The Fallout of a Sales Tax Case – Physical Presence is Outdated

On June 21, 2018 the Supreme Court ruled on South Dakota v. Wayfair, Inc. In its 5-4 decision, the Supreme Court overturned Quill and eliminated the long established standard that companies needed to have physical presence to have sufficient connection with a state before the state could make the company collect and remit sales taxes on its customers.

With Quill overturned what can the states do? The South Dakota law instituted clear safe harbor thresholds. It only applies to business selling $100,000 of goods and services into the state or engage in at least 200 separate transactions for the delivery of goods into the state. The thresholds exempt business that have minimal contact with the state from collection and remittance requirements. Truly small businesses will not be burdened. However, given that the average online transaction is below $100 in value, it’s likely that many smaller businesses might still have to file with the state because of the transaction threshold even though the value of goods sold into the state will be well below the $100,000 threshold.

The Supreme Court also noted favorably that the law prohibits retroactive application, giving businesses peace of mind about liabilities from prior periods. The South Dakota law is written in a way that it considers the prior calendar year for the thresholds. It is by no means clear what happens if a seller exceeds the thresholds in the current year and whether or not they have to go back and collect and remit sales taxes on prior transactions.

Lastly, the Supreme Court decided that because South Dakota is a member of the Streamlined Sales and Use Tax Agreement (SSUTA), filing and submitting sales tax withholdings and returns is greatly simplified. The Court even mentioned that the SSUTA provides free software to prepare sales tax returns, despite its limited availability and use. The Court’s opinion with regards to the SSUTA was that it reduced administrative burden and compliance cost for remote sellers in filing the sales tax returns. While having one tax return filing and one single place to submit sales tax withholding per state does reduce the cost of compliance, the true cost will not necessarily lie with making a return filing.

Change is Coming

Since the Wayfair decision was announced in late June, states have been called into action with a flurry of activity – many even adopting similar laws to South Dakota well before the Court decision was finalized. Several states are still reviewing their current sales tax nexus rules and are issuing continued guidance in light of the decision. What is certain since the Supreme Court decision is that states that adopt the South Dakota thresholds (or higher thresholds), have laws that are not retroactive and are members of the SSUTA are well within the constitutionality of the Wayfair decision. It remains to be seen what happens if any state lowers the thresholds or if states that are not members of the SSUTA adopt similar nexus laws.

Next Steps for Businesses

With all these changes what should businesses do next? The most important thing is to be proactive. Businesses should make sure that they have a good understanding of their sales footprint and that their systems can collect and organize relevant sales information. At a minimum, such information should include sales to customers by state and the number of transactions in each state.

The next step would be to become familiar with the laws of the state in which the business has sales. States may rely on the “old” physical presence standard or adopt a new economical nexus standard different from the South Dakota law. Again, it’s important to note that even though the Supreme Court ruled South Dakota’s law constitutional, it does not mean that all other states will adopt the exact same version of the law.

It is also crucial to understand the taxability of the products being sold. Just because a product is taxable in one state, doesn’t mean it will be taxable in the next.

With the knowledge of its sales footprint, state sales tax laws and the taxability of products, businesses should then develop compliance options. Considerations should include a cost/benefit analysis of not only filing in states where nexus exists, but also pre-emptively in states where activities are increasing. Businesses that find themselves in a position where state filings have been missed, should watch for state guidance on voluntary disclosure programs (VDA) or sales tax amnesty programs. With the changes in legislation it is expected that a number of states will enact such programs to help businesses become compliant and remit sales tax going forward. Some additional considerations include if filings will be completed internally or outsourced.

Questions Remain

With all these changes Congress has pretty much stood on the sideline and let the states have their day in court. Congress still has the ability to act under the Commerce Clause, but with several bills in both the House and Senate not having made any progress in recent years, it remains to be seen if the Wayfair decision will change the current inaction.

The decision will impact more than just sales of tangible goods. While the South Dakota law did not directly address sales of services, those may potentially also be impacted in states that choose to tax services. On the income tax side, the states have taken steps into economic nexus expansion for years and the Wayfair decision should further embolden states to become more aggressive.

Nadine Adams, CPA, senior tax manager, began her career with PKM in January of 2011, providing federal and state tax compliance services to community banks. Since joining PKM, her experience has expanded to providing tax services to both publicly-traded and privately-held multi-state financial institutions, insurance companies, and multi-state privately held manufacturing companies.