United States

Wayfair, sales tax, and economic presence laws

Determining when to collect and remit sales tax just got harder

INSIGHT ARTICLE  | 

Introduction

On June 21, 2018, the U.S. Supreme Court issued its decision in South Dakota v. Wayfair, overturning the long-standing "physical presence” nexus standard established through Quill v. North Dakota in 1992. With the Wayfair decision, the Court has opened up the possibility for states to impose sales and use tax collection and remittance responsibilities on remote sellers based solely upon their economic presence in a state.

How did we get here?

Historically, state budgets have relied heavily on sales and use taxes, evidenced by the fact that aggregate sales and use tax collections account for more than 30 percent of total state tax revenues. Sales and use taxes are some of the most stable and reliable as a revenue stream—with aggregate national collections only falling during periods of significant economic downturn such as the recession of 2008.

Not surprisingly, states have attempted to expand sales and use tax collections through a variety of strategies, including:

  • increasing rates (often unpopular and unsuccessful with voters)
  • expanding the sales tax base to professional services and other traditionally exempt items
  • increasing “sin taxes” (sales taxes on cigarettes and alcohol)
  • requiring use tax notification and reporting of remote sellers
  • pushing the boundaries of traditional sales and use tax nexus concepts

But for states to reap the financial benefit of sales and use tax, there must be a reliable system in place to capture that revenue. Traditional laws requiring physical presence quickly became insufficient when paired with the exponential growth of online and remote sales. The result is what we see in today’s marketplace, buyers moving away from brick-and-mortar shopping to online purchases, and states left to watch what was once valuable revenue escape.

In attempt to combat this lost revenue, states have enacted new sales and use tax nexus laws in response to the changing digital economy (and tax revenue lost due to remote commerce) through concepts such as “click-through nexus,” so-called “cookie nexus,” and employing broader applications of affiliate nexus. Most significantly, however, states began to directly challenge the physical presence nexus standard laid out in the 1992 U.S. Supreme Court case, Quill Corp. v. North Dakota.

In his concurrence to the U.S. Supreme Court’s 2015 opinion in Direct Mktg. Ass’n v. Brohl—a case out of Colorado challenging use tax notice and reporting requirements—Justice Kennedy concluded that tax loss from the combination of individuals’ use tax noncompliance and far-reaching systemic and structural changes in economic and social activities due to expanding use of the internet indicated a need for the court to revisit the Quill physical presence standard. Kennedy called for the states to provide the court with a case suitable to address whether the rationale in Quill is still viable in the modern world. The states moved quickly in response.

South Dakota v. Wayfair

On March 22, 2016, South Dakota Governor Dennis Daugaard signed Senate Bill 106, a statute that imposes an “economic sales tax nexus standard” on out-of-state sellers. Specifically, the statute obliges remote sellers to collect and remit sales tax if they have more than $100,000 of sales to, or engage in 200 or more transactions with, South Dakota customers—even if the remote seller has no physical presence in the state. The South Dakota Department of Revenue subsequently began mailing notices to remote sellers requiring collection and remittance of sales taxes on sales to South Dakota customers. The notices were followed by the Department filing a declaratory judgment action against three remote internet retailers in Hughes County Circuit Court. That action automatically enjoined the enforcement of the law during the pendency of the litigation.

After an attempt to hear the case in federal court failed, the Hughes County Circuit Court struck down the law. The South Dakota Supreme Court subsequently affirmed the Circuit Court's decision in September 2017. On Jan. 12, 2018, the U.S. Supreme Court granted the state’s petition for certiorari, agreeing to hear the challenge to physical presence nexus. On June 21, 2018, the Court eliminated the physical presence requirement entirely, replacing the Quill standard with the four-part Commerce Clause test established under Complete Auto Transit, Inc. v. Brady in 1977. States became free to enact their own economic sales tax nexus provisions.

Subsequently, the U.S. Supreme Court remanded the Wayfair litigation back to the state of South Dakota to fully examine South Dakota’s law under the Complete Auto test. However, the litigation was settled between the parties before any other constitutional issues could be addressed in the context of that test. Importantly, it should be noted that Wayfair does not establish South Dakota’s “200 transactions with or $100,000 in sales to in-state customers” standard as a constitutional minimum, opening up the possibility that other states could utilize lower or different thresholds.

Economic sales and use tax nexus landscape

How does the economic sales tax nexus landscape look today?

Nine months after the Wayfair decision, well over half of the states that impose a state-wide general sales tax had addressed economic sales tax nexus. Two dozen of those provisions were in effect at that time, with other states scheduled to enforce economic sales tax nexus throughout 2019. Many of these states have effective dates, sales and transaction thresholds and compliance requirements that vary from South Dakota's provision at issue in Wayfair.

A number of states anticipate future guidance or enforcement as taxing authorities consider a regulatory response or issuance of new policy. In 2019, every state legislature is scheduled to meet. Through these sessions, the remaining states that have not yet adopted economic sales tax nexus could address Wayfair-styled thresholds with some states likely to revise their originally adopted thresholds.

Through the end of July, the following states have enacted an economic sales tax nexus statute, promulgated a regulation, or issued final guidance impacting remote sellers post-Wayfair: Alabama, Connecticut, Georgia, Hawaii, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Massachusetts, Minnesota, Mississippi, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, and Wyoming. These states have varying effective dates and compliance requirements – each provision must be independently analyzed. Additionally, new states are addressing economic sales tax nexus on a weekly basis, or revising their previous positions, and this list will likely be much longer in only a few weeks.

Federal legislative remote-seller solutions

Congress may overrule the U.S. Supreme Court’s decision in Wayfair by exercising its constitutional power to regulate commerce between the states. Congress could codify the Quill physical presence standard into federal law, or enact a system of remote seller collection such as the frequently discussed Marketplace Fairness Act. 

On July 24, 2018, the House Judiciary Committee held a hearing to consider testimony on whether the House should address remote sales tax collection. However, even with at least eight bills introduced to address remote seller nexus between 2017 and 2018, no progress was made on the issue. With the 116th Congress kicking off in early January 2019, it is anticipated that a number of those remote seller sales tax proposals will be re-introduced. However, with almost every sales tax state addressing a Wayfair threshold, it seems increasingly unlikely Congress will independently address this issue.

Takeaways

The Wayfair appeal moved through the court system at a blistering pace. Even with a decision from the nation’s highest court, very little is settled. Under the U.S. Constitution’s Commerce Clause, Congress may have the authority to implement a remote seller solution or codify the physical presence standard into federal law. Whether Congress takes up the issue is a “wait-and-see” proposition.

Even with the death of Quill’s physical presence standard, sales tax nexus expansion is nevertheless far from certain. New litigation stemming from Wayfair is likely, and the decision’s effect will ripple through the states. What is certain is that the sales tax nexus landscape will be changing very quickly and preparation will be key.

Wayfair creates many more questions than it seeks to answer. Understanding how sales tax nexus may affect your business is extremely important.

Taxpayers should speak to their state tax advisers about the impact of the Wayfair decision on their business. 

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