Online tax law in Illinois ruled unconstitutional

CHICAGO — An Illinois law aimed at leveling competition between online and offline retailers while collecting more state sales taxes owed from Internet purchases is unconstitutional, a Cook County judge ruled.

The opinion is yet another shot in the highly contentious nationwide battle over which entity should collect online sales tax and how.

Consumers who live in sales-tax states, such as Illinois, owe state sales tax on their Internet purchases, whether they pay it during virtual checkout or when they file their state income tax returns. But few actually pay unless tax is collected at checkout. That has the effect of making online purchases cheaper than those at bricks-and-mortar retailers.

In March 2011, Illinois passed the Main Street Fairness Act, which expanded the meaning of physical presence beyond a warehouse, factory or office to include affiliate companies, which typically earn commissions for directing shopping traffic to an online store.

To avoid having to collect sales tax upon virtual checkout, some large Internet retailers, including Amazon.com, responded by cutting ties with affiliates in Illinois.

After the new law passed, some prominent Illinois-based Internet businesses, such as CouponCabin.com and FatWallet.com, fled to nearby Indiana and Wisconsin rather than be cut off from commissions from Amazon.com, Overstock.com and others.

Cook County Circuit Court Judge Robert Lopez Cepero said in court that the Illinois law violated the commerce clause of the U.S. Constitution, which limits what a state can tax, and that the law conflicted with the federal Internet Tax Freedom Act, which bans some types of Internet-related taxes.

The Illinois Department of Revenue was the defendant in the case. “We respectfully disagree with the court’s ruling and are reviewing our appeal options with the attorney general’s office,” the revenue department said in a statement.

Ultimately, the whole issue might be taken over by the U.S. Congress if it decides to pass pending federal legislation that would address the nationwide issue of Internet retailers collecting state sales tax.