On June 21, 2018, the U.S. Supreme Court issued the most important state and local tax decision in decades. South Dakota v. Wayfair, overturned the long-standing ‘physical presence’ nexus standard established under Quill v. North Dakota in 1992. Wayfair opened up the possibility for states to impose sales and use tax collection and remittance responsibilities on remote sellers based solely upon their economic activity in a state. The shift in focus from physical to economic presence represented a seismic shift for nexus analysis, giving states broad authority to tax remote sellers.
On the second anniversary of the Wayfair decision, it is important to examine the current sales tax landscape, the evolving compliance obligations of remote sellers, and the questions arising in Wayfair’s aftermath.
In 2016, South Dakota enacted a remote seller sales tax law specifically designed to challenge the Quill decision. The South Dakota law required remote sellers to collect tax if they have sales into the state of more than $100,000, or more than 200 different transactions shipped to addresses in the state. The law applied prospectively. Several companies challenged the law asserting that requiring out of state vendors to collect the tax without a physical presence violated the Commerce Clause as interpreted by the Quill court.
After an unusually quick appeal to the nation’s highest court, the physical presence standard set forth in Quill was overturned. In holding that the South Dakota law did not violate the Commerce Clause, the U.S. Supreme Court stated that several features of the law prevented discrimination against interstate commerce or undue burdens on interstate commerce. These included the small-seller safe harbor provisions, the prospective nature of the law, and that South Dakota adopted the Streamlined Sales Tax Agreement as a form of administrative simplification.
Where we are today
Economic sales tax nexus
As expected, states quickly began adopting laws to require out of state vendors to collect and remit sales tax. In the two years since the Wayfair decision, 44 of the 46 states imposing a general sales tax adopted remote seller collection laws. To date, only Florida and Missouri have not enacted laws specifically requiring out of state vendors to collect and remit sales tax. Although both states ended their regular 2020 sessions, economic nexus was proposed in each state for the second year in a row. Florida and Missouri could still address economic sales tax nexus in special sessions this year.
With the exception of Kansas, every state has adopted a safe harbor provision to shield small remote sellers from sales tax collection requirements. Many of these safe harbors are based on sales amounts, transaction quantities or a requirement that thresholds are met for both sales and transactions. However, safe harbor provisions vary greatly. States with sales-only thresholds are no lower than $100,000, but thresholds can be as high as $500,000 in states like California and Texas. No state has solely adopted a transaction threshold. In 2019, a number of states with both sales and transaction thresholds began to remove the transaction requirement. California, Colorado, Iowa, Massachusetts, North Dakota and Washington all eliminated the transaction threshold in favor of a sales-only threshold. At least nine other states never adopted a transaction threshold.
Marketplace facilitator nexus
The second major development arising out of the Wayfair decision involves marketplace facilitators. Many vendors use companies such as eBay or Amazon to facilitate their online sales. Rather than enforcing remote sales tax collection laws against multitudes of individual sellers, states have placed the burden of collection on the marketplace facilitator. These laws benefit both the state and sellers by reducing administrative and compliance costs. Only a handful of states have not adopted some form of marketplace facilitator law. It is likely most states will eventually adopt marketplace laws as they have with economic sales tax nexus.
Marketplace nexus provisions vary greatly among the states including who is subject to the law. Many states have adopted broad statutory definitions of marketplaces, in some cases resulting in more than one party to a transaction qualifying as a marketplace. Additionally, many implementation questions remain with little guidance from the states to assist taxpayers. For example, sellers using the marketplace may be unsure of how to report or evidence marketplace sales to states where they are already registered. Does the marketplace have the legal liability to collect the tax? How are marketplace sales treated for purposes of determining whether the seller has exceeded a Wayfair threshold for direct sales made outside of the marketplace? These questions will linger until the states can provide the appropriate guidance or legislative clarity.
Do excluded or exempt sales count towards the threshold?
Sellers are continuing to struggle with determining when they have met a sales threshold for purposes of a state’s economic sales tax nexus law. Some states have provided guidance on whether an exempt or excluded sale should be included. Other states, by the nature of the statutory and regulatory structure, apply the threshold to all receipts from the state. However, only a few states have provided direct guidance on determining thresholds. For example, Minnesota Sales Tax FAQs for Remote Sellers explains that ‘resale sales’ are not included in calculating the threshold.
When should a business register?
