If a company has sales tax nexus in a state, they are required to collect sales or use tax on sales to customers in that state. Before the internet and over a half century ago, in 1967, the U.S. Supreme Court held that states could not impose the obligation to collect and remit sales tax on out-of-state mail-order sellers for sales made to customers in states where those sellers had no physical presence. Consequently, if the sellers did not collect and remit the sales tax, the consumer was required to pay a use tax. Consumer compliance rates are notoriously low which results in lost revenues for many states.
Twenty-five years later, the court had a chance to re-examine the physical presence requirement in the Quill Corp. v. North Dakota case. In 1992, North Dakota filed an action to require Quill Corp., an out-of-state mail-order house with neither outlets nor sales representatives in North Dakota to collect and pay a use tax on goods purchased for use in North Dakota. The trial court ruled in Quill’s favor holding the earlier decision that a physical presence is required to impose a sales tax collection-and-remittance obligation on out-of-state sellers.
Since the Quill decision, Congress has not taken any action to change the physical presence requirement in 26 years. Though, the pressure kept building to eliminate the physical presence rule. Each year, it became further and further removed from economic reality because of the sharp growth in e-commerce resulting in significant revenue losses to the states. In addition, the physical presence requirement has long been criticized by brick-and-mortar sellers as giving out-of-state sellers an advantage.
After 50 years, there is change. On June 21st, the US Supreme Court issued a decision that would significantly change the sales tax collection requirements for the vast majority of online retailers and out-of-state sellers. The court ruled in Wayfair v. South Dakota that a substantial economic presence is all that is required for sales tax nexus under the Commerce Clause of the United States Constitution. Though this will largely effect online retailers, the impact of the Wayfair ruling is equally significant for companies that have sales in states for which they have no physical presence.
Although the Supreme Court did not specifically address minimum standards for economic nexus, what is clear is the Court believes the minimum thresholds in the South Dakota statutes for economic nexus were sufficient to comply with the Commerce Clause. The minimum thresholds for economic presence under the South Dakota statute are annual sales of $100,000 or 200 separate transactions.
Some states have already started to enact tax laws that will apply to remote sellers. More states will do so. Some of these additional states will likely conform to the South Dakota law or to the Court’s guidelines, but some will likely be more aggressive.
Companies need to review their sales by state information to determine potential filing requirements. As part of that analysis, companies should review the taxability laws of states they haven’t had to address before and determine if any exemptions or exclusions apply. Items or services that are taxable in one state, may not be in another.
Companies should be cautious of unintended consequences of registering for sales tax due to the Wayfair decision. Registering for sales tax could significantly increases the company’s visibility in a state. If the company should have filed tax returns in prior years, the exposure for tax, penalties, and interest can be substantial. The statute of limitations does not start if no tax returns have been filed.
We are monitoring this closely and will keep you posted. Please contact a member of the McClintock & Associates tax department to help you determine how this decision impacts your company and what actions you should or should not take.