Somebody famous once said that all generalizations are false. Well, maybe not all. But when it comes to the rules for state and local taxes, generalizations that hold up under scrutiny can be hard to find. Each jurisdiction sets its own rules.
Perhaps the one generalization you can truthfully cite is that it all comes down to nexus.
States can require sellers to collect sales tax on the sales made to customers in their jurisdictions if the seller has nexus. And nexus means having a sufficient connection in a state to be liable for the state’s taxes.
Here’s where the generalization starts to fall apart.
Background on State Sales Tax Nexus
The Commerce Clause of the U.S. Constitution has been interpreted to restrict state sales tax collections to sellers that have substantial nexus with the state.
Historically, the most widely supported consideration in establishing nexus has been whether a seller had some form of physical presence in the state — i.e., physical presence nexus.
The landmark case on nexus for sales tax purposes was Quill v. North Dakota. In that 1992 case, the Supreme Court held that a state can only require a business to collect sales tax on its behalf if there was some form of physical presence at play. An office, a warehouse, employees, delivery trucks, something that would establish a direct on-the-ground link between the business and the state.
Under Quill, sellers without a physical presence generally were not perceived to have nexus and therefore were not required to collect and remit sales taxes. Instead, customers were supposed to pay use taxes. Surprise, not that many did.
Then came the internet, with online sales of more than $400 billion annually.
It’s no secret that states have long been looking for additional revenue sources. More recently they felt they were missing out on taxes related to internet sales — and their brick and mortar businesses were at a competitive disadvantage as a result.
In part to address internet sales, various states began enacting provisions to expand the sales tax base, including nexus rules based on economic and virtual factors — affiliate or click-through nexus for example. Other states sued and a case brought by South Dakota (South Dakota v. Wayfair) eventually made its way to the U.S. Supreme Court. And now, in South Dakota v. Wayfair, the U.S. Supreme Court has overturned the physical presence requirement for state sales tax collections.
2018 Supreme Court Ruling on Physical Presence Nexus
In June of 2018, in South Dakota v. Wayfair, the Supreme Court ruled that a physical presence is not necessary for a state to require that companies selling to customers in the state collect and remit sales tax.
In other words, the Supreme Court ruling overturned the Quill v. North Dakota decision on physical presence nexus.
The Court identified a number of factors that made South Dakota’s law regarding sales tax collections without a physical presence acceptable. In short, the law was “designed to prevent discrimination against or undue burdens upon interstate commerce.”
With regard to small businesses, the Court noted that the South Dakota law offers a “reasonable degree of protection” by including the following:
The law includes a safe harbor for smaller businesses. South Dakota’s requirement to collect sales tax applies only to businesses with annual sales of at least $100,000 made to customers in the state — or with at least 200 individual transactions with customers in the state.
The law is not to be applied retroactively.
South Dakota is a member of the Streamlined Sales and Use Tax Agreement, intended to simplify administration and collection of sales taxes. Specifically cited by the Court, it standardizes taxes to reduce administrative and compliance costs and requires a single, state-level tax administration, uniform definitions and simplified tax rate structures. It also provides sellers with sales tax administration software that provides users with immunity from audit liability.
The ruling applies to all businesses with sales to South Dakota customers, not just online retailers. It also includes businesses that provide services to customers in the state.
Many states are following South Dakota’s example. They have either established or are considering establishing similar laws. However, states with laws that do not include the factors identified by the Supreme Court (above) are likely to face legal challenges.
The Impact on Sellers and Marketplace Facilitators
Because of the potential impact on state coffers, you can expect states to be vigilant in enforcing their state sales and use tax rules.
If you are a multi-state seller or marketplace facilitator (think Amazon) — whether online or not, product or service — you should reconsider your nexus with the thousands of state and local taxing jurisdictions.
In doing so, it is important to understand that the physical presence test is only one factor by which nexus can be established.
Economic nexus, typically based on sales or transaction volumes in a state, is another form of nexus often cited by states.
Other forms of nexus include the previously mentioned affiliate/click-through nexus. Some states even claim a form of virtual nexus as a result of things like website tracking cookies or the use of a seller’s app by customers in the state.
Various states are also implementing new reporting requirements that sellers must implement to avoid significant penalties.
What Remains Unclear
The degree with which South Dakota’s rules establish baseline requirements for other states has not been established. Is the safe harbor of an annual sales volume of $100,000 a minimum requirement, for example? What about the 200 individual transactions rule? What are the requirements in terms of simplified administration and uniformity? Does the state have to be a member of the Streamlined Sales and Use Tax Agreement?
The Supreme Court in its ruling invited Congress to establish safe harbors and other rules addressing these types of questions.
Congress has introduced two bills — the Marketplace Fairness Act and the Remote Transactions Parity Act — that would establish rules for states that require online sellers to collect state sales taxes.
Impact in Washington State
Washington’s Department of Revenue is “examining the [South Dakota v. Wayfair] decision and its implications for businesses and taxpayers, and we are working with other states to make the transition as smooth as possible for businesses.” When available, you can find updates on the Department’s Marketplace Fairness web page.
Meanwhile, it’s important to understand that Washington’s sales tax rules changed as of January 1, 2018, well before the Supreme Court decision.
Under the revised rules, certain marketplace facilitators and remote sellers without a physical presence in Washington must collect sales/use taxes on sales to Washington consumers — or comply with mandated reporting requirements.
The Washington law has a safe harbor for smaller businesses, similar to South Dakota’s provision. Only facilitators and remote sellers with annual sales of $100,000 or more to Washington consumers are subject to these rules. Smaller facilitators/sellers are exempted. There is no safe harbor based on the number of transactions with Washington customers, however.
The mandated reporting requirements for those subject to them require the following:
Notify their Washington customers about the state’s use tax requirements at the time of each sale and on sales and marketing materials. Failure to comply results in an annual penalty of $20,000.
Provide their Washington customers with an annual report that includes sales made during the year where sales/use tax was not charged. Failure to comply results in a minimum annual penalty of $5,000 and increases based on the seller’s gross receipts.
Provide Washington’s Department of Revenue with a detailed annual report of sales for which sales tax was not charged, including the names, addresses and total sales made to Washington customers. Failure to comply results in a minimum penalty of $20,000, calculated based on a charge of $25 per customer that should have been included in the annual report.
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