The end of tax-free e-commerce

NEW YORK (Fortune) -- One of the great things about shopping on sites like Amazon has been not having to pay a dime in taxes (or shipping, if you've spent enough). Since the dawn of Web commerce, the rule was that as long as a retailer didn't have a physical presence in the shopper's state, the company didn't collect a sales tax.

Well, it was fun while it lasted. Starting June 1, Amazon (AMZN, Fortune 500) will charge a sales tax to shoppers who live in New York, even though the retailer maintains no physical operations in the Empire State.

Why the crackdown? With the economy in the tank, the State of New York was getting desperate to fill its budget gap. So it expanded its rules about what constitutes a business presence in the state. Amazon lets other sites earn commissions by linking to products on its pages as part of a program called Amazon Associates. And because some of those sites are based in New York, the state considers the Seattle-based retailer fair game.

Amazon, for its part, has filed suit in the New York Supreme Court arguing the law is unconstitutional. The company says these third-party sites shouldn't be counted as agents of Amazon in New York because they're totally independent from the retailer. Instead, they act merely as advertisers who are compensated with commissions. Also in its complaint, Amazon points out there are hundreds of thousands of associates in the program, and the company can't always determine whether these sites are actually run by New Yorkers.

Some online shoppers in New York may be howling over this new law but technically they shouldn't feel a difference. In truth, all purchases on Amazon have always been subject to taxes. Until now, only four states required Amazon itself to collect the tax: Washington (where Amazon's HQ is), North Dakota (the site of customer relations operations), Kentucky and Kansas (those last two contain large Amazon distribution centers). In other states, shoppers are supposed to keep track of their untaxed out-of-state purchases and report them in their state income tax returns every year. Needless to say, this doesn't always happen.

The state doesn't pursue people for failing to report their tax-free online shopping, or at least that's not enough to alarm the authorities. "The sales tax itself isn't going to raise enough concern to prosecute anybody," says Tom Bergin, spokesman for the New York Department of Taxation and Finance. "Now, if there were other red flags involved with that tax return, then we'd look at everything."

Starting in the 2003 tax year, the state of New York added a new line on its income tax forms specifically for untaxed out-of-state purchases, and last year, the state collected $45.2 million in sales taxes that way. But states know they stand a better chance of getting all the money they're due if they require retailers to collect it, and in the case of New York, the state expects to get as much as an extra $47 million a year from Amazon and others.

The state of Texas, applying some more conventional legal reasoning, is looking closer at an Amazon distribution center in Irving that could quality as sufficient physical presence in the state to pick up some extra money. But with the economy continuing to slow, other states will surely be watching what happens in New York. If the courts uphold New York's line of thinking, the rest of the Union could be headed in this direction.