Wayfair Decision Will Have Wide-Ranging Implications for Retailers and States
James Ortiz | July 10, 2018
A REVIEW OF THE DECISION
In a 5-4 ruling on June 21, 2018, the U.S. Supreme Court overturned a 1992 precedent that barred states from requiring an out-of-state seller with no physical presence to collect sales tax on a sale to a resident of the state. Now, states stand to collect potentially billions of dollars in sales taxes from remote sellers who meet certain minimum standards. The Court remanded the case to South Dakota’s Supreme Court for a finding of whether other issues may block the tax. However, it is unlikely that any issues will surface.
In overturning Quill Corp. v. North Dakota and National Bellas Hess, Inc. v. Department of Revenue of Ill., the Court acknowledged that brick-and-mortar stores have been at a competitive disadvantage to out-of-state sellers. And as technology has become more involved in commerce year after year, it has created incentive for states to challenge the physical presence nexus rule.
Redefining nexus. Nexus in general means “a connection.” For state sales tax purposes, nexus describes the amount and degree of business activity that must be present before a state can tax an entity’s income, or for taxes on sales within the state. Each state views nexus differently, and states have created individual laws defining nexus for business transactions. For online sales, there are three different types of nexus – click-through nexus, affiliate nexus and cookie nexus. Click-through nexus is a direct connection between the buyer and the seller, while affiliate nexus includes the presence of an affiliate between the buyer and seller. Cookie nexus results when a seller uses apps or places browser cookies on a buyer’s computer.
The Supreme Court decision affirmed South Dakota’s standards as reasonable for these factors, according to Justice Kennedy, who authored the opinion of the Court:
- South Dakota’s
minimum standards:South Dakota minimum standards are $100,000 in sales or more than 200 transactions over a 12-month period.
These apply a safe harbor to those who transact only limited business in the state.
- It ensures that no obligation to remit sales tax may be applied retroactively.
- South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement, which standardizes taxes to reduce administrative and compliance costs. It also provides sellers access to sales tax administration software paid for by the State.
Since a 1967 Supreme Court decision, National Bellas Hess, Inc. v. Department of Revenue of Illinois, out-of-state retailers that sell products via mail order have been excused from collecting and remitting state sales tax to the customer’s state. In that decision, the use taxes (sales tax on out-of-state purchases) were still due, but they had to be collected from the in-state customer.
In 1992, the Supreme Court reaffirmed that judgment in Quill Corp v. North Dakota, which established physical presence as the test for sales and use tax nexus.
Today’s marketplace is vastly different from the one in 1992 when Quill was decided. At that time, less than two percent of Americans had Internet access. Today, that number is about 89 percent.
Consumers spent $453.46 billion on the web for retail purchases in 2017, a 16% increase compared with $390.99 billion in 2016. That’s the highest growth rate since 2011, when online sales grew 17.5% over 2010. E-commerce represented nearly 50% of all retail sales growth in 2017. Department of Commerce Quarterly Retail E-Commerce Sales.
In 2016, South Dakota’s legislature responded to what it declared a “fiscal emergency” arising from its eroding sales tax base, and passed a law requiring sellers with gross revenue from sales in South Dakota of more than $100,000 within a year, or at least 200 separate transactions in a year, to collect taxes on behalf of the state. The South Dakota Supreme Court held that legislation to be unconstitutional, and the U.S. Supreme Court granted South Dakota’s Cert Petition.
On June 21, 2018, reflecting the realities of an expanding digital economy, the U.S. Supreme Court ruled that the physical presence requirement adopted by Bellas Hess and Quill was flawed and no longer holds.
According to Justice Kennedy, who wrote the majority opinion in South Dakota v. Wayfair before announcing his retirement, “This expansion has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes. In 1992, it was estimated that the States were losing between $694 million and $3 billion per year in sales tax revenues as a result of the physical presence rule…Now estimates range from $8 billion to $33 billion.”
