As a follow up to our recent Tax Alert covering the June 21, 2018 U.S. Supreme Court decision in the South Dakota v. Wayfair case, this exclusive feature elaborates on the impact this ruling will have on sales and use taxes related to “economic nexus.”
Read on for further background information and key topics of consideration to empower your financial decision making in the wake of these breaking tax changes.
In a series of cases, the U.S. Supreme Court established a general rule of “substantial nexus,” which required an out-of-state seller to have a physical presence in a state before that state could require the seller to collect and remit sales and use taxes. That standard was upheld 26 years ago in the well-known Supreme Court decision Quill Corp. v. North Dakota. In that case, the Court barred North Dakota from requiring an out-of-state mail-order company from collecting sales tax on goods sold to North Dakota customers. The Court ruled that under the dormant Commerce Clause, the company could not be liable for North Dakota sales tax. The reason being that it had no outlets, sales representatives or significant property in North Dakota.
South Dakota’s Money Grab
With no income tax, South Dakota heavily relies on sales and use taxes to raise revenue. From the state’s perspective, it lost tremendous amounts of tax revenue to internet retailers that do not collect South Dakota sales tax. As internet sales increased, remote sellers had better access to in-state markets without having to physically enter the state. South Dakota estimated that it lost some $50 million in revenue per year in uncollected sales tax. In response, the state passed legislation that required out-of-state retailers to collect South Dakota sales tax if the retailer had annual gross revenue of more than $100,000 from sales in South Dakota. This legislation also applies if the retailer completed more than 200 sales annually in the state.
Following the enactment of the law, South Dakota sought to make four internet retailers liable for its sales tax based on the level of sales activity that the retailers had in South Dakota. None of the retailers had a physical presence in the state as defined under state law. Instead, South Dakota relied on the thresholds employed in its new economic nexus provision, particularly with respect to each company’s sales activities within the state. The retailers refused to comply with South Dakota’s rules, instead relying on the Supreme Court’s physical presence rule as set forth in Quill and appealed the case to the U.S. Supreme Court.
The Decision that Rocked SALT
The Supreme Court held that physical presence is not necessary to create substantial nexus with a state. The Court decided that South Dakota may require remote sellers to collect and remit sales tax when all the remote seller only makes sales to South Dakota residents. Essentially, the substantial nexus requirement with the taxing state is satisfied based on both the economic and virtual contacts the remote retailers have with the state when their in-state transactions meet the state’s mandated thresholds.
The impact of the decision is far reaching as States are now free to levy taxes on sales of goods and services regardless of whether the seller has a physical presence in the state. In the aftermath of the decision, the expectation is that states will immediately begin amending their sales tax statutes to allow for the levy of taxes on sellers without a physical state presence.
Since 2008, states have enacted a variety of new nexus provisions in order to require remote sellers to collect tax or provide information about in-state customers, including:
- Click-Through Nexus
- Affiliate Nexus
- Marketplace Nexus
- Use Tax Notice and Reporting Requirements
A number of states currently have rules in place to require remote sellers to collect and remit sales taxes. However, use of the South Dakota statute as a model provides a more streamlined approach for sales tax collection, and assures states of the constitutionality of such laws.
In addition, a number of states have passed similar statutes containing provisions of delayed enforcement until the issuance of the Wayfair decision. It is reasonable to conclude that such states will immediately begin enforcing collection responsibilities in the wake of this decision.
Where the states go from here becomes even more problematic. The next battle may well be to establish what amount of sales or other level of economic presence constitutes enough contact with the state to support nexus with it. It is by no means a free-for-all for the states, but the Supreme Court failed to provide whether the South Dakota thresholds are required or if they are just simply indicative of a substantial nexus. If $100,000 of in-state sales or 200 transactions are sufficient, what about $50,000 of sales or 100 transactions? Long term, states may begin pushing the envelope of the requirements of the holding, trying to stretch the definition of substantial nexus.
Remote retailers or service providers will likely have to implement new internal systems in to response to the impending wave of new state statutes. In many cases, these entities may already have systems in place for those jurisdictions where they have a physical presence and were collecting tax. However, now they will have to expand such systems to account for sales in states where no physical presence exists.
The question of retroactivity also comes into play. The Court looked favorably on South Dakota’s dollar statutory limitation that it would not apply the tax retroactively, but not all states levying economic nexus have such a limitation. This may be a cause of concern to small businesses selling remotely who cannot afford to remit back periods of sales tax.
Retailers are encouraged to review their state sales in light of the new sales tax playing field post-Wayfair. Multistate nexus studies can often identify those states where remote retailers may have sales and use tax obligations. Under the new Wayfair standards, vendors must track not only state revenues but also transaction volume to ensure compliance. Automated software can facilitate the proper tracking of these activities on a state -by -state basis.
Another consideration for remote retailers might be to participate in the Streamlined Sales Tax Registration System. Under the Quill physical presence regime, participation in the system was undesirable. This was because vendors had to collect in all of the streamlined states without regard to their physical in-state presence. Vendors ultimately gave up a competitive advantage over in-state sellers who were required to collect sales tax. With the removal of the physical presence requirement, this competitive advantage is erased. As a result, the ability to collect and remit sales taxes efficiently in more than 20 states with approved software solutions, service providers and liability protection for retailers is much more attractive.
To learn more about how this decision impacts your business, please contact:
Principal, Director of State and Local Taxation
Principal State and Local Taxation and Tax Controversy