With over 10,000 sales jurisdictions across the United States and the ever-increasing amount of online retailers, sales tax – especially across state lines – is a topic becoming more and more relevant. This holds true not only for internet retailers, but also brick-and-mortar stores, manufacturers and wholesalers alike.
Recently, the Supreme Court heard South Dakota v. Wayfair, Inc. 138 S. Ct. 2080 (2018) and voted to alter the out of state sales tax landscape, particularly in relation to online retailers. With the Supreme Court’s decision to overturn the longstanding ruling in Quill Corp. v. North Dakota (1992), sales tax legislation was drastically affected. Keep reading to find out more about the case, what is new, and what that means for you and your business.
What’s in this article
What did out of state sales tax look like prior to the case?
Throughout the 1980s and 1990s, states vigorously attempted to convince companies to collect sales tax on transactions into the state. Companies were making out of state sales through the mail and telephone and not collecting any out of state sales tax.
As a result, North Dakota instituted a law requiring any company engaging in “regular or systematic” solicitation in the state to register and collect sales tax. Subsequently, the state was taken to court in a then-landmark case, Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court determined that a physical presence (i.e. employees, property, or offices) was necessary before a state could require the company to collect sales tax.
Following the Quill ruling, sales tax compliance was fairly straightforward for companies. If they had a physical presence in the state, they collected sales tax. The states, on the other hand, were displeased.
Along Comes the Internet
As online retailers grew in popularity, states noticed a decline in revenue from sales tax. To combat the loss, states began to pass new laws and regulations to find nexus and collect sales tax. For instance, Massachusetts taxed sales based on the electronic “cookie” on a computer and New York developed click-through nexus to tax internet sales derived from clicking on website ads.
Collectively, the states changing the rules focused on a new concept of “economic nexus.” The general belief was that if a seller who is not physically present in the state makes a certain dollar volume of sales or a minimum number of sales transactions to customers in their state, the seller has adequate nexus with the state for the state to impose an obligation on the seller to collect sales tax. South Dakota was one of these states to buy into the economic nexus concept.
In 2016, South Dakota passed a law that stated if sellers amassed $100,000 or more of sales into the state or completed 200 or more transactions into the state within a single calendar year, the seller was required to collect sales tax. The state set out to provoke a litigation battle, hoping to force the topic onto the agenda of the Supreme Court. In order to do so it went after three companies it knew passed each regulatory threshold: Newegg, Overstock.com and Wayfair.
Game changer: South Dakota v. Wayfair, Inc.
In 2018, South Dakota (and most likely several other states watching in anticipation) got their wish. The case, South Dakota v. Wayfair, Inc. fell into the laps of the Supreme Court.
On June 21, 2018, the Court ruled in a 5-4 decision in favor of the state. With the ruling, Quill was effectively overturned. States are now able to mandate businesses without a physical presence in the state to collect and remit sales tax on transactions in the state. Based on the South Dakota law that initially reached the Court, the economic nexus or threshold that businesses had to pass before states could require sales tax collection is $100,000 in sales or 200 transactions within a calendar year.
In addition to increasing the power of the states, the ruling also opened the door for counties and other municipalities to impose the same regulations.
What are the concerns and implications of the Wayfair case?
The 2018 Wayfair ruling has substantially shifted the ground under online retailers, consumers and state tax authorities throughout the United States. No longer does the longstanding “presence nexus” stand true, but rather the new “economic nexus.”
However, the ruling raised additional questions regarding sellers, state tax authorities and legislators.
What is the actual economic nexus threshold?
Unfortunately, the nexus requirement is still up in the air, seeing as the Supreme Court did not address the minimum amounts in their decision. However, what is for certain is that $100,000 of sales and 200 transactions into the state in one year satisfy the constitutional threshold set in place by Wayfair.
Since the ruling, some states have moved very quickly to enact economic nexus laws. The thresholds, though, are all over the map. For instance, some are $250,000 in sales, others are $250,000 in sales and 200 transactions (e.g., Connecticut), and others are at $500,000 (e.g., Ohio and California).
What about items that are already taxable? Are there any exemptions?
Notably, many states and other jurisdictions tax different goods and services. For example, many states already collect sales tax on clothing. However, some states do not tax clothing (e.g., Pennsylvania) and some apply a threshold (e.g., New York taxes clothing costing $110 or more). Another example is groceries. Most states do not have a tax on groceries, but some do and even then groceries are taxed at a considerably lower rate. Ultimately, there is significant complexity when it comes to determining what tax is needed for what items in what jurisdictions. As of now, the tax guidelines and regulations come down to a jurisdiction-by-jurisdiction analysis.
When will the change take effect?
