Americans are used to hearing the refrain, "We pay the sales tax," from mattress sellers and car dealerships during big sales weekends. The phrase, "You pay the sales tax," however, is something we're all going to become a lot more familiar with in the wake of the Supreme Court's ruling in South Dakota v. Wayfair.
That's because the Wayfair decision reverses precedent set by 1967's National Bellas Hess v. Illinois and upheld in 1992's Quill v. North Dakota, in which the court ruled that states could require companies to collect sales tax only if they had "sufficient physical presence" in the state.
In South Dakota v. Wayfair, however, the court ruled that making physical presence the minimum standard is "unsound and incorrect." The result is that states now can require businesses to collect sales taxes if they meet the lower standard of "economic nexus" in the state — a condition state legislatures get to define on their own.
This is a big win for state governments, whose desire to overturn Quill has intensified in recent years due to the rise of e-commerce and the billions of dollars in taxes that go uncollected every year. (Residents in states with sales tax are supposed to file a use tax return with items purchased outside the state, but most do not). By requiring remote sellers to collect sales tax, states are expecting to see a huge increase in the sales tax revenue, especially this holiday season.
Unfortunately, the battle to recover this tax base also is likely to result in significant collateral damage in the form of the burden it places on e-commerce businesses. Many small and medium-sized e-commerce companies run on thin margins and have few resources to devote to ensuring they collect the appropriate amount of sales tax on each order. Indeed, the reason the court decided in the past not to require businesses to collect sales taxes on orders sent across state lines was that they acknowledged the serious administrative burden associated with this task.
Economists can debate the macro effects of the decision: Will this lead to residents of states with complex sates tax structures being underserved? Will it lead to lower competition because of the additional administrative costs needed to start or operate an e-commerce business? However, what business owners want to know is how this will affect their operations and profitability.
The first thing companies should know is that you don't need to conduct a lot of business in a state to trigger economic nexus there. In South Dakota, the physical presence condition remains, but it is compounded by an economic nexus rule that says if you have US$100,000 worth of sales, or more than 200 transactions involving customers in the state during the current or previous calendar year, then you must collect sales tax on all transactions with customers in that state.
This type of safe harbor threshold quickly is becoming the norm, given that South Dakota's definition is serving as a model for the dozens of other states that have passed or are in the process of passing similar laws.
Worse, companies have been given extremely short timetables to comply. The decision came in June, but many economic nexus laws are already in effect, and more will go into effect early next year. Many businesses, having other, more immediate worries, still aren't sure even where to start. While there are technology solutions out there, they take time and expertise to implement, which many small and medium-sized businesses just don't have.
Impact on SaaS
The impact of Wayfair largely has been on e-commerce, but that doesn't mean e-commerce businesses are the only ones that need to evaluate the effect of the new economic nexus laws. Some states require companies that sell intangible goods over the Internet, such as Software as a Service (SaaS), to collect sales tax where they have an economic nexus.
Now that states are making it easier for taxpayers to trigger sales tax nexus in their state, SaaS, cloud computing and other service-based businesses that never have had to worry about sales tax in the past (because the state in which they physically are located doesn't tax their products) may already be in noncompliance, without even knowing it.
The aftermath of the U.S. Supreme Court's Wayfair decision certainly creates a unique situation calling for today's businesses to immediately address sales/use tax issues created by hastily drafted reactionary legislation and interpretations establishing economic nexus thresholds with effective dates in the second half of 2018 and early 2019.
Reasoned analysis and decisions are needed, as it does not appear that the economic nexus standards for sales/use tax collection responsibilities are going away any time soon. The proper decision for each business may vary widely, from not doing anything at the moment to registering in all sales/use jurisdictions as soon as possible, or somewhere in between.
No matter the final decision, businesses should be resigned to devoting in-house resources or hiring outside resources to address the impact of the current evolution in the world of sales and use taxes.
On the positive side, the need for additional resources may be temporary if an efficient sales/use tax collection and remittance system can be put into place effectively. For today's current situation, businesses may be well suited to hire a third-party to notify them when new obligations are created, and to explain what actions are needed. It may be unrealistic for small to medium sized businesses with limited resources to track changes on their own.
Once a business accepts the fact that sales tax collection is a business obligation that is not going away soon, and that missteps have the potential to bankrupt an otherwise successful business down the road, an easily overlooked factor in the cost/benefit analysis is who will likely pay the tax due if sellers do not collect tax at the time of sale from the buyer.
