In one of the most significant state and local tax developments in the last 50 years, the U.S. Supreme Court narrowly sided with the state of South Dakota in allowing the state to impose a sales tax on out of state online sales. The 5-4 decision in the case of South Dakota v Wayfair will have a big impact on emerging internet sellers, who will be confronted by the need to collect state taxes, along with significant variations in rules and filing requirements across different jurisdictions, but may lack the internal accounting resources to comply.
A bit of tax history
Prior to the Wayfair decision, state sales tax policies were guided by a 1967 Supreme Court ruling in the case of National Bellas Hess. The Court held that the state of Illinois could not collect “use tax” (a close cousin of sales tax) from the mail order company because it did not have a physical presence in the state. It was determined that National Bellas Hess lacked the minimum contacts needed in the state required by the U.S. Constitution’s Due Process and Commerce Clauses to require it to collect tax.
Later in the early 1990s the Court came to a similar conclusion in Quill Corp. v. North Dakota. These are the two most commonly cited cases in the area which basically protected many internet companies from having to collect sales/use tax for out of state sales.
Evolution of our economy
Unless you have just emerged from a deep hibernation, you may have noticed that our economy has changed a bit in the 50 years since National Bellas Hess was decided. As more and more retail transactions have been occurring over the internet, states grew increasingly frustrated as billions of dollars of sales tax per year went uncollected. Smaller local retailers felt increasingly disadvantaged as they were required to collect sales tax on their sales but the internet retailers were not.
Many thought that something had to be done to equalize the playing field. Although bills have been put forth in recent years, Congress failed to reach any agreement as to the correct course of action. Therefore, the U.S. Supreme Court stepped back into the breach to readdress the problem.
In direct contravention to the earlier court rulings, South Dakota put a new law in place to help it capture the millions in revenue it was losing annually. South Dakota’s new law requires out of state retailers that made at least 200 sales, or sales totaling at least $100,000, to collect and remit a 4.5 percent sales tax. South Dakota then sued several retailers that had no physical presence in the state and were not collecting the tax. In one of those cases the Supreme Court determined that when a business “avails itself of the substantial privilege of carrying on business” in a jurisdiction it creates an adequate connection to require it to collect tax.
What this means for you
Many consumers who were not paying their fair share will be paying more sales or use taxes. As a business owner you need to be aware of what this means for your company. If engaging in out of state sales, the cost of complying with the new law may become significant. Many states have already passed laws similar to that of South Dakota, using it as a guide of what may be acceptable under the new rules. Other states have passed laws that are different from South Dakota. Still others have not yet acted.
Larger businesses have internal tax departments that can shoulder the burden of creating systems to track and comply with the different laws in all 50 states. But, smaller businesses typically lack such internal resources, and will need to hire outside consultants or accountants to help them meet their filing obligations. Among the issues small businesses will need to address: a myriad of differing rates and rules in each state, remitting withheld tax and filing tax returns as required in each of the states.
Business owners first need to address their current exposure to these rules, remembering that the laws are changing on a weekly basis. Second, either via their own internal personnel or in conjunction with their outside consultants, they must develop a plan and systems to comply with the rules as they become effective. Additionally, they should consider planning strategies that might minimize exposure to these rules now and in the future.
Tax professionals are concerned that states may apply the Wayfair decision to other types of state taxes, such as an income tax, and that states may become more aggressive in trying to assert nexus even when a company does not have a presence in the state. There also exists the possibility that the federal government may attempt to step back into the picture and put legislation in place that will either do away with this rule or create some type of uniform sales/use tax to apply to all 50 states, which at the least would lessen the compliance burden on small businesses.
In any event, unless the federal government acts to make state sales tax rules more uniform and consistent, emerging online sellers will find more of their resources and brainpower will be needed to address these changing and diverse rules and filings.