In a 5-4 decision, the U.S. Supreme Court ruled South Dakota’s economic nexus law constitutional, potentially requiring online retailers and other remote sellers to collect and remit sales tax to states in which they do business, without regard for their physical presence within those states.
The decision overturned Quill Corp. v. North Dakota (504 U.S. 298 (1992)) that for more than 25 years required “physical presence” (e.g., employees, independent agents, property residing or situated in the state) for states to require a business to register and collect sales and use tax.
The South Dakota v. Wayfair, Inc., et al ruling upheld S.D. Codified Laws § 10-64-2, requiring sellers without physical presence in the state to collect and remit sales tax if:
- The seller’s annual gross revenue from the sale of goods or services into South Dakota exceeds $100,000; or
- The seller has 200 or more separate transactions annually in the state
The court noted Quill is “unsound and incorrect” and has for too long given out-of-state sellers an advantage, resulting in substantial lost sales tax revenue to states. Further, the court stated Quill provided a tax shelter for a business that limited its physical presence in a state, but sold products and services to consumers over the internet. The court provided the example of a business that maintained inventory in a state was required to collect and remit sales tax, but a seller with a “substantial online presence” in the state would not have been required to collect and remit sales tax if it did not have physical presence.
The decision pointed at South Dakota’s two tests for establishing sales tax nexus as being reasonable safeguards for protecting small businesses from multistate sales tax compliance. It also noted other elements of the court’s Commerce Clause doctrine remain in force to ensure interstate commerce is not unduly burdened by state taxes. This is a key point as it puts states on notice that they do not have unlimited power to tax interstate transactions under any and all sales tax regimes.
What does this mean?
The ruling opens the door for states to require online and remote retailers to collect sales tax on transactions in the state, based on an “economic” presence such as dollar threshold of sales or number of transactions in the state. Taxpayers will no longer be afforded protection previously provided under Quill when a retailer had no physical presence in the state.
Companies need to consider the following to address new sales tax standards:
- Does the company know its economic footprint (e.g., gross sales or number of transaction in states) as well as its physical footprint? This includes extensions of where its operations through agents and marketplace facilitators (e.g., online inventory) are located.
- What tools does the company have to identify states where immediate registration and compliance is required by the decision versus states with nexus rules, including those purporting to have economic nexus standards that do not fit within the Wayfair parameters?
- Does the company know if it sells taxable goods in other states? Does the company need to collect exemption or resale certificates in states where historically it has not been required?
- Does the company have adequate personnel to prepare returns? Does the company have sufficient policies and procedures in place surrounding its sales and use tax compliance in general?
- Does the company have sales and use tax compliance software? If not, will the accounting system be able to charge sales tax in new jurisdictions where the business may be liable? Does the company have access to current state and local tax rates?
- Is customer service prepared to explain to customers why sales tax is now being charged on purchases where historically it was not?
Although Wayfair appears to be a black-and-white answer to the question of sales tax nexus, many issues remain. For example, do states need to have legislation similar to South Dakota’s to assert nexus absent physical presence? Undoubtedly, some states will administratively assert sales tax jurisdiction based on economic nexus under existing laws. It would appear some type of safe harbor for small businesses and multistate retailers is required.
There is also the question of whether overturning Quill will affect prior years. Serious doubt remains as to how far back the decision may reach. To the extent Wayfair’s look-back is limited, businesses should carefully examine their historic nexus and sales tax exposure strategy. Are financial statement reserves for such exposure affected in any fashion?
States can be expected to react quickly to the Wayfair decision. Some will enact “copycat” economic nexus statutes while others will begin to enforce anti-Quill laws that were contingent on the repeal of the physical presence test. For retailers, developing a well-thought-out plan to respond to Wayfair, rather than registering in all jurisdictions where they have sales, will be critical to cost-effective multistate sales tax compliance.
Baker Tilly state and local tax professionals are analyzing the decision to determine its ultimate implications. We will continue to monitor states’ reactions to Wayfair and provide additional guidance and takeaways from the decision.
For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.
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