The Supreme Court of the United States (SCOTUS) has issued its decision overturning the substantial physical presence standard. In this blog, we’re hoping to explain the high-level meaning of the decision, give our reaction, and provide a little insight into what is to come following this decision.
What does this mean? In short, businesses need to be aware of each state’s threshold for economic standards. Economic nexus refers to a company having the responsibility to abide by the jurisdiction’s sales and use tax laws based on satisfying the substantial presence based on economic factors. Prior to this ruling, SCOTUS held the position from the Quill v. North Dakota (1992) ruling that businesses were required to have substantial physical presence in a state to have nexus. Essentially, this meant businesses were required to have either company owned property, employees, agents acting on their behalf, or be performing service within the border of a state.
First, is the decision known as “Wayfair” really fair? Just like pretty much any sales tax question, the answer is “it depends.” It depends because the ruling itself isn’t necessarily dictating how the states may implement economic nexus standards. The ruling also doesn’t dictate consistency between the states, consequences for violations, or outline limitations for the states. The ruling was essentially only to determine “Should states be able to impose sales and use tax laws on companies without physical ties to the state?” If that alone is the question, I would be in agreement with the SCOTUS ruling. States are absolutely losing out on large sums of sales tax revenue rightfully owed to them because retailers are not required to collect and remit sales tax if they don’t have “nexus” in those states. There are compensating use tax laws, but these are largely ignored by individuals and businesses alike. Businesses are often audited, but individuals are not because it is not cost-effective (impossible) for the state to do so. I believe the court accounts for the current landscape and the advantages of online retail giants without taking into consideration the impact of smaller companies.
Previous rulings, Bella Hass (1967) and Quill (1992), accounted for the undue burden registration would put on businesses operating largely mail order operations. The technology was significantly different in that information was not readily accessible by computers. Software systems designed to calculate sales tax nationwide were not viable options for most companies in times past. In 2018, that is a different story. There are tax rate tables, accounting software, sales tax software, and return preparation services that are user friendly and/or relatively affordable. The court was wise to acknowledge these differences.
Justice Kennedy’s opinion on the matter touches on three separate issues that played into his ruling in favor of South Dakota:
1. The standards adopted by South Dakota ($100,000 or 200 individual transactions in the previous year) offer a safe harbor to those businesses conducting only limited business in South Dakota.
2. No obligation to remit sales tax may be applied retroactively.
3. South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement.
His position does not comment on the fairness of the thresholds and he offered no commentary on the burden it puts on the taxpayer. While I am sure this was a consideration in the endless briefs reviewed, I do not think the impact it may have on small businesses was appreciated when the decision is intended to allow state taxing jurisdictions to go after retail giants. Some of these retail giants were using the lack of physical presence as a competitive advantage. They weren’t being required to charge sales tax where in state competitors were required to do so. However, the counter-argument to that is the online retailers have to account for the shipping costs somehow. I don’t believe interstate commerce was being effected as much as some of the briefs I have read would like to suggest.
The major point of contention I like to look at is the impact on marketplace retailers and businesses with de minimis activities in a state. The court was asked to make a determination that would go on to impact marketplace retailers. Marketplaces such as Etsy, Amazon Marketplace, Ebay, Wayfair, etc. are platforms used by companies and individuals to reach a much larger online market than a brick and mortar location. In my review, the states with transaction count thresholds are between 100 – 200 in the prior year. That’s not that many transactions. If a small shop is making $5-10 per transaction, that is not a lot of revenue for an additional filing requirement. Small business that make bumper stickers, refurbish cell phones, buy at wholesale to sell at retail, and the like will meet these thresholds and then be required to abide by each jurisdiction’s sales tax laws. Not all these laws mirror one another. Sure a few states have passed marketplace nexus laws placing that burden on the platform, but not many. The options are pretty limited for these smaller companies. They can risk getting caught by not registering to collect and remit sales tax. They can learn all the rules, register, and remit collected tax in all the states they have achieved nexus. They can register and tax every transaction and hope their customers do not know the difference between a taxable and non-taxable item. For small businesses, those are three not great options.
Finally, we have to ask ourselves what happens to those companies that satisfied the physical presence standard, but are nowhere near the economic nexus thresholds. The physical presence nexus standard does not go away just because the economic nexus standard has come into play. There is an apparent unfairness about one day of physical presence and $1 of sales triggering nexus when a competitor could have no physical presence in the state, 199 transactions and $99,999 in sales without triggering nexus. Which brings us to the question “Where do we go from here?”
I suspect following the decision many states will pass economic nexus laws, most mirroring the $100,000 or 200 transaction thresholds used by South Dakota. The Streamlined Sales and Use Tax Agreement has already outlined these thresholds for its participating states. I can see the transaction count threshold subsiding somewhere down the road because this is not necessarily a qualitative measure of tax revenue, which seems to be the intent of the states. Some states have already adopted marketplace laws requiring marketplaces to collect on behalf of the sellers. That should become the norm seeing as how those marketplace retailers are already driven by complex, easily customizable software infrastructure. This would remove the burden from the small retailers using these site that do meet the nexus thresholds while also capturing the smaller retailers using the websites that will not meet the thresholds. I do not anticipate the physical nexus standards to go away, but it is highly possible that the states outline de minimis activity for physical presence. Only a few states have outlined de minimis activity for physical presence, but with the introduction of economic nexus it would make sense for states to revisit the physical presence standards.
In conclusion, sales and use tax remains sales and use tax. The states will not be uniform in their nexus laws, just like they will not be uniform in their treatment of taxable transactions. The importance of sales and use tax understanding has grown significantly with this decision, especially for remote sellers and multi-state businesses. There are many excellent resources for tracking the economic nexus changes. Companies would be wise to leverage the wealth of information available online by service providers (like us… wink wink). Just make sure the tax advice uses citations from current statutes or regulations. There will likely be some fallout from this decision. The dates of implementation are sure to vary, as will the grace periods for registration. If you have any questions about your current nexus situation, feel free to contact us to speak with one of our partners.