Illinois children’s boutique sues over retroactive taxation by California. ‘It’s basically going to be the end of my business’

Robert Channick, Chicago Tribune

When Isabel Rubinas launched Lollipop Seeds in 2012, the upscale children’s boutique was a small storefront in Chicago’s Lincoln Square neighborhood, and the fulfillment of a lifelong entrepreneurial dream.

The venture has since morphed into a virtual storefront on Amazon and a battle with the taxman 2,000 miles away.

Rubinas, who now runs Lollipop Seeds from the kitchen table of her Glen Ellyn, Ill., home, is suing California after the state froze her bank account and seized more than $2,300 last month in a dispute over unpaid Amazon sales tax.

The lawsuit, filed Thursday in Chicago federal court, alleges the California Department of Tax and Fee Administration is unfairly pursuing Rubinas and other third-party Amazon merchants for sales tax incurred before the e-commerce giant began collecting it in 2019.

“It’s basically going to be the end of my business,” Rubinas, 42, told the Tribune.

Last year, Lollipop Seeds received a $10,000 tax bill from California based on purchases dating back to 2017, when the store began selling everything from footie pajamas to quilted throw blankets through the Fulfillment by Amazon program.

An integral part of the Amazon retail model, the program stores third-party merchandise at warehouses across the country, including California, handling the payment and shipping, and then reimbursing the seller for a percentage of the proceeds.

For years, however, state sales tax was not part of the third-party Amazon transaction, leaving billions of dollars in uncollected revenue on the table.

That changed with a 2018 U.S. Supreme Court decision in the South Dakota v. Wayfair case, which found that online retailers meeting a minimum sales threshold were required to collect state sales tax, even if they don’t have a physical presence in that state.

The decision precipitated a wave of new tax laws, and Amazon now collects sales tax on third-party sales in every state but Florida, Kansas and Missouri.

Illinois, for example, passed a law in 2019 requiring Amazon to start collecting sales tax on online purchases from third-party merchants beginning Jan. 1, 2020. In California, Amazon began collecting third-party sales tax under the state’s new Marketplace Facilitator Act Oct. 1, 2019.

Where California diverges from other states, the lawsuit alleges, is aggressively going after third-party Amazon merchants like Rubinas for retroactive sales tax.

“California’s tax collectors have reached deep into Illinois to crush a small children’s clothing boutique owner,” the lawsuit alleges. “Not because of what she did, but because of what California tax officials did for nearly a decade and now need to clean up — they let Amazon avoid collecting taxes on most sales in Amazon’s store.”

Efforts to reach a spokesperson for the tax agency were unsuccessful, and the California governor’s office did not respond to a request for comment. Amazon, which is not a party to the lawsuit, also did not respond to a request for comment.

The pandemic has accelerated e-commerce growth, which is projected to reach $794.50 billion in U.S. sales in 2020, up 32.4% year-over-year, according to research firm eMarketer. Amazon represents 39% of e-commerce sales at a projected $310 billion for 2020.

Overall, e-commerce is projected to account for 15% of total U.S. retail sales in 2021, according to eMarketer.

For the third quarter, Amazon reported $48.4 billion in sales from its own online stores, up 38%, and $20.4 billion in third-party sales, up 55% year-over-year.

California has the largest economy of any state, making online sales there likely for many Amazon merchants.

Rubinas is one of potentially thousands of Illinois-based Amazon merchants whose business information was shared with California and several other states in 2018 for the purposes of collecting back sales taxes, the lawsuit alleges.

Another is Denise Rasbid, 51, of Lake Zurich, Ill., who runs CQC Boutique, an online women’s clothing store. Rasbid received an email from the California tax agency in July 2019 urging her to register with the state as an out-of-state retailer to avoid penalties for retroactive sales tax.

Rasbid didn’t register at the advice of her lawyer, but calculates she could owe California tens of thousands of dollars in sales tax and penalties for business conducted on Amazon since 2014. While the state hasn’t seized her bank account, the “threat” of action has caused her significant distress, she said.

“I feel that it’s very unfair that they were able to come back to me and say, guess what, you owe us all of this money that you’ve never collected,” said Rasbid, who is not a party to Rubinas’ lawsuit. “I lost so much sleep over this. My children suffered, my marriage suffered.”

Rasbid was referenced in a similar lawsuit filed in September in a California federal court by the Online Merchants Guild, a nonprofit trade association, against the tax agency. The guild’s executive director, Paul Rafelson, is a Florida-based state tax attorney who also filed the lawsuit on behalf of Rubinas.

Rubinas, who previously worked for a Chicago recycling firm, launched Lollipop Seeds as a bricks-and-mortar storefront in 2012.

“It was something that I had always wanted to do,” Rubinas said.

The store closed in 2014, but the business continued online with its own website. In 2017, Rubinas signed on as an Amazon third-party merchant and sales took off, hitting a half-million dollars the following year.

Rubinas buys high-end lines of baby and children’s clothes, with 90% of her merchandise moving through Amazon warehouses across the country. She keeps some of the better-selling and higher-end products at her west suburban home for direct shipping.

Sales dropped 75% during the pandemic, Rubinas said, with the business operating at a loss for 2020.

“Nobody’s buying expensive kids clothing when they can’t find toilet paper or cleaning wipes,” she said. “Nobody is going out. There’s no need to dress your kids up in nicer clothing.”

As consumer demand fell during the pandemic, California began demanding retroactive sales tax payments with increasingly aggressive collection methods, Rubinas’ lawsuit alleges.

After being contacted by the California Department of Tax and Fee Administration, Rubinas registered with the agency and paid just over $2,600 in January 2020 to cover the first nine months of 2019 — before Amazon started collecting sales tax. She was then told she owed $10,000 more for sales tax, penalties and fees from 2017 and 2018, the lawsuit alleges.

Rubinas told the agency she didn’t know she was supposed to collect sales tax from Amazon customers in 2017 and 2018, that she hadn’t collected sales tax and that she didn’t have the money to pay the retroactive tax bill out of Lollipop Seeds, the lawsuit alleges.

The agency left Rubinas a voicemail message Dec. 1 informing her that unless she agreed to a payment plan within three days, they would proceed with “further collection action,” the lawsuit alleges. Rubinas said she didn’t retrieve the message at the time.

On Dec. 19, Rubinas received a notice from Chase Bank that it had frozen her account under orders from the California tax agency. Two days later the agency withdrew $2,368 from her account, the lawsuit alleges.

The lawsuit alleges the Fulfillment by Amazon is a consignment program, and that Amazon, not Rubinas, is the retailer responsible for collecting and remitting any sales tax due the state.

“Even prior to the enactment of the new state laws, Amazon was already responsible for the sales tax,” said Rafelson, Rubinas’ attorney.

That position is supported by California Treasurer Fiona Ma, who in March 2019 sent a letter to Gov. Gavin Newsom requesting him to direct the tax agency to cease its collection activity of third-party sellers.

In the letter, which was attached to the lawsuit, Ma said the third-party sellers had no control over where their inventory was stored or sold, placing the burden to collect and remit sales tax on Amazon.

“Third-party sellers whose goods are sold via online platforms — many of whom are women and minority-owned businesses — are not subject to sales tax, either prospectively or retroactively,” Ma said.

The lawsuit alleges the California tax agency’s pursuit of retroactive sales tax collection from Rubinas violates the Internet Tax Freedom Act, due process and the commerce clause. It is seeking a declaration that the agency’s actions are unconstitutional, an order preventing it from further collection actions, a return of the seized bank funds and undisclosed damages.