More states may now attempt to assess sales taxes on businesses that do not have a physical presence in the state. In South Dakota v. Wayfair, the Supreme Court recently struck down the rule from Quill v. North Dakota that permitted states to collect sales tax only from businesses that had a physical presence in the state. The Supreme Court did not replace the physical presence test with a new test, but instead remanded the case to the South Dakota Supreme Court to decide whether the state's current bill is constitutional. South Dakota's bill establishes an economic "nexus" for sellers that exceed $100,000 in revenue from goods and services or execute more than 200 transactions annually. Once nexus is established, South Dakota can collect sales tax from sellers. In its opinion, the Supreme Court hinted that South Dakota's bill is likely constitutional and should be upheld by the lower court. In anticipation of this forthcoming ruling, states are expected to act quickly by enacting legislation similar to that of South Dakota, requiring businesses without a physical presence to pay sales tax. This could affect different businesses in different ways, including perhaps a substantial increase in compliance costs for small businesses with a multistate presence.
The old law (Quill) and the new (Wayfair)
Before the Supreme Court's decision in Wayfair, Quill served as the nexus precedent. Under Quill, states could require out-of-state sellers to collect and remit state sales tax only if the business established a physical presence in the state. This meant that a seller had to have "a small sales force, plant, or office" in the state. At the time of the decision in 1992, mail-order sales were popular, as opposed to online sales. North Dakota legislation subjected mail-order companies to state tax even if they maintained no property or personnel in the state. Ultimately, the Supreme Court decided that a state could not require a corporation that delivers all of its merchandise to the state by mail to collect and remit state taxes because simply sending mail orders to the state did not meet the physical presence requirement.
Wayfair has replaced Quill as the precedential decision on out-of-state taxation. Physical presence no longer serves as the test. Instead, individual states are able to determine what "economic nexus" is sufficient for a seller to be required to collect and remit state sales tax. The Wayfair case arose out of a challenge to recent South Dakota legislation. The bill, S.B. 106, requires out-of-state sellers to collect and remit sales tax if they execute at least 200 separate transactions or exceed $100,000 in revenue from in-state sales annually. This means that online sellers without a physical presence in South Dakota could be required to collect and remit sales tax if they meet the economic threshold. Wayfair and others challenged the bill, arguing it violated Quill's physical presence requirement. The Supreme Court found the reasoning in Quill was "unsound and incorrect" because it was from a different era, one that was not based on e-commerce. Though the Court overruled Quill, it did not officially uphold the bill—instead, it sent the bill to the South Dakota Supreme Court for review. Many commentators expect the bill to be upheld and other states may soon enact similar legislation.
Impact on small businesses
States will ultimately determine what impact Wayfair will have on businesses as states enact legislation. In fact, twenty-one states have already enacted "economic nexus" models. Each has different thresholds of economic activity and enforcement dates. These bills vary between setting the economic activity threshold at 100 and 200 transactions, or $10,000 to $500,000 of in-state sales. In order to assure compliance, a business must first collect data to determine whether it meets the state economic threshold for collecting and remitting taxes for that state. For example, Minnesota proposed an economic nexus threshold of either: (1) 100 transactions; or (2) $100,000 of in-state sales over at least ten transactions, enforceable after the Wayfair decision. Oklahoma, however, proposed a threshold of only $10,000 of in-state sales with no transaction alternative, enforceable as of July 1, 2018. Given the discrepancies between states, it is important that businesses first determine whether they meet the threshold of each state.
If a business does not meet the threshold for a given state, then it will not have to concern itself with compliance for that state. However, all businesses will have to continue to track sales in each state to determine whether it ultimately will cross the threshold and be forced to collect and remit sales tax in that state.
If a business does, however, meet the economic threshold of a given state, compliance with that state's tax codes and laws is required under Wayfair. This could be difficult and costly in the beginning—the calculations, filings, and data collection necessary for compliance will likely impose a large burden. There are now over 12,000 different tax jurisdictions in the United States.
As an example of how certain industries may be impacted, software-as-a-service (SaaS) businesses will have to carefully track where their services are being used because they are often accessed remotely or transferred electronically. This may require collecting data from consumers and continuous documentation of goods and services across all of the many different jurisdictions. Tax software likely will have to be used to facilitate the process given the unique determinations for each jurisdiction. At a minimum, businesses will likely have to dedicate at least one specialist to perform the complex tax work required to comply with each jurisdiction.
The administrative burden is not the only consequence of the Wayfair decision. Certain industries, like brick-and-mortar shops, may benefit. Imposing state tax on online retailers may help level the playing field for brick-and-mortar shops that are already collecting and remitting sales tax. The Wayfair decision may help these shops better compete with online retailers.
Regardless of size or industry, all businesses will have to track business activity outside of their states following the Wayfair decision to stay in compliance with other state nexus laws.
Events to track
- Constitutionality of the South Dakota bill. The Supreme Court indicated that elements of South Dakota's bill will help it pass constitutional muster before the South Dakota Supreme Court. If constitutional, expect states to follow suit and continue to enact legislation to increase tax exposure for out-of-state entities. If unconstitutional, states may still enact similar legislation and try to comply with Wayfair.
- Subsequent state legislation. State legislation following the Wayfair decision will likely contain varying thresholds of economic activity levels and enforcement dates. Some practitioners predict that states may change certain reporting and notification tax regimes. Others wonder whether states will apply their current laws retroactively, but do not expect this to be the case.
- Ways to improve quickly computing taxes for many jurisdictions. Given the future demand for efficient and cost-effective software, tax program service providers may develop new ways to collect and remit taxes for out-of-state sales, which may help small business reduce costs and save time with compliance.
- Possible acts by Congress. Both the majority and the dissent in Wayfair contemplated congressional action in their opinions. Congress may act in the coming months to provide thresholds for states or guidance on limitations of economic activity. It is possible, however, that the Wayfair decision "waylaid Congress's consideration of the issue,” and Congress will not act at all.
The Supreme Court's decision in Wayfair was significant—it overruled longstanding precedent that permitted states to collect taxes only when a seller established a "physical presence" in the state. Now, if South Dakota's bill is ruled constitutional, states enacting similar laws can collect taxes based on an economic nexus. The cost of compliance will likely be burdensome for small businesses that sell out of state, but brick-and-mortar stores may have a slight short term boost. Subsequent events, however, will impact all businesses moving forward: states will continue to enact legislation and Congress may have something to say as well. In the meantime, all businesses should track legislation of the states in which they sell and be on the lookout for improved tax software that will help compliance be more efficient and cost-effective.
This article is also written by Nathanial Gier.