U.S. Supreme Court
Shakes-Up Nexus World
Physical Presence No Longer Required
Sales Tax Impact is Far Reaching
The U.S. Supreme Court’s decision in South Dakota v. Wayfair on June 21, 2018 was a landmark case that likely will have very significant tax consequences affecting both business owners and consumers. By way of background, in 1992, the Supreme Court barred North Dakota (Quill Corp. v. N. Dakota) from requiring an out-of-state mail-order company to collect use tax on goods sold to N. Dakota customers. The company solicited business in N. Dakota using catalogs and flyers, advertisements, and telephone calls. The Court reasoned that, under the dormant Commerce Clause, the company could not be liable for N. Dakota sales tax because it had no outlets, sales representatives (employees or other agents), or significant property (owned or leased) in N. Dakota. The Supreme Court upheld the physical presence requirement for sales tax nexus. A business may be constitutionally subject to due process in a state, but that does not mean it also necessarily has the presence required to create nexus as required by the Commerce Clause for the state to impose tax on it.
Why Did South Dakota Pursue Wayfair?
South Dakota does not have an income tax. Thus, it relies on sales taxes for funding. From the state’s perspective, it loses massive tax revenue to internet retailers that don’t collect S. Dakota sales tax. While S. Dakota residents who made taxable purchases on the internet are subject to S. Dakota’s use tax (a complementary tax imposed by states that have a sales tax), many taxpayers are unaware that this use tax exists or simply choose to ignore it.
Let’s look at an example as to how the use tax works. Assume a resident of PA purchases $500 of jewelry on the internet or in DE (a state that does not impose a sales tax). The resident is required by law to remit $30 (the PA sales rate is 6%) to the PA DOR as a use tax. The PA-40 tax return has on page 2 a section where the taxpayer computes the use tax due PA and remits it along with any income tax due. If a taxpayer fails to report the use tax due, states such as S. Dakota, are losing tax revenues.
Accordingly, it passed legislation that requires out-of-state retailers to collect South Dakota sales tax if the retailer:
- had annual gross revenue of more than $100,000 from sales in South Dakota; or
- completed more than 200 sales annually in South Dakota.
South Dakota included an appeals process in the legislation that would expedite any taxpayer challenges to it.
Supreme Court Overturns Quill
After the law was enacted, S. Dakota sent notices to several companies about the new law and advised the companies to register to collect S. Dakota sales tax. When the sellers did not register, the state sought a declaratory judgment against them. Eventually, the case was heard in a S. Dakota circuit court. The district court found in favor of the sellers, and the S. Dakota Supreme Court affirmed, following Quill. Hence, S. Dakota appealed to the U.S. Supreme Court where it prevailed as the court found that Quill’s physical presence rule is unsound and incorrect.
State and Business Consequences
The short-term impact of the decision is that states will likely act quickly to amend their sales tax statutes to reflect the holding of the Court and begin levying sales and use tax on any interstate commerce that has substantial nexus. It is our understanding that there are 20+ states that already have this provision in its laws.
However, it is by no means a free-for-all where states can subject any and all interstate commerce to states’ sales taxes. States are still required to limit their taxation to sellers and service providers where a substantial nexus exists with the state. Further, the opinion does not address any due process requirements, only those established by the Commerce Clause.
Of particular note, the Court stated that the substantial nexus requirements are present in S. Dakota because of the required value of goods delivered ($100,000) or the number of transactions engaged (200) in order to be subject to tax. However, the court did not say whether this is a threshold requirement or simply indicative of a substantial nexus. Thus, the barn door was left wide open as to what constitutes substantial nexus. If $100,000 in sales or 200 transactions is sufficient, what about $75,000 in sales or 150 transactions? Longer-term, states may begin pushing the envelope of the requirements of the holding, trying to stretch the definition of substantial nexus. If each state establishes its own substantial nexus standards, then the cost of compliance becomes more challenging and expensive to internet retailers. Some states may require that both the sales volume and number of transactions tests are met; others may rule that only one of these thresholds is met.
Discrimination and Undue Hardship
The Supreme Court noted that S. Dakota’s tax system includes several features designed to prevent discrimination against or undue burdens upon interstate commerce:
- The Act applies a safe harbor to those who transact only limited business in S. Dakota;
- It ensures that no obligation to remit the sales tax may be applied retroactively; and
- Dakota has adopted the Streamlined Sales and Use Tax Agreement, which: (1) standardizes taxes; (2) requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules; and (3) provides sellers access to sales tax administration software paid for by the state. Sellers who choose to use such software are immune from audit liability.
In other words, S. Dakota took steps to ensure that its tax did not overly burden small businesses.
Any retailer or service provider will likely have to implement or change internal systems to respond to new state statutes.
Congress may now decide to move ahead with legislation on this issue to provide a national standard for online sales and use tax collection, such as the Remote Transactions Parity Act or Marketplace Fairness Act, or a proposal by Rep. Bob Goodlatte, R-Va., that would make the sales tax a business obligation rather than a consumer obligation. Under that proposal, sales tax would be collected based on the tax rate where the company is located but would be remitted to the jurisdiction where the customer is located.
Business owners, who sell tangible goods or taxable services outside of their state of domicile, should meet with their tax professional to identify those states and begin the process to ensure compliance with current state laws and those that will be enacted. For example, does the business owner have systems in place that will enable the business to identify (1) sales by where the customer is located (sales by destination); (2) compile the dollar sales by state; and (3) identify the number of sales transactions by state. Since some states have multiple sales tax rates depending upon where the sales occur within those states, and some states have local sales taxes, this could conceivably increase the small business owner’s sales tax compliance cost.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.