WHO FACES THE BIGGEST IMPACT?
Positive impacts for local businesses and governments:
Local businesses that operate brick-and-mortar stores are getting a more level playing field, where they can be more competitive with online retailers. States and local governments will receive increases in tax revenue.
Negative impacts for some businesses:
Wayfair will be challenging for small- to medium-sized businesses. Sales tax software that automates the process of tax calculation and collection for each state can be costly. Companies that barely meet the minimum standard requirement will be especially hard hit. The impact of this ruling reaches beyond just online sales. Any company doing interstate commerce, whether wholesale or retail, will need to reevaluate their nexus footprint. In general, all businesses will go through some retrofitting.
Even with mid-sized companies, the impact is likely to be substantial in terms of the investment of time, staffing and technology.
Congress may act. Congress does have the power under the Commerce Clause to regulate interstate commerce. There may be pressure from small- to medium-sized businesses for them to step in and simplify the sales tax collection and compliance process by providing one set of rates and standards that apply to all states that impose the sales tax. However, it is unlikely that it will enact a law that reverses Wayfair and reinstates the physical presence standard.
Regardless of whether Congress acts or not, states will have to decide their reactions to the ruling. Some states may be able to expand their tax collection requirements by issuing modified rules, others may require new laws, and some may decide that their current laws already meet the standard of South Dakota v. Wayfair.
State courts are going to be busy. After Wayfair, states need no longer wait for permission from Congress to require remote sellers to collect tax. This ruling is likely to prompt states to become more aggressive in pursuing sales tax on out-of-state businesses that do not have physical presence in the state but that sell and deliver into their state. Forty-five of fifty states now impose sales tax on purchases. Thirty-one have laws taxing internet sales, and sixteen of those have laws similar to South Dakota.
North Dakota and Vermont have already announced enforcement dates for their laws. North Dakota will begin collecting the tax on Oct. 1, 2018, or 60 days after a remote retailer meets the state threshold of $100,000 in sales or 200 separate transactions into the state.
Several more states have announced intentions to advance on the matter. Most legislative sessions are not due to reconvene until January, meaning that the full effect of this new framework will take shape beginning in 2019. Each state sets its own standards. We maintain a map of all 50 states and update state standard information as the rollout of this decision progresses.
What may also happen. Currently, the majority of states do not tax services and software. States may move to levy taxes on services and software, in addition to goods. Each state has its own concept with regard to taxes on services.
CONSEQUENCES BEYOND SALES TAX
There could also be some consequences well beyond the sales tax arena. The decision also solidifies economic nexus in the income tax area and may impact net worth and income-type taxes. While many companies have benefited from the federal Tax Cuts and Jobs Act (TCJA), they could end up paying some of that benefit back to state governments in the form of income tax.
WHAT SHOULD REMOTE SELLERS DO?
While the decision has certainly created more work for state courts, the reality is that the next steps for remote sellers have to do with compliance. Retailers who sell into other states should take care to follow compliance practices on sales tax collection. This includes foreign retailers.
First of all, determine whether you meet the thresholds in each state. Second, you’ll need to assess whether your business is compliant with the thresholds. If you conduct business in many states, you may want to consider a review with our state and local tax specialists. Lastly, you will need to determine which of your businesses activities are taxable in each state in which you operate.
Businesses will do well to lean on established relationships with their tax and advisory partners to ensure that they determine whether their activities in the states they sell to meet the new minimum standards. There has never been a better time to assess, plan, and consider future options.
Streamlined Sales and Use Tax
The Streamlined Sales and Use Tax Agreement was developed through an open and cooperative process between the states and the business community. The Agreement contains numerous simplification and uniformity requirements states must adopt to remove or reduce the undue burdens on all sellers.
The following states are full members:
|Kansas||North Dakota||West Virginia|
The following state is an associate member: Tennessee.
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|Contact the Author:|
REDW State and Local Tax Senior Manager