Use Tax Reporting: Is Colorado Back in Business?

By Sarah McGahan, J.D., LL.M.

Editor: Jamie Yesnowitz, J.D., LL.M.

Over the past few years, much activity and discussion has addressed remote sales tax collection and the revenue loss to states as a result of e-commerce. As all state tax professionals know, states cannot require a remote retailer to collect and remit tax on sales made to in-state customers unless the retailer has nexus in the state. For sales and use tax purposes, to establish nexus, a retailer must have some physical presence in the particular state 1—either the retailer’s own physical presence or the physical presence of an affiliate or third party that enables the retailer to establish and maintain a market in the state. 2

Many states have considered and enacted various legislative measures aimed at asserting nexus over remote, primarily internet-based retailers based solely on their relationships with other entities—sometimes affiliated, sometimes not—that have nexus in the state. At the same time, many states (and “Main Street” retailers) have been hoping for a federal solution, specifically, congressional legislation that would overturn the Quill decision. While various iterations of such legislation have been introduced and languished in past Congresses, supporters of a federal solution were dealt a significant victory in May when the Senate approved the Marketplace Fairness Act (MFA) of 2013. 3 The MFA, which would grant certain states the authority to require remote sellers to collect and remit sales and use taxes on sales into the state, is currently in the House, where its fate remains uncertain. 4

With all this activity, many may have forgotten that more than three and a half years ago, Colorado lawmakers adopted a unique approach to address the loss of revenue associated with e-commerce and the corresponding failure of the Colorado citizenry to comply with the state’s use tax laws. The state’s answer to these persistent problems was to impose use tax reporting requirements on retailers that do not collect sales tax on goods sold to Colorado purchasers.

The reporting requirements were quickly challenged on a number of grounds, and, in March 2012, at the request of the Direct Marketing Association (DMA), a federal district court judge permanently enjoined the Colorado Department of Revenue from enforcing the law. 5 Nearly 17 months later, the Tenth Circuit Court of Appeals held that the injunction was invalid. 6 In the court’s view, the Tax Injunction Act 7 (TIA) precluded the DMA from obtaining an injunction against enforcing the requirements. In light of these recent developments and in anticipation of further proceedings, this column revisits the issues presented by DMA’s suit and the history thus far.


On Feb. 24, 2010, Colorado House Bill 1193 was signed into law, adopting certain information reporting requirements for retailers that do not collect Colorado sales tax. 8 Specifically, noncollecting retailers were required to comply with three separate reporting requirements:

  • Effective beginning March 1, 2010, retailers were required to inform the purchaser at the time of the purchase that use tax may be due and that Colorado requires purchasers to file returns and pay use tax directly to the state.
  • Retailers were required to provide each Colorado purchaser with a statement by Jan. 31 of each year showing the general types and volume of purchases made during the prior year on which tax was not collected and stating that the purchaser may owe use tax on such purchases.
  • Retailers were required to file an annual report with the Department of Revenue (DOR) by March 1 each year identifying the name and address of each Colorado purchaser and the general type and volume of purchases made by such purchaser. 9

Shortly after the law’s enactment, the DMA filed suit in federal district court in Colorado seeking to enjoin enforcement of the reporting regime. The DMA is a group of businesses and organizations that market products via catalogs, advertisements, broadcast media, and the internet. According to a press release issued by the DMA, the organization viewed Colorado’s law as “an unprecedented invasion of consumer privacy” and as a law that “unfairly discriminates against interstate commerce.” 10 The release called for the law to be “abandoned in short order,” alleging that the reporting requirements would “force out-of-state companies to turn over confidential customer information or, in the alternative, to forgo their Constitutional rights and agree to collect Colorado sales tax.” 11

In its pleadings, the DMA argued that the new reporting requirements (1) imposed an undue burden on sellers in interstate commerce that did not have a physical presence in the state, (2) chilled the exercise of free speech, and (3) violated certain privacy protections. In early 2011, the court temporarily enjoined enforcement of the law, holding that the DMA had a substantial likelihood of succeeding on the merits of its claims and that irreparable harm would be done to sellers if the reports due Jan. 31 were required to be filed.

