On June 21, 2018, the United States Supreme Court rejected the “bright-line” physical presence rule that has governed multi-state sales tax practices for the past half century. By issuing its long-awaited opinion in South Dakota v. Wayfair, the Court ushered in a new era for sales tax compliance, especially for e-commerce platforms and nation-wide retailers who may now be subject to sales tax compliance in the states into which they sell. The 5-4 decision treated South Dakota’s pilot economic nexus law and sales tax administration system as a model and levied pressure on the states and Congress to enact significant policy changes to bring billions of revenue dollars within the grasp of state and local governments in ways that don’t discriminate or unduly burden interstate commerce.
Specifically, states will need to treat South Dakota’s newly-enacted economic nexus statute and other circumstances surrounding South Dakota’s sales tax administration and compliance processes as the baseline against which to measure their own nexus statutes and circumstances. The Court’s new balancing test considers whether a state’s nexus laws, administrative processes, and compliance requirements may discriminate against or unduly burden interstate commerce. The Court’s implied instructions to the states are threefold.
First, the states’ laws must provide reasonable thresholds for the number and dollar amount of a remote seller’s sales made into the state. South Dakota’s statute set the compliance thresholds at 200 transactions or $100,000 in sales volume.
Second, the states must provide “simplified” tax laws and processes. Questions to consider include: Is the state part of the Streamlined Sales and Use Tax Agreement? Does the state provide centralized tax administration? Does the state provide compliance software free of charge? Does the state exempt the remote seller from audit if it uses the state-provided tax compliance software? Has the state committed to reducing compliance and audit costs?
Finally, the Court implied that states should not apply their nexus statutes retroactively. The Court twice recognized that South Dakota’s law would not be applied retroactively, or even until its constitutionality was judicially established.
As noted in Justice Roberts’ dissent, the decision will raise compliance costs for multi-state sellers, especially small businesses that sell online but lack the resources to analyze and follow the varying (and rapidly evolving) sales tax laws of over 10,000 state and local jurisdictions across the country. States that pursue and implement more aggressive sales tax nexus statutes—or even aggressive taxing authority regulations—will open themselves up to constitutional challenges in court.
Writing for the majority, Justice Kennedy clearly denounces the physical presence nexus requirement articulated in the High Court’s earlier decisions (Quill v. North Dakota and National Bellas Hess, Inc. v. Department of Revenue of Illinois). In doing so, the Wayfair opinion discusses the economic realities of the modern online market, which have evolved to support use-tax noncompliance, deprive states of tax revenue, and favor internet vendors over brick-and-mortar stores. The Court explains that physical presence is not a fair proxy for the administrative burden of tax compliance. Declining to adhere to prior precedent, the Court condemns its own creation of a “judicially-created tax shelter.” The Court boldly states that the physical presence standard of Quill was “unsound and incorrect,” and its intersection with evolving internet technology led to discriminatory outcomes that hindered state tax policies.
While the Wayfair decision seeks to level the playing field and spur a more transparent and unified sales tax scheme suited to ever-growing interstate commercial activity, it leaves room for interpretation and ensures rapid change in state sales tax laws that will affect all multi-state sellers.
Since the “bright-line” physical presence standard is gone, a multi-state seller should immediately determine into which states its sales are made and whether the state laws and compliance requirements are sufficiently similar to South Dakota’s so that the remote seller must collect, report, and remit sales tax. A remote seller should also evaluate its current IT structure and capacity to adapt to the increased number of state and local jurisdictions with which it must comply. This includes not only multi-state reporting, but also state-by-state certificate maintenance and the ability to transfer large volumes of documents securely via the internet when remote audits arise. State voluntary disclosure programs may be available, and early assessment of potential sales tax liability is critical. For more on the practical implications of Wayfair and what businesses and tax professionals should consider and undertake in response, visit https://lat-seminars.com/webinars to explore LAT Seminars’ upcoming course offerings.