pages, and more visual clutter.
  • Trying to run the site through donations. I suspect that if I just put a big Donate button in a prominate position, I might be able to match what came in from affiliate programs for a very short period. The nice thing about the affiliate programs is that once you had the habit of using them, they presented a long-term, fairly predictable level of support. Donate buttons don't tend to do that. Just like NPR has to go on the air and do direct solicitations several times a year, I'd have to do the same thing, I think. Donate buttons are too easy to ignore. Moreover, that money comes out of your pocket, whereas the affiliate program money came out of the retailer's pocket.
  • Switching the site to be behind a pay wall. Making my site subscription-only has both benefits and problems. On the plus side, a constant stream of money would definitely allow me to do more, especially on the technique side. It would allow for respectful and moderated forums. But it also reduces the visibility of my teaching, too. As most of you know, it's never been about how much money I can make. It's been about how much money does it take to be an effective teacher and have a widespread influence?
  • Sell my Web sites and move on. It's not as if I don't have other things I could do, some of which would probably pay the bills more reliably.

At this point, I'm assessing what to do next. Obviously, all of the above has some impact on site redesign, so that project is temporarily on hold while I ponder my options.

Thanks to all of you who used the Support this Site links in the past: your support helped me get where I am, and was highly appreciated.


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