Another struggle for remote sellers approaching or exceeding thresholds is determining when registration and collection is required. The time it takes to complete a registration with the taxing authority and add the new state to a seller’s sales and use tax compliance system can take upwards of a month. Some states have provided a short period of time for sellers first meeting the threshold to register and prepare before having to collect the sales tax.
Local sales and use taxes
One significant issue of concern is the Wayfair decision’s effect on local option sales taxes. There are many local governments with the authority to impose sales taxes. This authority varies widely by state. Some states allow only select jurisdictions to impose the tax. Generally, the local sales tax is levied on the same base as the state sales tax. In most states collection and administration of all sales taxes occurs at the state level. In some states, local governments administer their own sales taxes. In these states, the local sales tax base can and often does differ from the state tax.
Alaska does not impose a state-wide sales and use tax, but over 100 local jurisdictions have the authority to impose a local sales and use tax at widely varying rates. Before Wayfair, this was mostly a concern for sellers physically located in those jurisdictions. Since Wayfair, a number of Alaskan localities have adopted economic sales tax nexus. Additionally, the Alaska Remote Sellers Sales Tax Commission was established to simplify remote seller administration of local Alaskan sales and use taxes.
Alabama and Louisiana have both taken steps to make remote seller collection a little bit simpler for sellers without physical presence in the state. In Alabama, the state has created a simplified sellers use tax program with a flat rate and single point of collection. In Louisiana, which intends to begin remote seller enforcement on July 1, 2020, the state’s Sales and Use Tax Commission for Remote Sellers will be a single collection point for sales tax due on sales to Louisiana customers.
Remote sellers should also be cognizant of local jurisdictions enforcing remote seller provisions without economic sales tax nexus provisions. In Colorado, for example, a number of localities administer their own sales and use tax laws. As of the date of this article, no local authority in the state has adopted a separate economic nexus threshold. However, some localities in states with local sales taxes have begun to enforce collection based on the Wayfair decision without a threshold or specific economic sales tax nexus law under broad interpretations of pre-Wayfair local tax law.
Existence of pre-Wayfair nexus laws
After the Quill decision through to when Wayfair was decided, many states enacted laws designed to expand the physical presence standard. States enacted affiliate nexus, click-through nexus, cookie nexus, and use tax notice and reporting requirements. Many of these laws generally remain on the books and serve as another tool for a state to impose nexus on a remote seller. States will continue to apply nexus expansion provisions to remote vendors who do not meet the gross sales or transaction threshold standards of economic sales tax nexus. Remote sellers should be prepared to examine nexus-creating activities from every perspective, and not just whether sales or transactions into a state exceed an economic nexus threshold. All taxpayers should understand that, while Wayfair changed the constitutional nexus standard, the decision did not eliminate nexus established through a physical presence.
ASC 450 concerns
Remote sellers should also consider contingencies required to be booked related to potential liabilities stemming from exceeding nexus thresholds. Noncompliance with economic sales tax nexus could have substantial financial statement audit impacts. Due to the various effective dates of state economic sales tax nexus following the Wayfair decision, a few states each month beginning in the fall of 2018, many businesses may not have timely registered. Some businesses chose to register prospectively in groups of states once it was easier to handle the onslaught of new compliance obligations. Timing differences between when the threshold was met and when collection began may result in material amounts of tax, interest and penalties.
Foreign inbound enforcement
For foreign inbound sellers, sales tax nexus was historically a concern if the business established a physical presence in the United States through, for example, offices, warehouses, inventory, salespeople, or employees. After the Wayfair decision, foreign-based remote sellers are no longer protected by the physical presence safe harbor. While state sales tax audits of economic sales tax nexus compliance will likely focus on domestic businesses in the near-term, inbound businesses may also be subject to state sales tax nexus provisions. There are a number of mechanisms states may use in enforcement against foreign sellers. Some considerations for foreign sellers include whether the foreign business has any presence in the United States, including real estate, bank accounts, or property owned by officers and owners of the business, and whether the foreign business is owned by a U.S. company. There are too many considerations to note here, but consider reading RSM’s article, 5 misconceptions for inbound businesses in a post-Wayfair world, for more information.
What’s the minimum activity threshold?
There are a number of issues that the Wayfair court never addresses in its opinion. Some of these questions will ultimately result in litigation. For example, while South Dakota’s small-seller threshold was $100,000 in sales or 200 transactions, the Court did not bless that threshold as a constitutional minimum. While no state has enacted a threshold below $100,000 of sales, a state may still enact a lower threshold. Kansas, with no sales or transaction threshold, may violate the Wayfair decision and various constitutional provisions because it failed to adopt a small-seller threshold. As the COVID-19 pandemic has devastated state and local finances, remote sellers should pay careful attention to changing nexus standards by states looking for more revenue.