Following the temporary injunction, both sides to the controversy agreed to submit the matter to the federal district court for a determination solely on the Commerce Clause issue (i.e., whether the state could impose such a reporting burden on a seller with no physical presence in the state). On March 30, 2012, the federal judge ruled on the parties’ summary judgment motions. 12

Federal District Court Ruling

In district court, the DMA argued that the use tax reporting requirements violated the dormant Commerce Clause because they (1) impermissibly discriminated against interstate commerce and (2) imposed undue burdens on interstate commerce. The court first addressed the discrimination allegation, noting that the U.S. Supreme Court has adopted a two-tiered test for analyzing such claims. The first tier requires the court to determine whether the statute at issue directly or effectively favors in-state interests over out-of-state interests. If so, the court will generally strike down the statute without further inquiry. 13 If a statute has only indirect effects on interstate commerce and regulates evenhandedly, the court will look at whether the state’s interest is legitimate and whether the burden on interstate commerce clearly exceeds the local benefits. The second tier of the analysis involves a determination of whether the law advances a legitimate local purpose and, if it does, whether other reasonable nondiscriminatory alternatives cannot adequately serve the purpose (the so-called Pike 14 balancing analysis). The court noted that there is no clear delineation between state laws that are virtually per se invalid under the Commerce Clause and those that are subject to a Pike balancing analysis.

In opposition, the DOR focused its argument on the fact that on their face, the statute and regulations did not distinguish between in-state retailers (those with a physical presence in the state) and out-of-state retailers (those with no physical presence in the state). Rather, the statute and regulations applied equally to all retailers that did not collect Colorado sales tax. However, the court noted that, under Quill, retailers lacking a physical presence in Colorado were not required to collect and remit Colorado sales taxes. Therefore, the effect of the law was that in-state and out-of-state retailers were treated differently. As such, the court concluded that the use tax reporting statute and regulations effectively discriminated against out-of-state retailers and, consequently, discriminated against interstate commerce.

The court next addressed whether the use tax reporting requirements advanced a legitimate purpose that could not be served by reasonable nondiscriminatory alternatives. The DOR argued that the reporting requirements served three significant purposes: (1) They enhanced the DOR’s ability to recover sales and use taxes due the state; (2) they promoted fair distribution of the costs of government; and (3) they fostered respect for the sales tax laws. The court agreed that these were all legitimate state interests and purposes.

The DMA argued that there were at least three reasonable nondiscriminatory alternatives to the use tax reporting requirements. First, the DOR could have included a line item on the Colorado income tax return for residents to report use taxes owed the state. 15 Second, the DOR could have increased business audits to collect any use tax owed by business purchasers in Colorado. Finally, the DOR could have stepped up its efforts to educate consumers on use tax obligations.

Because the DOR had focused much of its efforts on proving that the use tax reporting requirements were not discriminatory, the court observed that the record was essentially devoid of evidence establishing that the DMA’s proposed nondiscriminatory alternatives were not viable means to accomplish the state’s objectives. Therefore, under the strict scrutiny standard that applied to the second-tier test, the DOR had failed to meet its burden of proof. In conclusion, the court found the use tax reporting requirements to be unconstitutional because they discriminated against interstate commerce.

The court next addressed the DMA’s claim that the use tax reporting requirements placed undue burdens on interstate commerce. The DMA focused on the physical presence test established in Quill, arguing that it established a bright-line test to ensure that out-of-state retailers were not unduly burdened with collection and remittance of sales taxes. Although the Colorado law did not mandate that out-of-state retailers collect sales taxes, the court determined that the practical effect of the law was to place burdens on retailers that were akin to those condemned in Quill. As such, the court held that the use tax reporting statute and regulations placed undue burdens on interstate commerce and were therefore unconstitutional. Having determined that the Colorado law was unconstitutional, the district court granted a permanent injunction against the enforcement of the Colorado use tax reporting requirements.

