Editorial: California is clobbering small businesses with a retroactive tax grab

Workers quickly pack items on Cyber Monday at the Amazon Fulfillment Center on November 28, 2016 in San Bernardino, California.
California tax officials argue that if Amazon stored goods from out-of-state retailers in its facilities in this state, such as this fulfillment center in San Bernardino, sales taxes must be paid on any sales to California residents. (Los Angeles Times)

Isabel Rubinas of Glen Ellyn, Ill., operates Lollipop Seeds, a virtual boutique that sells clothing for young children online. And like many small specialty businesses, its sales have slumped badly during the COVID-19 pandemic.

It's also being clobbered by the California Department of Tax and Fee Administration, the state agency that oversees the collection of sales and use taxes. This month the CDTFA froze Rubinas' business bank account in Illinois in an effort to collect thousands of dollars in taxes on sales that Lollipop Seeds made to California shoppers through Amazon.com in 2017, 2018 and 2019. The freeze threatens to push Lollipop Seeds out of business.

And her dilemma is not unique. For about two years, advocates of small business say, the agency has been dunning out-of-state retailers that sold through Amazon's marketplace prior to 2019, when Amazon started collecting sales taxes on those transactions — and seeking to collect taxes on sales from as far back as 2012. A trade association for those sellers has sued, accusing the agency of an unconstitutional overreach and unlawful discrimination.

The CDTFA's mission is important, overseeing taxes that support schools, public safety and other essential services. And out-of-state online sellers that don't collect sales taxes have an unfair advantage over in-state stores that do. That's why state lawmakers around the country sought for years to force Amazon and other online retailers to collect sales taxes, ultimately leading the Supreme Court in 2018 to overturn decades-old precedents and let states require companies outside their borders to collect and remit taxes on sales to people inside their borders.

California did so through a law enacted in 2019. But the CDTFA argues that retailers that relied on Amazon to store and ship their goods are liable for taxes even before then, dating back to the first day any of their products were stored by Amazon in a California warehouse — even though Amazon is managing the entire process through its "Fulfillment by Amazon" program.

In its lawsuit, the Online Merchants Guild argues that the duty to collect those taxes should have fallen on Amazon, which acts as a virtual consignment store and should have been treated that way. But state tax officials gave the company a pass from 2012 to 2019, creating a hole that the CDTFA is trying to fill by retroactively taxing companies like Lollipop Seeds.

There's a caveat in the Supreme Court's South Dakota vs. Wayfair decision that the CDTFA is ignoring, as well as other important principles of good policy. In the majority opinion, Justice Anthony Kennedy noted that states "may not impose undue burdens on interstate commerce," such as requiring entities that do little business there to collect taxes from their residents. That's why the state's 2019 law exempts out-of-state companies with less than $500,000 in annual sales to California residents.

So far this year, Rubinas said, Lollipop Seeds had made all of 16 sales in California.

Beyond that, California is going after online retailers years after the sales were made, giving them little realistic chance of passing the taxes on to the customers who shopped there. The sales tax borne by consumers thus becomes a gross receipts tax on businesses. For low-margin retailers, a tax bill amounting to roughly 10% of their California revenue — plus interest and penalties — can be an impossible burden. According to the Online Merchants Guild, the state is seeking more than $10,000 from Lollipop Seeds.

What's particularly unfair is the lack of timely notice. Despite the efforts of California and other states to level the retail playing field, it was a well-established principle that states couldn't require companies with no presence of any kind within their borders to collect sales taxes from their residents. Had retailers been told by the CDTFA or Amazon that they would be liable for sales taxes the moment their goods wound up in a California warehouse, they would have been given the chance to collect those taxes from California shoppers or to stop using Amazon to fulfill their orders.

The state's pursuit of these small sellers was bad enough when times were good, and hats off to state Treasurer Fiona Ma for making that argument in the flush days of 2019. It's even harder to stomach now. Amazon should have been collecting sales taxes for third-party sellers like Rubinas as soon as it opened a distribution center in this state. The state should stop hounding small businesses for sales taxes they didn't know they'd be asked to remit and move on.

This story originally appeared in Los Angeles Times.