Non-sales and use taxes
Wayfair addressed whether a state can require an out-of-state seller to collect sales and use tax when the seller lacks a physical presence in that state. However, the Court’s analysis in determining whether a state tax nexus law is constitutional under the commerce clause applies to all state taxes. States may begin to consider economic activity tests for non-sales and use tax nexus, like existing income tax factor-presence standards already adopted in several states. A flurry of activity around non-sales and use taxes occurred in 2019 as states first began to use Wayfair to expand economic nexus beyond sales taxes.
A summary of some of that activity is below:
- Hawaii enacted a $100,000 sales or 200 transaction standard for purposes of the corporate income tax effective for tax years beginning after Dec. 31, 2019
- Oregon enacted a new commercial activity tax with a sales threshold of $750,000
- The Pennsylvania Department of Revenue established a rebuttable presumption that corporations with $500,000 of gross receipts establish nexus beginning on or after Jan. 1, 2020
- Texas adopted a $500,000 receipts threshold for purposes of the franchise tax effective for reports due on or after Jan. 1, 2020
- Washington reduced the business and occupation tax threshold to $100,000
Noteworthy, the Hawaii and Texas thresholds are identical to each state’s economic sales tax nexus standard. Many of these actions are because of, or justified by, the Wayfair decision. It is important that businesses consider how Wayfair may impact their non-sales and use tax obligations, such as income and franchise taxes and gross receipts taxes.
The impact of COVID-19
The impact of COVID-19 on state tax collections is currently incalculable, but policy specialists and early data forecast total losses on the high end of over $500 billion. Many of the losses will be due to steep declines in individual income taxes, due to job losses, and sales and use taxes. States will undoubtedly address these shortfalls through several strategies including new legislation and increased audit activity.
The 2020 state legislative season has, at the time of publishing this article, seen little new legislative action or clarification around economic sales tax or income tax nexus. As noted, Missouri and Florida again ended their regular sessions without an economic sales tax nexus provision. Anticipating 2020 special sessions and regular 2021 sessions, it becomes increasingly likely that states will continue to target both sales tax and income and franchise tax nexus for remote businesses.
Additionally, any leniency the states have provided for businesses registering due to new nexus standards will likely end. State and local taxing authorities are likely to increase nexus questionnaires, review new registrations with heightened scrutiny, inquire about nexus creating activities taxpayers may have had before the Wayfair decision, and begin to audit for economic nexus compliance.
What should your business be thinking about two years after Wayfair?
Two years after the Wayfair decision, it should be immediately clear that the states will take economic sales tax nexus seriously. The states have created a fragmented landscape of various sales tax nexus provisions, thresholds and responsibilities with much guidance still needed.
Businesses must have a plan for responding to Wayfair. Consider the following questions to help your business begin to tackle the Wayfair decision:
- Where and how much are your sales and services sold into each state?
- What was your nexus footprint prior to the Wayfair decision? Voluntary disclosure and amnesty should be considered for noncompliant collection and remittance as state statutes of limitations of three or more years will still apply to past periods. Considerations should be given to ASC 450.
- What products and services do you sell? Items and services may be exempt from the sales and use tax in one state, and taxable in another. Understanding how those items are characterized is important for multistate tax compliance.
- How does your business maintain and track exemption certificates?
- Has your business considered a technology, automation or co-sourcing solution? If so, does your ERP track “ZIP+4” shipping address, individual line item taxability on an invoice, customer exemption status by state, and export sales into a return software? Determining sales tax compliance obligations in 10,000 jurisdictions requires using the right tools. Technology and ERP solutions are not necessarily “one size fits all” and should be considered with the needs of the business.
- How do you ensure the correct tax rate is collected and how are rate changes tracked and updated?
- How does your business stay up to date on new nexus legislation?
Additionally, businesses should consider a system of tracking state legislative changes, regulatory developments and guidance issued addressing the myriad of economic nexus issues still pending. New litigation stemming from the Wayfair decision is almost certain. Taxpayers without a plan to address these new economic nexus requirements are creating significant exposure to multistate tax liabilities, interest and penalties that could be devastating to middle-market and small businesses.
Taxpayers selling across state lines should consider speaking to their state and local tax consultants to consider the impact of Wayfair and to develop a strategy to efficiently and quickly move forward.