Court of Appeals Decision

Not surprisingly, the DOR appealed the injunction barring enforcement of the reporting requirements. On Aug. 20, 2013, a three-judge panel for the Tenth Circuit ruled that the TIA barred the DMA from seeking a ruling on the constitutionality of the use tax reporting requirements in federal district court. 16

In its discussion of the case background, the Tenth Circuit noted the overwhelming failure of consumers to remit use taxes despite their legal obligation to do so. In fact, the court cited a 2010 report that projected that, in 2012, Colorado state and local governments would lose $172.7 million as a result of purchases by in-state purchasers from noncollecting internet remote retailers. Nevertheless, the court did not address the merits of the case. Rather, it held that the TIA deprived the district court of jurisdiction to enjoin Colorado’s tax collection effort. The court remanded the case to the federal district court for dismissal of DMA’s claims and dissolution of the permanent injunction.

The TIA provides that “district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.” 17

The court first addressed whether the DMA’s action sought to “enjoin, suspend or restrain the assessment, levy or collection of any tax under State law.” In its brief, the DMA argued that the TIA did not preclude federal jurisdiction because the DMA (1) was not a taxpayer seeking to avoid a tax, and (2) was challenging notice and reporting requirements, not a tax assessment.

With respect to whether the DMA was a taxpayer seeking to avoid state taxes, the court observed that the DMA’s argument was based on a misreading of the U.S. Supreme Court decision in Hibbs v. Winn. 18 Although the Hibbs Court stated that the TIA applies to “cases in which state taxpayers seek federal-court orders enabling them to avoid paying state taxes,” 19 the Tenth Circuit found that this language has not been interpreted as holding that the TIA applies only to taxpayer suits. Rather, the TIA is to be considered “revenue-protective,” with the key question being whether the plaintiff’s lawsuit seeks to prevent the state from exercising its sovereign power to collect revenues. Viewed in that light, the court concluded that the DMA could not avoid the TIA merely because it is not a taxpayer challenging a tax payment.

The court next addressed the DMA’s argument that it sought to enjoin notice and reporting obligations, as opposed to a tax levy or assessment. The crux of the DMA’s argument appeared to be that, although its suit related to use taxes legally owed by consumers, it was not a suit seeking to enjoin collection of Colorado’s use tax. In other words, even if the DMA’s constitutional claims were affirmed, Colorado consumers would still owe use taxes. The court disagreed; in addition to suits that seek to directly enjoin collection of a tax, the court noted that the TIA also prohibits federal lawsuits that restrain the collection of a state tax.

Stating that “restrain” commonly is defined as “to limit, restrict, or hold back,” the appellate court noted that the reporting requirements were enacted for the clear purpose of improving the ability to collect use tax from Colorado purchasers, and that enjoining enforcement of the procedures would certainly restrain the ability of the state to collect the use tax. Consequently, the court observed that attempting to enjoin either the imposition of a tax or the procedures used to collect that tax would interfere with state revenue collection, and both fall within the “traditional heartland” of TIA cases that require dismissal of federal lawsuits to protect state coffers.

The court next addressed whether the DMA had a “plain, speedy, and efficient remedy” in the Colorado courts. The DMA did not dispute that the Colorado courts can and do address the constitutionality of state tax laws. However, it appeared to argue that the TIA language contemplated something more than the general availability of a remedy to “the universe of plaintiffs who sue the State.” The court observed that Colorado law allows taxpayers that are denied tax refund claims or assessed penalties in tax matters to file administrative appeals and, if necessary, appeal administrative decisions to state court. As such, the court concluded that Colorado provides avenues for remote retailers to challenge the use tax reporting requirements.

Next Steps

The DMA filed a petition for rehearing en banc on Sept. 18, 2013, which was denied on Oct. 1. The DMA now has to decide whether to petition the U.S. Supreme Court for review of the TIA issue or to pursue its arguments in state court. All companies making sales to Colorado purchasers that are not currently collecting sales and use tax should be aware that the injunction will likely be lifted in the near future. It remains to be seen how the DOR will respond once the injunction is lifted, or whether, for instance, it will require noncollecting retailers to file retroactive reports.

