June 21, 2018, marked the end of an era for retailers not charging sales tax. The Supreme Court’s 5-4 decision in South Dakota v. Wayfair, et al. favored states when it overruled the “physical presence” standard long held in Quill Corp. v. North Dakota.
As a result states will now have more control over requiring any out-of-state business to collect sales tax — regardless if they have a physical presence in the state. This much-anticipated decision is poised to bring significant changes for all sellers.
Justice Kennedy delivered the opinion of the Court, which essentially confirmed what many states have been upset about for a long time — the explosive online retail environment of today makes the 1992 Quill standard of needing a physical presence to show significant business activity outdated. Specifically, Justice Kennedy noted that Quill’s physical presence standard is “unsound and incorrect” and that it served as a “judicially created tax shelter.”
The four-prong test established in a previous case, Complete Auto Transit v. Brady, remains the standard to determine whether a state taxing statute is constitutional. The tax must:
- Apply to an activity with substantial nexus, or connection, to the taxing state;
- Be fairly apportioned;
- Not discriminate against interstate commerce; and
- Be fairly related to the services the state provides.
The Quill case focused on the first prong, asserting that a physical presence was needed to satisfy the substantial nexus requirement. However, in Wayfair the Court found that the substantial nexus prong does not require physical presence, but instead can be satisfied if the entity conducts business in the state, online or otherwise. The Court found that the threshold South Dakota had imposed on Wayfair, which taxed the home store when it reached $100,000 in state sales or 200 or more separate transactions in the state, could only occur if the seller was conducting substantial business in the state, therefore satisfying the substantial nexus test.
The issue raised to the Court was very narrow and only addressed the physical presence requirement. The Court remanded the case to the South Dakota Supreme Court for further proceedings to address other Commerce Clause principles that could invalidate the South Dakota statute. Although the Court's decision did not officially address the validity of the statute under the remaining prongs of the Complete Auto Transit test, Justice Kennedy noted that the following aspects of the South Dakota law “appear designed to prevent discrimination against or undue burdens upon interstate commerce”:
- The $100,000/200 transaction threshold creates a safe harbor for sellers that transact only a limited amount of business in South Dakota.
- The Act cannot be applied retroactively.
- South Dakota adopted the Streamline Sales and Use Tax Agreement, which provides for simplified compliance.
What Taxpayers Should Do Now
Most importantly, DO NOT begin collecting sales tax in any jurisdiction until you are properly registered to remit the collected tax.
The Wayfair decision leaves many open questions and issues. What is the threshold that will satisfy substantial nexus? Would $1 or one transaction, as raised in oral arguments, be sufficient? The answer is likely no; however, it remains to be seen whether a state challenges the threshold amounts.
Economic nexus statutes are not limited to South Dakota. Over one dozen states have enacted economic nexus statutes with thresholds similar to those found in the South Dakota statute. In many cases, these statutes have been stayed pending the outcome of Wayfair or pending state litigation. Now that the Wayfair decision has been issued, states will begin to enforce their own statutes and resolve pending litigation in the absence of the physical presence standard. The question as to when the statutes will become effective remains open. There is also uncertainty about the threshold in states that have dollar or transaction thresholds lower than those included in the South Dakota statute, such as the state of Washington, which currently imposes a very low $10,000 receipts nexus threshold.
The Wayfair decision likely will impact other areas of state and local tax. States began eroding the Quill physical presence standard for income tax purposes over 20 years ago. In recent years, we have seen more states adopt economic nexus and factor-presence standards for income tax purposes. The Wayfair decision likely will lead to legislation in states that previously applied the physical presence standard. Additionally, states that broadly define nexus as “doing business” in the state may become more active in asserting nexus over out-of-state taxpayers.
The Wayfair decision affects ALL sellers, not just online retailers. All sellers need to develop an action plan to determine how the Wayfair decision will impact their business. While it is likely that states will not immediately enforce existing sales tax economic nexus statutes, it is inevitable they will very soon.
As you begin evaluating the new sales tax nexus landscape, you should initially consider the following:
- Review your business’ 2017 sales by state reports to identify states in which you have more than $100,000 of sales. You also will need to review customer reports to determine if the 200 transactions threshold is exceeded in any state.
- Review your current sales tax processes and procedures. Do you have processes in place to identify the taxability of the products/services you sell? Do you need to automate the taxability decision process? Also evaluate the impact on your current use tax procedures as vendors begin to collect.
- Review your customer exemption certificates and update as needed.
- Start discussions about sales tax compliance. Where will you need to register? Will you keep the compliance in house? If you prefer to maintain your compliance in house, should you automate your process?
Work with your state and local tax team to help you evaluate your current procedures and multi-state nexus thresholds, and to identify opportunities to reduce risk in non-filing states. It is imperative for sellers to understand their reporting and collection requirements and take steps to limit any further exposure based on the Wayfair decision. If a seller does not collect a required sales tax from their customer, the state will assess the seller for these taxes, along with interest and penalties.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.
Contact Hannah Prengler at firstname.lastname@example.org or a member of your service team to discuss this topic further.