By Jack Schmoll, CPA
Sales tax collection responsibilities for businesses are changing dramatically. The days of businesses ignoring tax collection on out of state sales are coming to a close due to the Supreme Court of the United States (SCOTUS) ruling in South Dakota v. Wayfair. This will not only affect online businesses, but any business selling into states where they are not currently collecting sales tax.
Supreme Court Overturns Quill v. North Dakota
The minimum connection a business must have with a state before the state can force the business to comply with its tax laws is called nexus. States and businesses have fought for years over what level of connection is necessary to create nexus for various types of taxes. These clashes have made it to SCOTUS many times as the issue is largely a constitutional one.
In the Wayfair decision, the court overturned a prior SCOTUS decision, Quill v. North Dakota (1992). Quill held that a business had to have some type of physical presence in a state before sales tax nexus was established. The Wayfair court stated that the rulings in Quill and a prior case, National Bellas Hess v Illinois (1967), were in error. It was a surprisingly direct rebuke of the Quill court, especially considering that two current justices were also on the Quill court.
A Fundamental Change In The Application of Nexus
This is a fundamental change in the application of sales tax nexus and will eventually lead to products being taxed regardless of the customer's location. Many people view this as a tax on internet sales, but it has a greater reach than that and will impact anyone selling taxable goods or services across state lines.
The South Dakota statute, which was considered by the court, asserts nexus if sales exceed $100,000 or 200 transactions, regardless of physical presence of the seller. While the case has been remanded to the South Dakota Supreme Court for further consideration, it seems doubtful that any substantial changes will result. In its ruling, the court stated it approved South Dakota's law, in part, because the thresholds were high enough to protect small businesses (debatable), it will be applied prospectively, and South Dakota is a member of the Streamlined Sales Tax Project. However, the court did not require a state's nexus scheme to include these three elements, so the states still have great latitude.
How Other States Are Reacting
Many states, including North Carolina have already taken steps to enforce requirements similar to South Dakota's sales tax nexus thresholds. As of the writing of this article, a handful of states have requirements that are being actively enforced. There are many other states which have requirements becoming effective within the next six months. Still more have statutes that were in place prior to the Wayfair ruling, that will be enforced immediately. Because the court did not make prospective treatment a requirement, there is some concern that states may impose the requirements retroactively. Massachusetts has done this and is asserting threshold nexus back to October 1, 2017. I expect we will continue to see a flurry of activity as more states get themselves in position to take advantage of this tax windfall.
Furthermore, a business cannot assume it does not have a tax related responsibility in a state where they do not have nexus. Many states require sellers without nexus to give their customers, in that state, notice that tax may need to be paid directly to the state. Generally, a business is required to give notice to their customer at the time of sale, again at the end of the year, and to provide the state a list of its customers. The penalties for failing to comply are substantial, with several states imposing minimum penalty of $20,000. Businesses are relieved of these onerous requirements if they choose to collect sales tax.
What Businesses Can Do Now
Over the coming months, businesses and their advisors will need to pay close attention to this dynamic situation. This can be a burdensome process requiring businesses to register, collect tax, and file returns in a multitude of states. Sellers will need to become familiar with the taxability of their products in each state and possibly begin collecting and tracking exemption certificates in many states. Business need to reach out to their accounting professional to get the proper systems and processes in place to ensure they are compliant in each state in which they do business. Because sales tax rates are high and apply to gross sales, liability can accrue quickly if businesses are not on top of the situation.
Jack Schmoll has worked exclusively in state and local taxation for 26 years, 17 in public accounting and nine with the Washington State Department of Revenue. In his practice, he works with a wide variety of businesses to help them avoid contingent state tax liabilities while minimizing the amount of tax they pay. He enjoys working with North and South Carolina issues, but has a wealth of experience with multistate tax issues as well. Jack is a regular presenter for the NCACPA and other organizations and also provides state and local tax education directly to CPA firms and businesses.