2016 midyear state and local tax update - Sales and use taxes

Nexus issues again dominate the sales and use tax area. Two states accepted the US Supreme Court’s invitation in its opinion in Direct Marketing Association v. Brohl, US Supreme Court, No. 13-1032 (March 3, 2015) to challenge the Quill physical presence standard.

Alabama started the nexus fight when it put a bright-line test in place beginning Jan. 1, 2016. It requires out-of-state vendors with more than $250,000 in annual sales to register for and collect sales tax. No physical presence is required on the part of out-of-state businesses to be subject to the registration requirement.

South Dakota followed suit with a bright-line nexus threshold in March 2016 (SB 106). Effective May 1, 2016, the state requires any retailer selling tangible personal property, digital goods, or services delivered in South Dakota to register for sales tax if:

  1. Gross sales into the state exceed $100,000 during the previous calendar year (or)
  2. The retailer has 200 or more sales transactions into South Dakota during the prior calendar year.

Alabama immediately began enforcing its new nexus standard by sending preliminary assessments to the top out-of-state retailers selling into the state. It is expected that a serious constitutional challenge to Alabama’s standard will be mounted as soon as one or more assessments become final and move into the appeals process. Note that Alabama has adopted a “carrot-and-stick” approach by expanding its “simplified remittance program.” It allows sellers without physical presence to voluntarily register and remit sales tax at 8 percent with the Department of Revenue handling the local tax computation and forwards it to the appropriate taxing jurisdictions.

Several lawsuits have been launched in South Dakota to stop enforcement of SB 106. The enabling statute was designed to prevent the bright-line nexus test from taking effect unless the state of South Dakota prevails in its litigation to defend its constitutionality and the direct attack on Quill. South Dakota indicated its intent not to enforce the new sales tax registration requirements until it prevails in its litigation. This will hopefully protect retailers from retroactive fallout if South Dakota is fortunate enough to win its case.

The out-of-state retailer notification program pioneered by Colorado to force businesses without nexus to register for sales tax still has life. A US appeals court upheld the constitutionality of Colorado’s burdensome compliance requirements in February although a Supreme Court appeal is expected. (See Direct Marketing Association v. Brohl, 10th Circuit, No. 12-01175, Feb. 22, 2016.)

The Vermont legislature enacted provisions similar to the Colorado notification requirement in H. 873. Out-of-state retailers meeting certain conditions will be required to send notices to Colorado customers purchasing more than $500 in products or services during the previous calendar year that they may owe state and local use tax on these purchases. The notices are due by Jan. 31 of the calendar year following the transactions. In addition, vendors with more than a specified sales volume, measured by dollars or number of transactions, must annually file a report with the Department of Taxes detailing their in-state customers and purchases. Penalties are imposed on businesses that fail to comply with the customer notification and Department of Taxes annual filing requirements. H. 873 is expected to be signed by Vermont’s governor and would commence on the earlier of July 1, 2017, or first day of the quarter starting after Colorado’s out-of-state seller notification requirement are legally permitted to go into effect.

Click-through nexus laws continue to appeal to states. Originally enacted by New York, the statutes and, in some cases, administrative policies define sales tax nexus to include commission arrangements between remote sellers and internet affiliates that have an in-state physical presence. These click-through nexus requirements appear to violate Quill. However, the US Supreme Court chose not to hear constitutional arguments on the issue when it denied certiorari to Amazon in its sales tax dispute with New York. The Oklahoma state senate passed a click-through nexus statute in April: HB 2531. A recent BNA article cited an estimate of 35 bills introduced in various states during 2016 which aim to impose sales tax on remote sellers.

The plethora of legislative and administrative action on taxing internet sales reflects state impatience with congressional inaction on proposals to overturn Quill. The two most prominent proposals—the Marketplace Fairness Act and the Remote Transactions Parity Act—remain stalled in committee. Many state and local tax policy experts predict that neither will be passed during 2016 due to the pending presidential election and the death of Supreme Court Justice Antonin Scalia. To the extent this is true, the complexity of state sales tax nexus regimes and their lack of uniformity will continue to worsen for multistate retailers.

On the bright side, the approval of the Trade Facilitation and Trade Enforcement Act of 2015 on Feb. 24, 2016, finally made the ban on state and local taxation of internet services permanent. The states allowed to tax internet services under the grandfather provisions of the old Internet Tax Freedom Act were given until June 30, 2020, to phase out their tax. This group includes Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin.

The sales and use tax treatment of cloud computing remains a very hot topic and promises to remain so as more software and information technology infrastructure migrates into the form of software as a service (SaaS), platform as a service (PaaS), and infrastructure as a service (IaaS). States have moved to capture sales tax revenue related to such software and services but often have been forced to rely on outmoded statutes that do not neatly cover them. Businesses that sell or purchase “cloud” software are troubled by the absence of legal and administrative guidance on what is taxable. To add insult to injury, some states have enforced relatively new cloud taxation policies on a retroactive basis. Tennessee reversed earlier administrative rulings in December 2015 and declared that remotely accessed software is taxable in Important Notice No. 15-25. Michigan’s courts, on the other hand, blocked the Treasury’s attempt to tax cloud computing software. This is an area that bears close watching in the months ahead due to dollars being invested in SaaS and cloud applications as well the increased bundling of services like market analytics with remotely accessed software, including apps for mobile devices.

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