Although Colorado is not the only state that has adopted use tax reporting requirements, 20 its law is by far the most extensive. Other states have limited their requirements to ensuring that the seller informs the purchaser at the time of the transaction that use tax may be due on the purchase. The DMA received a favorable ruling on the merits in federal court, but it is not clear whether it will be equally successful in state court. Given the uncertainty surrounding the enactment of the Marketplace Fairness Act of 2013, more states may enact use tax reporting requirements to increase use tax compliance if the courts ultimately leave the Colorado statute undisturbed.



1 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

2 See, e.g., Scripto, Inc. v. Carson, 362 U.S. 207 (1960).

3 Marketplace Fairness Act of 2013, S. 743, 113th Cong., 1st Sess. (2013). This bill, in essence, would allow states to require remote sellers that annually make more than $1 million of remote sales to collect and remit sales tax.

4 The MFA currently sits in the House of Representatives Judiciary Committee. In the Senate, the MFA bypassed the committee process. In contrast, the MFA is expected to go through the full legislative process and be the subject of a robust debate in the House. House Judiciary Committee Chairman Bob Goodlatte, R-Va., recently issued a press release outlining seven principles that provide what Rep. Spencer Bachus, R-Ala. (chairman of the Subcommittee on Regulatory Reform, Commercial and Antitrust Law, to which the bill is referred) called a “thoughtful framework for discussion on the internet sales tax issue.” Based on these principles, it appears the MFA will be revised in the House.

5 Direct Marketing Ass’n v. Huber, No. 10-CV-01546-REB-CBS (D. Colo. 3/30/12).

6 Direct Marketing Ass’n v. Brohl, No. 12-1175 (10th Cir. 8/20/13).

7 Tax Injunction Act, 28 U.S.C. §1341.

8 Colo. Rev. Stat. §39-21-112(3.5).

9 Colo. Rev. Stat. §39-21-112.3.5(d). Implementing regulations adopted by the DOR limited these reporting requirements to sellers with over $100,000 of sales in Colorado. Colo. Code Regs. §39-21-112.3.5 also provides that the January report be provided only to customers with $500 or more in purchases from the seller in the preceding year. Absent the injunction, the first annual statements to purchasers would have been due on Jan. 1, 2011, and the first annual reports to the DOR on March 1, 2011.

10 Direct Marketing Association, “DMA Files Lawsuit Against the State of Colorado Over Internet Sales Tax Law,” (June 30, 2010).

11 Id.

12 Direct Marketing Ass’n v. Huber, No. 10-CV-01546-REB-CBS (D. Colo. 3/30/12).

13 Though, as noted below, courts do sometimes weigh the burden on interstate commerce with the state’s legitimate interests.

14 Pike v. Bruce Church, Inc., 397 U.S. 137 (1970).

15 Interestingly, up until 1974, the DOR included a use tax return with individual income tax returns. However, the practice was discontinued because the amount of tax collected did not justify the extra printing costs.

16 Direct Marketing Ass’n v. Brohl, No. 12-1175 (10th Cir. 8/20/13).

17 28 U.S.C. §1341.

18 Hibbs v. Winn, 542 U.S. 88 (2004).

19 Id. at 107.

20 Kentucky (Ky. Rev. Stat. §139.450(2)), Oklahoma (Okla. Stat. tit. 68, §1406.1), South Dakota (S.D. Codified Laws §10-63-2), and Vermont (Vt. Stat. tit. 32, §9783) have adopted statutes requiring that remote sellers not responsible for collecting tax provide clear notice to buyers at the time of a purchase that the purchase may be subject to use tax and that the purchaser may be required to file and pay use tax directly to the state.



Jamie Yesnowitz is a principal with Grant Thornton LLP in Washington, D.C., and is the firm’s State and Local Tax–National Tax Office practice leader. Sarah McGahan is a senior manager, state and local tax, with KPMG LLP. Mr. Yesnowitz is chair and Ms. McGahan is vice chair of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact Ms. McGahan at


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