On June 21, 2018 the U.S. Supreme Court issued a decision in South Dakota v. Wayfair Inc., holding that a physical presence in a state is no longer necessary for a state to require an out-of-state retailer to collect sales tax within the state. This decision reverses a 1992 ruling on Quill Corp. v. North Dakota which requires a seller to collect state sales taxes only if the seller had a physical presence, such as a warehouse or an office, in the state. The big question for this is what does this mean going forward.
South Dakota’s Move and Impact in Other States
South Dakota, like many other states, imposes a sales tax on the sale of goods in the state. However, the state estimated that it loses between about $50 million a year in sales-and-use-tax revenue from sales to state residents by out-of-state businesses that do not collect sales tax for the state. To try to counteract the loss of this revenue, in 2016, South Dakota enacted a law requiring out-of-state sellers that annually delivered more than $100,000 of goods or services into the state or engaged in 200 or more separate transactions for the delivery of goods or services into the state to collect and remit sales taxes to South Dakota. South Dakota’s Legislature was aware that its new law would be unconstitutional unless Quill Corp. v. North Dakota was overturned. In anticipation of legal measures, South Dakota filed a declaratory judgment action in state court against Wayfair Inc., and the other large internet merchants that have no employees or real estate in South Dakota and do not collect sales tax for the state. After the law was declared unconstitutional by South Dakota courts, the Supreme Court granted certiorari and issued their opinion. The Supreme Court’s decision applies this change prospectively, meaning that states cannot go back and charge retailers for uncollected sales tax or customers for unpaid use tax.
Currently, there are 22 states that have economic nexus laws in place. Most of these laws were put into place knowing that this court decision was a potential outcome. These states will begin rolling out guidance on a state by state basis pending when their economic nexus laws go into effect (North Dakota’s law went into effect immediately once the court ruled in favor of South Dakota). This will mean that retailers that meet the thresholds of qualifying for economic nexus will need to register with that state. This law also impacts service providers that provide services remotely as some states put a sales tax in place on services. There are also bills in the House and Senate that would directly impact this ruling by allowing Congress to set national rules or create a national clearinghouse for state sales tax.
Implications of the Supreme Court’s Decision
As mentioned previously States will be encouraged to enact sales and use tax economic nexus legislation following that of South Dakota. States will also be encouraged to enact state income tax economic nexus provisions. Currently, there are about a dozen states that already have economic nexus provisions for state income tax purposes. This will impact a variety of businesses in different ways.
Remote sellers will be required to register and collect sales and use tax in all the states and localities where they have sales that satisfy the economic nexus standards. They will also need to pay state income taxes in states where they meet the economic nexus standards.
Digital service providers will be impacted similarly to other e-commerce companies but may face additional sourcing challenges related to determining which taxing jurisdiction the customer received the digital good or service.
Buyers of businesses may be more reluctant to assume nexus risks in states where the Quill decision had previously provided some protection. They may also need to factor into their investment decisions the administrative burden and compliance costs that will result from having to file in more jurisdictions.
Businesses that may not previously have been subjected to sales tax in certain states may find themselves owing significant amounts of tax. Each business will need to evaluate how this decision will impact them as well as monitor the expected changes to occur in other states going forward.
How Companies Can Prepare for the New Nexus Standard
How to prepare for these changes will vary depending on how your business is structured. The following are some of the ways to prepare.
- Maintain or invest in a system that tracks how products and services are sold in different states.
- Understand how products or services will be taxed in all the states that impose a sales and use tax in which you conduct business.
- Maintain or invest in an accounting system that can handle the reporting requirements for all the states in which you conducts business.
- Identify which potential sales and use tax liabilities you may be exposed for.
- Communicate to stakeholders about the change from physical nexus to economic nexus in determining state sales tax and potentially state income tax.
There is still uncertainty and remaining questions surrounding this issue that must be monitored and reviewed. How other states will determine their standards will need to be monitored. Since the court concluded on this specific case it is unclear how other states will impose their specific rules and whether those changes are imposed retroactively.
If you have any questions regarding the new business interest deduction or the new net operating loss restrictions and how they may impact you and your business, or require any other assistance with your tax planning and compliance needs, please call or email one of our knowledgeable team members:
Mark Levine (email@example.com)
Nathan Rizk (firstname.lastname@example.org)