By William R. Stromsem, JD, CPA, David E. Colmenero, JD, CPA-Dallas, and Brandon S. Honea, CPA-Dallas
The U.S. Supreme Court’s recent decision in South Dakota v. Wayfair, Inc. (585 U.S. ___ (2018)) provides difficult tax compliance challenges for businesses that make sales to customers in other states, including sales over the internet, and for their tax advisors. In the past, sales tax nexus required physical presence (Quill Corp. v. North Dakota, 504 U.S. 298 (1992)), but the Supreme Court overruled the physical presence standard and upheld South Dakota’s version of “economic nexus” for purposes of establishing substantial nexus, although it left open whether the statute could be challenged on other Commerce Clause grounds.
Comptroller Mulls Wayfair Implementation
Before the Wayfair decision, a company could avoid creating sales tax nexus (and thus avoid having to collect a state’s sales or use taxes) by simply avoiding physical presence in the remote state by not sending or establishing any people or property there, such as an office, a store, warehouse, service center, delivery vehicle, certain representatives, etc. Under Wayfair, at least for purposes of establishing substantial nexus, the court upheld South Dakota’s “economic nexus” statute, which requires companies to collect the state’s sales or use taxes when the company, on an annual basis, delivers more than $100,000 in goods and services into the state or engages in 200 or more separate transactions for the delivery of goods or services into the state, even where the seller does not have a physical presence in the state. Nexus for sellers may ultimately depend on the number or amount of sales into each state, which are largely controlled by buyers, not sellers, because many and possibly even all states either have or likely will eventually enact laws that follow South Dakota’s lead at least to some extent. The 200 transactions threshold at issue in Wayfair could rope in all but the smallest online sellers. However, South Dakota is a small state; therefore, the same number of transactions may not be considered to establish a substantial nexus in other states.
Wayfair Complicates Sales and Use Tax Compliance for Remote Sellers
Approximately 20 states have already enacted laws asserting various forms of economic nexus for online sales. Additionally, there are an estimated 10,000 state, county and city jurisdictions that could seek revenue from taxing the approximately half-trillion dollars of internet sales each year.1 While the Supreme Court seemingly blessed economic nexus as defined by South Dakota, other states could select different nexus criteria. With varying nexus rules, rates, due dates for returns, rules on taxable and exempt sales, etc., compliance could be difficult. Current multistate sales tax software is generally inadequate, and although better programs may be developed after Wayfair, compliance may never be just a few clicks away.
To keep state sales tax nexus rules from developing into an ad hoc crazy quilt of confused law, Congress could seek to establish unified rules for state nexus or states may voluntarily subscribe to a multistate model statute. In Wayfair, the Supreme Court looked favorably on the fact that South Dakota had joined with 20 other states in the Streamlined Sales and Use Tax Agreement (SSUTA) to reduce economic nexus compliance burdens. Notably, Texas is not a member of the SSUTA and, according to the Texas Comptroller of Public Accounts, could only become a member through legislative action.2 Tax professionals should bear in mind, however, that the SSUTA would not fix everything because states can exempt different items and the SSUTA still requires the collection of varying local tax rates. Notably, the SSUTA definition of “food,” which Texas has adopted, created significant controversy in its initial interpretation and different states have interpreted it differently.
In his Wayfair dissent, Chief Justice John Roberts expressed the view that Congress rather than the courts should establish any new nexus rules in regulating interstate commerce. The majority opinion also recognized the possible need for congressional action, saying that the opinion “may pose legitimate concerns in some instances, particularly for small businesses that make a small volume of sales to customers in many states….” Several bills have been introduced in Congress to address state sales tax nexus issues, but Congress has considered such bills for years without enacting any into law. Congress has been divided, and now that the court has acted, may choose to wait and see how state sales taxes develop before taking further action. If sales and use tax collection and reporting obligations become overly complex in the wake of Wayfair, Congress may very well decide to finally act, but perhaps not for a while.
Small Businesses are Likely to Face Significant Compliance Issues
Wayfair will greatly complicate state sales tax compliance for smaller companies, whether they sell online or not. Smaller online companies may find themselves subject to nexus in new jurisdictions and are less likely to have multistate sales tax compliance software and in-house expertise in sales tax compliance. This may require adding a sales tax compliance person, using outside consultants and paying other compliance costs.
Large Businesses May Face Additional Compliance Issues, as Well
Larger online companies likely have sales or use tax nexus in many states, and some possibly even in all states, based on physical presence with warehouses, delivery vehicles, etc. However, online retailers that act as platforms for third-party sales may similarly face additional complexities, as states may now require them to ensure that sales and use taxes are collected and remitted on third-party sales. The Texas Comptroller, for example, has suggested that the Texas Legislature amend the definition of “seller” and “retailer” in Section 151.008 of the Texas Tax Code “to include marketplace platforms used by third party sellers….”3
Will States Seek to Apply Wayfair Retroactively?
One of the lingering concerns for many businesses is whether and to what extent states may attempt to apply the Wayfair decision retroactively. If a state determines its laws permit it to do so, it may very well seek to assert nexus on the basis of Wayfair for prior periods. Adding to this potential risk is the fact that many states do not provide a limitations period for assessments against taxpayers that have not filed sales tax reports with the state. Certainly the fact that many states are struggling to find additional sources of revenue only compounds this possibility. States that currently do not impose a sales and use tax may also be disadvantaged by the new laws.
