Companies (NOT JUST ONLINE RETAILERS) without a physical presence are now required to collect sales tax.
On June 21, 2018, the United States Supreme Court ruled in a 5-4 decision in South Dakota v. Wayfair, Inc., et al, that the physical presence test under the 1992 Supreme Court case (Quill Corp v. North Dakota (504 U.S. 298) no longer applies to the obligation to collect and remit sales tax on sales to customers in a state. In other words, a company can now be required to collect sales tax by simply selling over the internet or by using any other method, regardless of whether the company or its representatives ever step foot into the state. The ruling is in respect to South Dakota’s law, but has implications for all states.
The ruling provides that South Dakota’s sales tax collection law is acceptable because the law and the state meet the following three criteria:
- There is a safe harbor for small businesses – meaning, only businesses with $100,000 or more in annual sales to customers in South Dakota; or 200 or more separate transactions annually with customers in South Dakota; are required to collect South Dakota sales tax.
- The South Dakota law is not retroactive.
- South Dakota is a member of the Streamlined Sales and Use Tax Agreement (which is supposed to make sales tax collection easier)
What Does This Mean?
The media may inadvertently lead companies and consumers to believe that states now have unlimited power to require companies to collect sales tax, but this is not the case. Despite the physical presence test no longer applying, the Court made it clear that the Commerce Clause remains in place and can still protect companies from any undue burdens on interstate commerce. Consequently, businesses still have the ability to challenge any state's nexus law, they just can't fight the law based on the physical presence test.
This decision applies to all companies in any industry including service providers, not just online retailers. Any company that has previously not collected sales tax on taxable sales into a state because they didn’t have a physical presence in the state may now have a sales tax collection obligation in that state.
Similar to state economic nexus laws for income tax, companies can now have an obligation to collect sales tax based on economic nexus. Prior to this ruling, a company without a physical presence in a state could have a requirement to file an income tax return because of a state’s income tax economic nexus law, but not have an obligation to collect sales tax.
Economic nexus sales tax nexus provisions have already been enacted in several states. Even more states proposed economic nexus provisions in 2018 hoping the U.S. Supreme Court would remove the physical presence standard. States with economic nexus sales tax nexus provisions include Alabama, Connecticut, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maine, Minnesota, Mississippi, North Dakota, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Tennessee, Vermont, Washington, and Wyoming.
Without any further challenges or intervention to the Wayfair ruling, companies that exceed the 100,000 in annual sales threshold, or 200 or more transactions threshold in South Dakota are required to start collecting sales tax on sales to customers in South Dakota.
This ruling is a major change and despite the simplicity of the physical presence test being overturned, questions remain regarding how states will respond and what laws are actually acceptable. For example, will other states with sales tax collection laws similar to South Dakota’s be required to meet the three criteria mentioned earlier to be considered acceptable law? Or will states be able to simply hold that any amount of sales or number of transactions in a state requires a company to collect sales tax?
Must a state’s law be prospective only? Must the state be a member of the Streamlined Sales and Use Tax Agreement?
Will states hold that their current nexus laws allow them to impose collection obligations on companies without having to enact the new law? Will states hold special legislative sessions to enact laws similar to South Dakota’s?
What Actions Should I Take?
Companies should review their sales by state information to determine potential filing requirements. As part of that analysis, companies should review the taxability laws of states they haven’t had to address before and determine if any exemptions or exclusions apply, etc. Items or services that are taxable in one state, may not be in another.
Once this review is done, companies should pause to determine whether they should register and start collecting or if there is an opportunity, based on the facts and a state’s law, to not register and collect. The Commerce Clause still applies and Congress could act to regulate interstate commerce and impose limitations. Consequently, there is a need to act, but in a cautious and controlled manner. Voluntary disclosure agreements and amnesty programs may also come into play for companies who haven’t collected in prior years when they should have, even prior to this ruling.
Companies that haven’t had to file sales tax returns in many states and thus, have filed manually, may now need an automated solution to comply with thousands of taxing jurisdictions. Companies should consider different providers to find the best fit for their industry and transaction volume.
Companies should follow state legislative actions and non-legislative actions closely. Companies should not play the ‘wait and see' game, but should prepare now regardless of how things shake-out over the next few months. Congress could act or new litigation and challenges could arise.
We are monitoring this closely and will keep you posted. Please contact us to help you determine how this decision impacts your company and what actions you should or should not take.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.