Sales tax: the rules may be changing
June 13, 2022
By Terry Barrett, CPA
States historically have required sellers with a physical presence in the state to collect and report the tax due on taxable sales. A physical presence is created by a storefront, warehouse or other location, through assets held or inventory stored, or through employees or other representatives working in a specific state. Sellers without a physical presence generally have been able to escape tax collection requirements but that may be about to change.
On April 17, 2018, the United States Supreme Court was scheduled to hear oral arguments in the case of South Dakota v. Wayfair Inc., in which the physical presence requirements will be reexamined. South Dakota passed legislation in 2016 that requires remote sellers with sales of $100,000 or 200 separate transactions in the state, thereby with an “economic presence” but no physical presence, to collect and remit South Dakota sales tax. The law contained provisions to fast-track the issue into court and to preclude the enforcement of the tax collection provisions until the legal issue is decided. Rulings by the South Dakota Sixth Judicial Circuit Court and the South Dakota Supreme Court in favor of remote sellers and in support of the physical presence requirements previously established by the U.S. Supreme Court have paved the way for the current case. A ruling is expected by the Supreme Court in late June.
Many believe this reexamination of the physical presence limitations is long overdue. The sales and purchasing practices of the world have changed dramatically in recent years, so why haven’t the tax rules kept up? Back in 1992, the U.S. Supreme Court ruled in Quill Corp. v. North Dakota that a seller must have some physical presence (office, inventory, people, etc.) in a state to have sufficient “nexus” or connection with the state to require the collection of sales/use tax. With its decision, the Court recognized that the traditional means of selling were changing. Quill was a mail-order office supply store selling supplies to customers in various states. However, the Court also recognized the administrative challenges of requiring out-of-state sellers to comply with the myriad of state and local tax rates and regulations if there were no physical presence rules and thus agreed with physical presence standards previously established in its decision in the National Bellas Hess v. Department of Revenue ruling in 1967. The Court suggested Congress may be a better forum for crafting sales tax collection standards.
Over time, Congress has considered legislation that would impose sales/use tax collection requirements on remote sellers. That legislation has been met with debate and has gone nowhere. Some of the concern has been over federal intervention in states’ rights, placing administrative burdens on small sellers, and generally how to make it all work given more than 10,000 sales and use tax jurisdictions nationwide. Meanwhile, online sales have grown substantially. Online sales in the United States in 2015 were $349.25 billion, they grew by 14.4 percent to $399.53 billion in 2016, and are expect to grow to close to $530 billion in 2018 according to a 2017 report by the Centre for Retail Research. While some online sellers collect sales tax — Amazon collects sales tax on all of its taxable sales in the states that impose sales tax — many remote sellers do not. For example, many third-party sellers through Amazon and other online marketplaces do not, and will not, collect the tax, unless forced to comply with tax collection and requirements.
Given the popularity of online sales, many traditional brick-and-mortar stores have seen their sales decline. Many have been forced to close or have ventured into the highly competitive online market scene. State and local jurisdictions faced with a shrinking traditional base of sales tax revenues have sought different (and sometimes creative) ways to enforce compliance generally in keeping with the physical presence requirements. These include “click-through,” affiliate nexus and marketplace nexus provisions.
- “Click-through” nexus provisions require an out-of-state seller with an instate representative who receives a commission for facilitating sales for the out-of-state seller to be subject to tax collection requirements due to its relationship with the instate representative. The instate sales generally must be above a certain threshold, i.e., $10,000, during the preceding year. Twenty-two states have such laws.
- Affiliate nexus is created if an out-of-state seller’s parent or affiliate has a physical presence in the state. The specifics of these affiliate nexus laws vary widely by state and often the affiliate provisions are combined with “click-through” provisions. The affiliate nexus rules were enacted when a number of brick-and-mortar stores created separate legal entities to sell online (to avoid the collection of the tax) and the states wanted assurance they could capture the tax on online sales. Twenty-five states have affiliate nexus provisions.
- More recently, there have been efforts by the states to impose sales tax collection requirements on marketplace facilitators. These laws essentially require a marketplace facilitator that has a physical presence in the state to collect sales tax on all sales made through its marketplace, regardless of whether the third-party sellers have nexus. Washington State, Rhode Island and Pennsylvania have enacted such legislation.
The above-all focus is on the physical connection between the seller and the state and the sellers’ tax collection requirements. Some states have directed their attention not so much on the seller collecting the tax but rather on the purchaser paying the tax. All sales tax states require in-state purchasers, whether individuals or businesses, to self-assess and report use tax on taxable purchases where the seller does not collect the tax. Eleven states have passed legislation creating notice and reporting requirements for remote sellers. These laws generally require remote sellers with no physical presence in the state to provide certain types of notices on their websites and invoices to in-state customers purchasing from them. The notices are to advise the in-state purchasers that the sellers are not collecting sales tax and that use tax may be due on the purchases. The sellers may also be required to provide year-end reports to the in-state customers and to the taxing jurisdictions about the customers’ purchases. Penalties are imposed for failing to comply with the notice requirements. Even without the notice requirements some states are asking (demanding?) that sellers provide information regarding in-state purchases.
Massachusetts has taken a slightly different approach to requiring remote sellers to collect the tax in the state. Massachusetts passed a regulation that requires remote sellers to collect the tax if apps or cookies from their websites are “downloaded” on customer devices in the state. Such apps/cookies are deemed to be software and the state includes within its definition of tangible personal property subject to the tax software regardless of how delivered to the customer — in tangible or electronic format. Ohio has adopted a similar approach.
Several states, like South Dakota, have passed economic nexus legislation or adopted regulations or directives in preparation for the challenge to the physical presence requirements of Quill. Alabama, Indiana, Maine and Tennessee, among others, stand ready to enforce their laws with a decision by the Supreme Court in favor of South Dakota and economic nexus. Generally these provisions call for the collection of sales tax if sales to in-state customers exceed a certain threshold (e.g., $100,000) or a certain volume (e.g., 200).
Virginia has not adopted some of the more aggressive physical or economic presence tests but did enact legislation in 2017 that required any dealer owning inventory for sale in the state to register for collection of the sales tax. This was to clarify that having inventory stored in a third party’s warehouse or fulfillment center in-state constituted sufficient nexus with the state to create a tax collection and reporting requirement. Like other states, Virginia has been limited by the Quill decision in pursuing collection of sales or use tax by out of state sellers without some physical connection with the state; however, this could change depending upon the Wayfair decision.
The fact that the Supreme Court is hearing the Wayfair case is significant. Regardless of the ruling, whether in favor of economic nexus or holding fast to the physical presence standard, will be significant for all players — the states, consumers and remote and in-state sellers. Stay tuned!
Terry Barrett is a Tax Senior Manager at Keiter. Terry focuses on state and local tax consulting, with a special interest in and emphasis on sales and use tax in the multistate arena.