This past June 21st marked the second anniversary of the Supreme Court’s decision in South Dakota v. Wayfair. That decision eliminated the physical presence test for sales tax nexus and blessed the states using an “economic nexus” test.
In the two years since this landmark decision, the sales tax landscape across the country has changed dramatically. In light of COVID-19 and its impact on state budgets, we can expect further dramatic changes in the future.
On June 21, 2018, the Supreme Court overturned its 1992 decision in Quill Corp. v. North Dakota imposing a “physical presence test” on states seeking to collect sales taxes from out-of-state businesses shipping products to their residents.
The Wayfair decision held that South Dakota’s sales tax nexus requirements of $100,000 in sales or 200 transactions was constitutional, even in the absence of a physical presence, because such an amount or volume of sales created substantial nexus without imposing an undue burden on such remote sellers. The decision also noted certain steps taken by South Dakota to minimize the compliance burden on businesses.
Following Wayfair, every state except Florida and Missouri has adopted sales tax nexus provisions replacing the physical presence test with a test that focuses on the volume and value of sales into the state (“economic nexus”).
At the same time, almost 40 states passed legislation requiring marketplace facilitators to collect and remit sales tax on behalf of remote sellers (marketplace facilitators are entities that do not sell their own goods but provide a platform for sellers, such as Etsy or Amazon Marketplace). This is a massive change and naturally has caused many online sellers with no physical presence in a state (“remote sellers”) to now have a filing responsibility in multiple jurisdictions.
From the states’ perspective, it has not always been a smooth road to implement these changes. Aside from the obvious challenges of adopting new legislation, many Departments of Revenue needed to train their staff, upgrade their technology, amend various rules and regulations, and take other actions to meet the requirements of Wayfair. Louisiana, for instance, passed their remote seller legislation two years ago, but internal issues have delayed implementation of their marketplace facilitator legislation until July 1, 2020.
One positive for the states from a financial perspective is that most of them were able to implement their remote seller legislation prior to the COVID-19 pandemic. Therefore, states were able to see an increase in revenue from remote sellers, which helped to mitigate the dramatic losses of sales tax revenue from the economic slowdown related to the pandemic. This growth in tax revenue was amplified by the shift in consumer behavior to ordering more items online.
From the taxpayer perspective, large retailers with multistate locations adjusted fairly easily to their expanded compliance responsibilities, as they were previously filing in multiple jurisdictions, and just had to scale up their operations to do so in more places following Wayfair. But small retailers have faced a much more burdensome road to proper compliance. With little experience in handling sales tax in multiple states, small retailers continue to need advice with respect to how and where to register, what products are taxable, how to source local taxes, and many other related issues.
While the old physical presence requirement had its issues, it was usually fairly easy for a taxpayer to determine if it had physical presence in a state by looking at whether it had people or property in a state. Now, businesses may have to track a variety of information on a recurring basis to determine economic nexus. For example, in computing its revenue threshold for generating sales tax nexus, most states use an amount of $100,000. But states vary in many ways:
Despite the increase in sales tax revenue from remote sellers, states are still suffering massive shortfalls in tax revenue and face budgetary crises due to the pandemic. Taxpayers can expect to see more aggressive enforcement from state tax authorities to identify noncompliant remote sellers, and also a more aggressive push to collect income taxes from those same taxpayers.
Of course, another way for states to increase their sales tax revenue is to expand their sales tax base to include more taxable services, eliminate or narrow exemptions, and/or consider tax rate increases. Further, states may decouple from the tax provisions of the CARES Act for their income tax laws.
Taxpayers can also be expected to push back against the states’ expanded definition of sales tax nexus. Although not discussed above in detail, the Wayfair decision partially relied on the fact that South Dakota was a member of the Streamlined Sales Tax initiative, which offered taxpayers the ability to register and file in multiple states with free software and free advice.
For states with no free compliance software and challenging registration requirements, there may be an opportunity for legal challenges in the foreseeable future. Similarly, taxpayers may contend that the $100,000 threshold may have made sense for a state the size of South Dakota, but that may be an unconstitutionally low amount to create nexus in a more populous state, such as Pennsylvania.
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