Three years ago, the U.S. Supreme Court issued the most important state tax nexus decision in almost 30 years. The South Dakota v. Wayfair decision overturned the long-standing ‘physical presence’ nexus standard for sales and use taxes established under Quill v. North Dakota in 1992, allowing states to impose sales and use tax collection and remittance obligations on remote sellers based solely upon their economic activity in a state. The shift in focus from physical to economic presence represents a seismic shift for nexus analysis, giving states broad authority to tax remote sellers.
After only three years, Wayfair has emerged from young adulthood to near maturity and universal adoption with the final two states passing economic nexus standards in 2021 legislative sessions. However, questions remain, especially for growing businesses increasing multistate sales through ecommerce and fulfillment platforms.
The sales tax nexus landscape heading into 2022 and beyond
Economic sales tax nexus
Some variation of Wayfair economic sales tax nexus has been adopted by every state in the two years following the decision. Florida and Missouri held out the longest, but both states enacted economic nexus legislation in 2021 with varying effective dates. Kansas was initially a noteworthy outlier, choosing to adopt a policy-based remote seller collection requirement without a threshold-based safe harbor. In 2021, Kansas legislatively adopted a $100,000 threshold falling in line with every other state. Small-seller safe harbors have generally been based on sales amounts, transaction quantities or a requirement that thresholds are met or exceeded 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. A number of states originally adopted both a sales and transaction threshold, but have since removed the transaction requirement.
Marketplace facilitator nexus
Many vendors use companies such as eBay or Amazon to facilitate 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. Additionally, marketplace facilitator nexus allows states an opportunity to collect sales tax from sellers who may have total sales activity under $100,000, thus not individually qualifying under a remote seller provision, but sell through a platform that facilitates much more than $100,000 in sales.
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. Recently, more states have amended their marketplace provisions to provide clarity on whether the tax applies to vehicle rentals, restaurant and food aggregation platforms, lodging and accommodation rentals, and local taxes. In some cases, facilitators may be required to collect certain state and local excise taxes or fees that would normally apply in addition to any sales taxes.
Finally, 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 – efforts likely hampered by the COVID-19 pandemic in 2020.
Middle-market remote seller considerations
Do excluded or exempt sales count towards the threshold?
One consideration for remote sellers who sell for resale or sell mostly exempt property and services is determining when and how to calculate the 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. In some cases, sales for resale may not be included in the threshold calculation, but other exempt sales such as generally exempt manufacturing equipment may still be used to determine whether the threshold is exceeded. Remote sellers of exempt property or services, and remote sellers who sell primarily for resale, should review each state’s threshold calculation closely.
Another struggle for remote sellers approaching or exceeding thresholds is determining when registration and collection is required. First, 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. Remote sellers should closely monitor their sales and transaction activity in states where the threshold has not yet been exceeded. Second, sellers should be aware that most state registrations inquire when an economic nexus seller exceeded the threshold, or when the seller began doing business in the state. In some cases, a state may require additional sales evidence to substantiate that the threshold was not met in earlier periods. A number of states have initiated efforts to specifically audit the ‘doing business date’ on a registration. Taxpayers may need to consider voluntary disclosure or other mitigating remedies if they are registering in a state after having exceeded the threshold.
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 localities in select states have authority to impose and administer their own sales and use taxes, often in ‘home rule’ jurisdictions. In these states, the local sales tax base can differ from the state tax. Fortunately the majority of states levy all taxes, both state and local, at the state level, administered by a single state tax agency and using the same tax base.
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, Louisiana and Texas have taken steps to make remote seller collection easier 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 began remote seller enforcement on July 1, 2020, the state’s Sales and Use Tax Commission for Remote Sellers is a single collection point for sales tax due on sales to Louisiana customers. However, Louisiana remains administratively complex even though progress has been made to further ease those complexities. Texas also has enacted a single combined rate option for remote sellers.
In 2021, Chicago provided a nexus safe harbor for remote sellers with revenue under $100,000 derived from the city’s amusement tax as applied to electronically delivered amusements and the personal property lease transaction tax. For remote sellers with revenues higher than the safe harbor, the city may use a number of factors to determine if nexus has been established, including, but not limited to, whether the seller has physical presence in the city or advertising directed to city customers.
Remote sellers should also be cognizant of local jurisdictions enforcing remote seller provisions without economic sales tax nexus provisions. In Colorado, a number of home rule localities administer their own sales and use tax laws. Many of these localities have begun to adopt a uniform local Wayfair ordinance and are enforcing economic nexus on the local level. As of the date of this article, over three dozen local Colorado home-rule jurisdictions have adopted the model economic nexus ordinance.
Finally, some localities in states with local sales taxes have begun to enforce tax 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. Other localities may retroactively enforce Wayfair economic nexus. Ultimately, it should be clear that the complex and fragmented local nexus landscape will remain of significant concern to multistate remote sellers for the foreseeable future.
Physical presence nexus: Alive and well
In the 15 to 20 years before the Wayfair decision, many states expanded physical presence nexus through affiliate nexus, click-through nexus, cookie nexus and use tax notice and reporting requirements. Many of these laws continue to remain active methods to establish nexus for remote businesses.