To date, only one state has announced that it may apply Wayfair retroactively. Rhode Island has indicated that remote sellers could be liable for tax predating the Wayfair decision, although presumably this potential liability would only go back to Aug. 17, 2017, the date Rhode Island enacted its version of economic nexus statute.4
The Texas Comptroller’s office issued an announcement on June 27, 2018, providing some initial guidance on how it may respond to Wayfair.5 The announcement states that “the Comptroller’s office has started reviewing rules that may need updating.”6 It quotes Texas Comptroller Glenn Hegar as stressing that “this would not include any retroactive application of the new law to remote sellers that have no physical presence in Texas.”7 Many states in their amicus briefs in Wayfair expressed similar sentiments; however, the statements made in amicus briefs may not be binding on those states.
In-State Retailers and Customers Could Benefit from Wayfair
While compliance for remote sellers will certainly be a challenge, there could be some potential benefits for in-state retailers and customers. In the past, companies may have been reluctant to have offices, warehouses, repair facilities, etc., in other states because it might cause their sales or income to be taxed there. Justice Anthony Kennedy noted in his opinion that the Quill physical presence nexus standard, “produces an incentive to avoid physical presence in multiple states, affecting development that might be efficient or desirable.”
With nexus possibly determined by revenues and the location of online buyers instead of a seller’s physical presence, companies may be less reluctant to establish an in-state physical presence if they will be subject to a state’s tax collection obligation under a state’s economic nexus standard in any event. This could potentially result in companies expanding remote activities to enhance sales and provide better customer service.
In addition, there may be a potential benefit to in-state retailers, as well. For years, in-state retailers have complained of losing sales to remote sellers who could sell the same products without collecting tax and therefore at a lesser cost. By requiring out-of-state sellers to collect a state’s sales tax, in-state retailers may no longer be at a disadvantage.
Opportunities and Potential Challenges for CPAs
CPAs in business and industry will need to develop expertise to comply with new sales and use tax nexus requirements and their advisors may have a new area of consulting services, assisting clients in compliance. Computers will need to be reprogrammed to capture sales by taxing jurisdictions.
There are also potential challenges for in-house and outside CPAs who will need to become familiar with various sales or use tax nexus issues in various jurisdictions to avoid inadvertently failing to file some required returns.
Benefits and Challenges for States
The South Dakota law at issue in Wayfair was enacted to raise revenue and states are sure to follow its lead in asserting economic nexus. One of the reasons South Dakota asserted economic nexus for sales taxes was the widespread lack of compliance and problems with enforcing their use tax. Kevin Lyons, a spokesman for the Texas Comptroller, told the Wall Street Journal that “Texas welcomes the court ruling and is assessing the potential revenue effect and determining whether the state will need new rules or legislation.”8
States will need to carefully develop their laws to assert economic nexus as they may have to defend them in litigation, particularly if they adopt nexus rules that differ from South Dakota. Once the law is in place, they will have unprecedented compliance issues, with more sellers collecting and remitting sales taxes, new forms to develop and process, taxpayer information and services, and audits. This may require states to provide additional funding in an area that has traditionally not had a lot of compliance resources.
Will Wayfair Encourage Some Sellers to Relocate Outside the United States?
Some have raised concerns that Wayfair may encourage sellers to move out of the country to potentially avoid the taxing jurisdiction of states. To some extent, this possibility may be less likely to occur in the immediate future due to tariffs and customs applicable to physical goods that cross borders. However, what about downloads of software and other intellectual property? We use streaming “services” to purchase music, videos and books—what about the future when 3D imaging allows us to locally replicate physical products that could be sent from anywhere in the world? We will have to wait to see how the law develops in these areas, particularly because existing treaties do not generally address state sales tax issues.
What Will Be the Effect on State Income Taxes?
Now that the sales tax rules have been broadened, the next logical step might be to seek broader application of state income tax nexus rules, especially for states that have traditionally applied a physical presence standard for state income tax purposes, as well. Existing case law in the state income tax and gross privilege tax area has already blurred the nexus distinction for those taxes. Apportioning the income on e-commerce sales may be difficult, as revenues and expenses related to online sales would have to be sourced to a particular state or states. States may not be as motivated to go down this path, as it may result in little gain after income is apportioned. However, for states that are net “importers” of online goods, the income tax benefits to the states could arguably be more significant.
1 See Wayfair v. South Dakota, 585 U.S. ___ (2018)(noting that last year, “e-commerce retail sales alone were estimated at $453.5 billion.”)
2 See Texas Comptroller, Wayfair and the Ability of Texas to Require Remote Sellers to Collect Sales and Use Tax (July 5, 2018) available at http://src.bna.com/AhW.
3 See id.
4 See Rhode Island Dep’t of Rev. of Taxation, FAQs for Non-Collecting Retailers (Remote Sellers) Following Wayfair Decision, No. 8 (July 6, 2018) available at http://www.tax.ri.gov/notice/Remote_seller_FAQs_07_06_18.pdf.
5 See Texas Comptroller of Public Accounts, Comptroller Issues Initial Guidance on Remote Seller Sales Tax Decision by U.S. Supreme Court (June 27, 2018) available at https://comptroller.texas.gov/about/media-center/news/2018/180627-wayfair.php.