Economic nexus: The Supreme Court brings sales tax into the 21st century
By Jake Ouradnik
If you have tuned into the news or other media outlets in the last few weeks, you may have heard rumblings related to the U.S. Supreme Court’s recent ruling in South Dakota v. Wayfair. The Supreme Court’s decision will likely change the status quo surrounding sales tax, specifically as it relates to nexus, across the country. Here are a few things you should know about it.
First, the backstory
Nexus is the factor a state uses to determine whether an out-of-state business is liable for sales tax collection and remittance. Since 1992, as a result of the Supreme Court’s ruling in Quill Corp. v. North Dakota, “physical presence” had been the nationwide standard for sales tax nexus. In other words, if a seller had physical presence in a state, it was responsible for state sales tax collection and remittance.
In 2016, South Dakota enacted an economic nexus law, setting a new state standard for nexus. The law said that out-of-state sellers that delivered more than $100,000 of goods or service into the state or engaged in 200 or more separate transactions for the delivery of goods or services into the state triggered economic nexus. When retailer Wayfair challenged it, the case made its way up to the Supreme Court. The Supreme Court’s decision to side with South Dakota ultimately struck down the physical presence standard and replaced it with “economic (or virtual) presence.”
What does this mean for you?
With South Dakota’s victory at the Supreme Court, physical presence will no longer be the standard requirement for having a sales tax filing obligation with a state into which you are selling products or services. Currently, 18 other states have enacted or proposed economic nexus laws under similar principles as South Dakota. (Please reference the chart at the end of this article for a state-by-state breakdown of states that currently have economic nexus laws.)
Physical presence will still be a potential trigger for a sales tax requirement; however, with the introduction of economic nexus, it’s critical to be aware of your sales activity in any given state at all times. That’s because virtual nexus can occur in many forms. In addition to economic presence, some states have adopted “affiliate” and “Amazon law“ or “click-through” nexus rules. These rules do not require physical presence, nor do they have the dollar thresholds required under economic nexus laws. All of these rules are now fully enforceable since South Dakota prevailed in the Wayfair case.
What does this mean for other types of tax?
Although the acceptance of economic nexus is new to sales tax, it is nothing new in the world of income tax. With the Supreme Court’s acceptance of economic nexus for sales tax filings, individuals and businesses will likely be required to register to do business with more states than ever before. From an income tax perspective, this means that businesses will now be raising their hand and reporting their sales volume and quantities into these states. Although economic nexus standards for income tax filings vary from those for sales and use tax, it will be increasingly important to identify state income tax filing obligations where necessary.
Prior to South Dakota prevailing at the Supreme Court, it was estimated that the state was losing between $48 million and $58 million annually in potential sales tax dollars because of the physical presence limitation. Potential tax dollars are a large reason why most states have a strong appetite for enacting economic nexus laws. Although only 19 states currently have economic nexus legislation, with the Supreme Court’s ruling it will not be a surprise if that number grows very quickly.
What actions should you take?
With most states basing their economic nexus thresholds on the current or prior calendar year, the first step in complying with new sales tax filing requirements will be reviewing your activity on a state-by-state basis from both a sales dollar and transaction volume perspective. The next steps will be consulting with your advisor on what your activity with each state is, determining if your goods or services are taxable on a state-by-state basis, and verifying that you are complying with each state’s collection and remittance requirements.
What is the cost of not complying?
There are two simple answers to that question. First, if a business doesn’t file a sales tax return with a state, the clock doesn’t start on the statute of limitations, which generally establishes that a state is only allowed to go back three to four years to audit and assess tax and penalties. Not collecting and filing with a state could, in theory, expose the business to liabilities dating back to when it first opened its doors. Second, if a state does come in and assess tax plus penalties and interest, these costs will be out of your pocket. In many cases, the penalties and interest combined can be more than the actual tax assessment—and much more damaging than complying and passing the tax onto the customer.
Prepare for a new era of interstate commerce
The landmark case of Wayfair v. South Dakota certainly levels the playing field between brick-and-mortar retailers and online or out-of-state sellers. Supreme Court Justice Kennedy’s commentary during the case likened the prior physical presence requirement to a “judicially created tax shelter” that has created marketplace distortions and unfair and unjust incentives to avoid physical presence in various states. Clearly, economic nexus will extend the reach of states. Hopefully, in the end, it will even the tables for all and alleviate the headache that comes with expansion and growth.
With all the unknowns of economic nexus and additional state filings and requirements, it’s important to make sure you’re up to speed. If you have questions, please don’t hesitate to give us a call.
Economic Nexus by State