The U.S. Supreme Court recently issued a decision that significantly changes the Sales and Use Tax collection requirements for online retailers and out-of-state sellers.
Its decision in South Dakota v. Wayfair ruled that a substantial economic presence is all that is required for sales tax nexus under the Commerce Clause of the United States Constitution. If a company has sales tax nexus in a state, they are required to collect Sales or Use Tax on sales to customers in that state if the state has a Sales or Use Tax.
Prior to this decision, a substantial physical presence in a state was required to have sales tax nexus under the Commerce Clause. The physical presence standard was established with two Supreme Court cases: National Bellas Hess v. Department of Revenue of Illinois and Quill Corp. v. North Dakota. Under the physical presence standard, a seller had to have property, personnel or some other physical connection with a state to be required to collect and remit sales tax.
The Wayfair decision left a number of questions unanswered by remanding several issues to the South Dakota courts to rule. What appears to be clear is they believe the minimum thresholds in the South Dakota statutes for substantial economic nexus were sufficiently high enough. The minimum thresholds for substantial economic presence under the South Dakota statute is annual sales of $100,000 or 200 separate transactions.
A number of states have a similar minimum threshold in their substantial economic presence statutes. The current standard that states are moving to for Sales and Use Tax is a substantial economic nexus standard based on safe harbor and the levels of sales or number of transactions. South Dakota’s law, for example, limits imposition of a Sales or Use Tax collection responsibility to those taxpayers selling into the state who have $100,000 of gross receipts attributable to customers located in the state or 200 total sales transactions into the state over a twelve-month period.
Forty-five states currently impose a Sales Tax and/or Use Tax. Currently, 23 of the 45 states have statutes with nexus created by substantial economic presence. Companies meeting or exceeding the substantial economic nexus threshold established by a state are required to collect Sales Tax or Use Tax. Many of the 23 states have statutes similar to the South Dakota economic nexus provisions that were upheld by the Supreme Court in their Wayfair decision.
The effective date for economic nexus statutes in the 23 states phase in at various dates over the next six months. Four of the 23 states have very low economic nexus thresholds, but allow the online retailer to comply with onerous reporting responsibilities in lieu of registering and collecting sales tax.
We expect many of the states that do not have economic nexus statutes will pass legislation in the coming months. New Jersey currently has an economic nexus statute awaiting the Governor’s signature.
In determining the impact of the Wayfair decision and the introduction of the substantial economic presence nexus standard for sales tax, there are a number of potential issues to be considered:
- Determine states in which the company has a Sales Tax or Use Tax collection responsibility based on each states’ substantial economic presence thresholds.
- Determine the states the company should begin collecting Sales Tax or Use Tax on its sales. When collecting Sales Tax or Use Tax, the customer remits the tax to the selling company.The selling company then remits the tax to the appropriate state. If no tax is collected and the company is subsequently audited by a state, the Sales Tax or Use Tax is the responsibility of the company and it can be very difficult to subsequently collect the tax from the customer.
- Most states ask a series of questions when registering to do business or for sales tax. Two of the questions ask when the company began doing business in the state and the date of the first sale. The questions are often used to generate nexus questionnaires for sales tax or income tax.
- In states for which Sales Tax or Use Tax has not been collected based on the company having no physical presence in the state, review past practices to confirm there was no physical presence. This is especially important for companies selling their products in an online marketplace (i.e. Amazon, etc.) where they do not control where their inventory is held.
- Based on the analysis, determine any exposure that may exist for uncollected sales tax.
- In states for which income tax returns have not been filed based on the company having no taxable presence in the state, review past practices to confirm there was no income tax nexus. This is especially important for companies selling their products in an online marketplace (i.e. Amazon, etc.) where they do not control where their inventory is held.
- Based on the analysis, determine any exposure that may exist for income tax.
- There are a number of software alternatives to assist with the collection and remittance of collected Sales Tax or Use Tax. Most programs also provide for the preparation of the required state Sales and Use Tax returns.
The world of Sales and Use Tax has changed significantly with the Wayfair Supreme Court decision. Companies will need to evaluate their Sales and Use Tax collection responsibilities and appropriate next steps.