Importantly, physical presence nexus itself was not replaced with economic nexus – meaning that the presence of offices, employees, sales forces, inventory or other presence in a state will continue to establish sales and use tax nexus for an out-of-state business. States will continue to apply these and other nexus expansion provisions to remote sellers who may 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 replaced the constitutional physical presence nexus standard with economic nexus, physical presence remains a viable method to establish nexus.
ASC 450 concerns
Remote sellers should also consider contingencies required to be booked related to potential liabilities 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 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.
International sellers and state enforcement
Before the Wayfair decision, foreign-inbound sellers essentially had a sales tax nexus safe harbor because physical presence was the constitutionally-required nexus standard. Therefore, sales tax nexus was only a concern if the business established 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 begin to be audited for economic nexus compliance. 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.
Foreign-inbound sellers are just one-half of the consideration for cross-border sales. United States taxpayers selling to Canadian customers should be aware of new ‘Wayfair-styled’ remote seller provisions imposed at both the federal and provincial (local) levels. While traditional state nexus concepts do not exist internationally, many VAT countries, including Canada, impose various tax and compliance requirements on remote sellers.
Exemption certificate management
Multistate remote sellers should be cognizant that many products and services exempt or taxable in one state may not have the same tax treatment in another. Generally, a sale is taxable unless the customer provides a properly completed tax exemption or resale certificate. Historically, most businesses selling across state lines only needed to obtain exemption certificates from customers where sales were made to jurisdictions where nexus was already established, usually a smaller overall nexus footprint. Because of economic sales tax nexus and the resulting new state tax registrations, sellers may need to obtain state-specific certificates for sales to customers in a large number of new economic nexus jurisdictions. This can be particularly challenging when the states do not have similar exemption certificate requirements, such as expiration dates for certificates or other compliance requirements. For businesses selling significant amounts of exempt products or services in many states, the collection and compliance management of certificates can be overwhelming. Businesses may consider a software exemption certificate management solution or at the least develop a plan for tracking and maintaining certificates. Proper exemption certificate management is also necessary to substantiate under audit why the seller may not have collected a tax from the customer.
The rapid adoption of economic nexus standards by state and local tax authorities has thrown businesses into a whirlwind of statutory requirements that include managing thousands of state and local tax rates, maintaining product and service taxability across various tax jurisdictions and developing a mechanism to address exempt customer sales and documentation requirements, just to name a few. To help alleviate the ever-increasing complexity of compliance, there are automated solutions available to help manage these requirements in real time and allow your team to focus on core tasks to help your business thrive. Not all solutions are one-size-fits-all. There are a number of factors that will impact which automated tax engine is best for your business including the nature of your sales and purchase activity, your return filing responsibilities and the existing system infrastructure. Aside from selecting the right software vendor, deploying a detailed approach to integrating and configuring your automation system with the proper tax design is crucial. A system that meets your specific business requirements will help mitigate the additional burdens of tax processes on your workforce.
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 Supreme Court’s analysis in determining whether a state tax nexus law is constitutional under the commerce clause applies to all state taxes. States have already begun to consider economic activity tests for non-sales and use tax nexus, like existing income tax factor-presence standards previously adopted in several states. A flurry of activity around non-sales and use taxes occurred after the decision as states 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
- Maine enacted a $500,000 sales, $250,000 payroll or $250,000 property factor-presence standard effective Jan. 1, 2022
- Massachusetts promulgated a $500,000 corporate income tax nexus regulation
- 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
- Philadelphia adopted a $100,000 threshold for the city business income and receipts tax
- 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 supported 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 continuing impact of COVID-19
In mid-2020 during the early months of the pandemic, the collective state budget landscape appeared dire. Economic data began to project significant shortfalls in tax revenue and overall losses to the states projections as high as $600 billion at one point. However, a number of factors, including federal distributions and consumer spending, reversed that trend. Heading into fiscal year 2022, states are in surprisingly robust fiscal shape.
That turnaround may have delayed or lessened state legislative nexus expansion, especially concerning income and franchise taxes. However, existing economic nexus enforcement has increased as states are generating significant sales tax revenue due both to consumer spending and the overall adoption of Wayfair.
As state taxing authority operations return to normal, and as most states are in year two or three of their remote seller provisions, any leniency previously provided for businesses registering due to economic nexus standards will end. State and local taxing authorities are increasing nexus questionnaires, reviewing new registrations with heightened scrutiny – especially considering business start dates, inquiring about nexus creating activities taxpayers may have had before the Wayfair decision and are beginning to specifically audit for economic nexus compliance.
What should your business be thinking about three years after Wayfair?
Three years after the Wayfair decision, it should be clear that economic nexus is here permanently. While adoption has become universal, the states have created a fragmented landscape of various sales tax nexus provisions, thresholds, compliance hurdles 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?
- How do the states treat the taxability of the products and services you sell?
- How does your business maintain and track exemption certificates?
- Has your business considered a technology, automation or co-sourcing solution?
- 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 and registrations?
Finally, businesses should consider a system of tracking further state legislative changes, regulatory developments and guidance issued to address the myriad of economic nexus issues still pending. 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 especially devastating to small and middle-market businesses.