Recently, Schwartz International sat down with Ned Lenhart, sales tax specialist of Interstate Tax Strategies, P.C., to discuss the impact of South Dakota vs. Wayfair, the recent Supreme Court sales tax case. Below is a portion of their conversation.
South Dakota vs. Wayfair Supreme Court Case
On June 21, 2018, the U.S. Supreme Court issued its opinion in the landmark case of South Dakota vs. Wayfair. The Court’s decision in Wayfair overturned almost 50 years of precedence concerning sales tax nexus for sellers that do not have a physical location in the customer’s state. I will refer to these companies as ‘remote sellers’. The dust continues to settle on the fallout from this case as both sellers and state tax administrators adjust to these new rules. The following are some common questions that have been asked and my responses to them as it pertains to the new economic nexus rules embraced by the Supreme Court. These changes have the potential to impact every business that has customers in multiple states.
Q: What change to sales tax nexus does the Wayfair decision make?
A: For at least the past 26 years, state tax authorities were barred from forcing sellers of property or taxable services from collecting sales tax on these sales unless the seller had some minimal physical connection with the state. Physical presence could be created by: sending employees or independent contractors into the state to make sales, owning inventory in the state, renting an office in the state, performing services in the state, or delivering property on company vehicles into the state. With the explosion of e-commerce over the past decade, thousands of businesses could make sales of property using internet commerce without having a physical presence outside of their home state. There is also a huge number of foreign sellers that operate in the U.S.
Because of the physical nexus requirement established in 1992 in the North Dakota vs. Quill (“Quill”), states could not force these sellers to collect tax. To overcome this problem, several states adopted and enforced laws deeming nexus to exist under an ‘economic nexus’ test rather than a physical nexus test. The states knew these laws would be challenged and that the Supreme Court would eventually weigh in on the issue. The South Dakota law which was reviewed by the Supreme Court deems nexus to exist for remote sellers if they have over $100,000 of South Dakota sales or 200 separate South Dakota transactions during the prior calendar year. If so, these companies must register to collect sales tax. Failure to do so will result in assessment of tax and penalty by the state. To the surprise of most, the U.S. Supreme Court ruled that this economic nexus test was valid. The Court further stated the Quill decision was no longer valid and the state did not have to prove that taxpayers had a physical presence in their state before they could require tax be collected.
Q: When is the Wayfair decision effective?
A. States that had economic nexus laws on their books when the Wayfair decision was issued are free to enforce these laws as they wish. Several states have gone on record that they will not begin enforcing their economic nexus rules until October 1, 2018. This gives companies a chance to evaluate their sales levels in these states and to register in the state if required. Several states have laws that go into effect on January 1, 2019 and these will likely be enforced from that point forward. Many states are planning special legislative sessions to pass some type of economic nexus standard so that they can begin collecting sales tax from qualified remote sellers.
Q: What other states have laws similar to the South Dakota law?
A: As of July 1, 2018, the following states had some type of economic nexus rule in their state: Alabama, Georgia, Indiana, Minnesota, Massachusetts, Mississippi, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Washington, and Wyoming. More states are expected to be added by the end of 2018.
Q: Does the Wayfair decision only apply to e-commerce sellers?
A: NO! This may be the most important issue to understand. The Wayfair decision applies to all business not just online sellers of property. By eliminating the physical nexus requirement, states that pass some form of economic nexus law are free to require any business that meets the economic nexus test to comply with the sales tax laws of that state. In some cases, this may mean that sales tax must be collected on taxable sales. In other situations, it may mean that remote sellers must collect resale exemption certificates from customers in that state who are not taxable on their purchases in that state. The elimination of the physical nexus requirement will allow states to require some type of compliance from all sellers that meet the economic nexus test of their state. Just because your company does not make taxable sales, does not mean you are not impacted by the Wayfair decision. This decision applies to wholesalers and retailers.
Q: Does physical presence still create nexus under Wayfair?
A: Yes! It appears that the Wayfair decision allows states two opportunities to require remote sellers to collect sales tax or comply in some other way with their state’s sales tax law. For remote sellers with a physical connection in the state, the rules have not likely changed. If a seller does not have physical nexus but exceeds the economic threshold of the state, then nexus may also be created. It appears that the economic nexus thresholds laws are drafted to only apply when some other type of physical nexus does not exist. In fact, the Wayfair case seems to allow states to develop any type of physical nexus requirement they want. Massachusetts has adopted the ‘cookie’ nexus test which deems software ‘cookies’ to create a physical presence in the state if the program is loaded onto the customer’s computer.
Q: Did the Supreme Court automatically adopt the South Dakota economic nexus standard that each state must adopt?
A: Not really. It is beyond the scope of the Court to formally impose a uniform standard on this sort of issue. The Court noted that there must be a balance between the benefit the state receives (tax revenue) and the cost incurred by the out-of-state business to provide that benefit. The Court, while not specifically outlining that balancing test, stated that the features of the South Dakota law met this balancing test. I think that most states will do their best to model the South Dakota law, but states are free to set higher standards if they wish. Some states have set revenue thresholds of $200,000, $250,000, and $500,000. A couple of sates have thresholds of $10,000! Wayfair is not going to be the last court case on the validity of these economic nexus rules.
Q: Does Wayfair only apply to sales tax?
A: No. The physical nexus rules of Quill also applied to taxes that were not based on income, such as franchise taxes, gross receipts taxes, and similar taxes. Under Wayfair, states that have such taxes could easily apply the economic nexus rules to these taxes. Further, many states have used economic nexus tests for income taxes when related to revenue from services or from revenue from intangible property. Many states have adopted these ‘factor present’ test for income tax.
Q: What should remote sellers do now?
A: Every business situation is different. I would first recommend that remote sellers analyze in which states they may have even the slightest physical presence. Under Wayfair, states appear to be able to legally enforce any type of physical nexus with the state, regardless how minor. I would then recommend that remote sellers evaluate their sales levels in all states where they are not currently registered and where they don’t have a physical connection. If sales in those states exceeds $100,000, then further analysis of the state law will be needed to determine any compliance obligation. I would also recommend that wholesalers begin collecting resale certificates from all customers in all states regardless of the sales volume. Failure to have a valid resale certificate on audit could present some serious problems.
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Please contact Ned Lenhart for any of your sales tax needs at P: 770.985.9573 E: firstname.lastname@example.org
Please remember to think of Schwartz International for any of your individual or business international tax needs: www.schwartzintl.com