Most importantly, many states have issued guidance explaining that they will enforce their economic nexus statutes prospectively rather than retroactively. A few states instituted remote seller statutes with effective and enforceable dates of July 1, 2018. Others have initiated change throughout the year following the ruling, like California’s economic nexus law coming into effect on April 1, 2019.
Will Congress react to the ruling?
As it stands today, Congress has two significant bills pending. Each could specify what simplifications a state must make to be able to require online sellers to collect sales tax. Such a law would need to be compatible with the Court’s ruling and provide protections for sellers and consumers. The Marketplace Fairness Act (MFA) intends to provide federal-level authorization for states to collect sales and use tax from sellers with no physical presence in their jurisdictions. Similarly, the Remote Transactions Parity Act (RTPA) aims to provide compliance clarity. It is still to be seen if either bill or any other is passed.
How does this impact online retailers specifically?
Wayfair stands to have a direct impact on a number of digital businesses.
Retailer and eCommerce – Companies with large retail or eCommerce sales, despite a lack of physical presence, may be subject to sales or use tax collection and remittance.
Software as a Services (Saas) and digital goods/services – Businesses selling SaaS, cloud and other digital goods/services to end users, even without a significant nexus footprint, may be subject to additional sales and use tax collection.
In-bound Companies – Even businesses without a permanent establishment (PE) in the U.S. but sell into the U.S. may have U.S. sales or use tax collection responsibilities.
Online retailers can develop a framework to evaluate their nexus indicia, meaning the taxability of goods or services in that jurisdiction, especially digital goods and services such as cloud and SaaS; the capability to identify relevant transactions; and the dollar amount exposure.
Evaluating their nexus indicia may prove to be quite challenging for small to mid-size retailers. Some helpful actions to take and address the Wayfair changes are:
- Identify and prioritize your jurisdictions;
- Determine existing statutes in those identified jurisdictions;
- Determine the proper systems, processes and information needed to meet the new tax filing policies;
- Develop a compliance strategy; and
- Consider other potential non-indirect tax impacts.
What are some steps I can take with my business?
Since Wayfair, some remote vendors have started to collect and remit sales tax if they meet the economic nexus for their state. Enforcement, though, has been slow. However, a majority of the 45 states that impose a sales tax are starting to work toward enforcing new rules. The talk has ramped up regarding finding the balance between encouraging online retailers to get compliant and reaching for the audit letters – with assessments, penalties and interest to follow.
Therefore, it is in your best interest – if you are an online seller potentially affected by Wayfair to get into compliance as soon as possible. Here are some steps you can take:
1. Determine Your Nexus and Filing Requirements
Several states have passed economic nexus statutes for sales and use tax purposes. Additionally, some states have enacted economic “factor presence” statutes for income tax purposes. While many states impose the $100,000 in sales or 200 transactions thresholds set by South Dakota’s precedent, it does vary from state to state. For example, California’s economic nexus law – in effect and enforceable as of April 1, 2019 – is a total combined sales of $500,000 or more.
2. Evaluate Product and Service Taxability
As previously mentioned, some goods and services already have specific taxes in place from state to state. It is imperative to stay aware of the taxability of the goods and services sold (and any purchases made) within the state and more local jurisdictions.
3. Calculate Potential State Exposure
In the states where nexus and tax exposure exists for prior periods, businesses are encouraged to quantify the historical sales tax and income tax exposures using historical sales and income data and totals by state and by product. Furthermore, some companies may need to record the state tax exposure as a liability for financial reporting purposes.
4. Mitigate and Disclose Historical Tax Liabilities
Use the exposure estimates to determine appropriate efforts to mitigate and disclose taxes. The necessary action varies by state, but may include sales/use tax mitigation or voluntary disclosure or amnesty programs.
Voluntary Disclosure Agreements (VDA) or amnesty programs can considerably reduce the tax, penalties and interest ultimately paid to resolve historical liabilities. They can also streamline registration, tax filings and payment of historical tax liabilities.
5. Implement a Sales Tax System
Implementing a sales tax system allows you to stay on top of every sales tax rate for different jurisdictions and streamline compliance. Indirect automation focuses on system integration between an ERP/eCommerce system and third party tax software.
Once you are in compliance, work diligently to stay there! There are a number of unanswered questions about the Wayfair case that could see resolution in the next several months or years. The implications regarding mergers & acquisitions, nonprofits, foreign businesses and more are still up in the air. Keep yourself abreast of the situation and any relevant new out of state sales tax laws.
How can we help?
Our State & Local Tax Team, led by Partner Jeff Davis, is comprised of highly technical, well-experienced professionals here to assist you with your out of state sales tax compliance concerns. We are dedicated to providing excellent service and guiding you through the post-Wayfair sales tax landscape. Reach out for more information.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.