Many sellers may not fully realize that their future audit assessments might have to come out of operating funds of the business — or more dramatically, out of the pocket of the individual owners or officers of the business.
Instead of looking at sales tax as a payment between a business and the state imposing the tax, sales and use taxes in today's context are more properly viewed as a decision between the seller and the buyer. Either the buyer pays the tax at the time of sale, where allowed, or the business likely has to pay the tax at the conclusion of an audit, which may take place up to three years later when the original purchaser cannot be contacted to pay the tax due.
However, the daunting task of complying with state and local sales/use tax obligations in 45 states and the District of Columbia may not be as intimidating as a business owner might think, with today's technology.
Sales/use tax compliance is certainly not as simple as downloading an app to your smartphone, but, by the same token, businesses with a repetitive, uncomplicated business process and product line may be able to automate the preparation of sales tax returns and the remittance of tax almost to a point where returns can be produced with a "push of the button" for every filing period.
Electronic filing and electronic payments also may be reduced to a data input process that can be accomplished in a low-cost manner.
With additional registration requirements created by new economic nexus standards for sales/use taxes on the horizon, business also must take the next step, and determine what other registrations are triggered automatically when registering for sale/use tax purposes. Some states make registration with the Secretary of State a prerequisite to get a valid sales/use tax permit.
Secretary of State registration usually requires the presence of an in-state registered agent and additional registration fees for the business, on top of any costs to collect sales/use taxes due.
Sales tax registration does not automatically require the filing of income tax returns, as income tax nexus standards are independent of sales/use tax standards. It is possible that sales/use tax filings are required under economic nexus laws, but that state income tax filings are not.
States may however, make inquiries of the new businesses registering for sales/use taxes purposes to make an accurate determination of the new businesses' income tax filing obligation. Businesses need to fully understand the specifics of their nexus-generating activities, and the questions they are being asked that will determine whether income tax return filings are also due.
Even though Wayfair is a sales/use tax case, states also are closely examining the Supreme Court's analysis to determine if new interpretations of law are possible under the Wayfair rationale that could increase income tax payments or other revenue streams into the state.
Although economic nexus has been the focal point for many businesses since the Wayfair decision in June, businesses cannot overlook the other laws recently passed by states to collect the sales/use tax on sales by remote sellers that otherwise do not have nexus with the state.
Marketplace Nexus, Reporting Obligation
Marketplace Nexus laws establish registration and collection obligations on third-parties that provide the virtual e-commerce marketplace and key services for remote sellers to execute sales.
Amazon and eBay are popular marketplace sellers, and they both have started or will start collecting and remitting sales/use tax on some states' transactions executed in their marketplaces established for their sellers. Businesses may have to distinguish sales executed through their marketplaces from their direct online sales, so they can collect and remit applicable sales properly, and use taxes themselves on their direct online sales.
When physical presence was still the standard, Reporting Obligation laws were passed requiring non-nexus remote sellers to notify buyers on their invoices of their use tax obligations for non-taxable purchases they made.
Remote sellers also may be required to send all in-state purchaser information to states, so states can contact in-state purchasers directly to collect the use tax due. Colorado was the first state to pass Reporting Obligation laws, and approximately 13 other states have such laws on their books. These requirements may take as much effort for compliance as the actual collection and remittance of sales and use taxes due.
Even in states without economic nexus legislation, like California, businesses with no substantial physical presence are not necessarily free from sales/use tax collection obligations, because many states have broad "doing business" statutes that could be interpreted as creating sales/use tax nexus for a remote seller.
Such laws state that when "doing business" in a state, the requisite nexus is established to enforce the obligation to collect sales and use taxes. The requisite level of "doing business" is very subjective and difficult to anticipate in some situations.
Thus, a new, aggressive interpretation that a remote seller is "doing business" in a state may be preferred by states to establish sales tax nexus in lieu of trying to pass economic nexus laws in tax-adverse legislatures now that "substantial physical presence" is no longer the overriding standard.
Much remains to be seen in the near future for the post-Wayfair sale tax world, but one thing is certain, businesses should educate themselves about all of the possible scenarios, so they can decide what actions to take and when they should be taken. What used to be a relatively easy decision to make is now anything but.