For many years, states have known that sales and use tax revenue rightfully owed to them was just beyond their grasp. Close to $13.4 billion in sales and use tax revenue was lost in 2017 alone, according to U.S. Government Accountability Office estimates. This revenue was unattainable due to physical presence (also known as nexus) standards imposed by prior Supreme Court decisions that curtailed a state’s right to assess tax on online retailers who sold goods to its residents.
Previous approach to online sales tax collections
Since retailers had no reporting requirements for online sales, the responsibility for reporting and remitting sales and use tax fell to the buyers, who seldom complied. States tried to get around the physical nexus standard by imposing an economic presence standard to force online retailers into collecting and remitting their sales tax or disclosing customers within their states. These efforts were fought by many taxpayers and had limited success by most states imposing sales and use tax.
Physical presence standard removed, with caveats
Through its recent decision in South Dakota v. Wayfair, the Supreme Court has now removed the physical presence roadblock that previously prevented the collection of state sales and use tax from online vendors. In the past, a physical presence standard made sense. Now, as technology changes and shapes how entities conduct their business and how consumers purchase goods and services, the nexus requirements allowing states to tax a business are outdated.
Although the physical presence standard was lifted, states are still limited to asserting nexus only in cases where substantial nexus exists. The Supreme Court mentioned that the South Dakota law requires sales of at least $100,000 and at least 200 transactions within the state for nexus to be deemed substantial.
Expected impact of Wayfair decision on state tax collections
Taxpayers may expect states to quickly act upon the Wayfair decision and remove the physical presence nexus standard. However, we expect that it will take some time for states to determine how they will seek to tax online retailers and what minimum activity threshold within their states is needed to define substantial nexus. A number of questions remain, including:
- Will states follow their own determinations as to what creates substantial nexus?
- Will Congress seek to enact criteria for online retailers to follow when determining if substantial nexus has been reached?
- Will states seek to ease reporting and collection for online retailers by entering the Streamlined Sales and Use Tax Agreement (intended to simplify sales and use tax administration for sellers and create uniformity around definitions and rules) or something similar?
Ways for companies to assess potential exposure
As the court decision is not retroactive, we strongly urge taxpayers to fully familiarize themselves with the prior sales and use tax exposure for online sales based on the laws and policies of various states. We also encourage taxpayers to take stock of their sales in different states by assessing historical, current and possible future sales within the state as well as the number of transactions completed (or expected to be completed) with customers within the state. A review of this information will lead to a clearer picture of potential exposure and highlight states to monitor for future interpretation and application of the Wayfair decision.
RKL can help your company prepare for impact
RKL’s State and Local Tax team can assist with this review and provide valuable feedback to help your company proactively prepare for impact. We are closely monitoring state responses to this decision and are exploring the best compliance methods for online retailers and companies conducting business across state lines. Contact us with any questions or for more information.