Wayfair Ruling Changes the Game for Sales Tax Nexus Requirements
The United States Supreme Court, in South Dakota v. Wayfair, Inc. (“Wayfair”), recently made headlines with their dramatic shift in sales tax nexus requirements. For nearly 3 decades, companies have relied on the proposition that they must have physical presence within a state to be subject to sales tax registration and collection/remittances responsibilities. However, with the ruling in Wayfair, sellers (and not just those making online sales) may find themselves with sales tax exposure in states from which they were previously shielded.
On March 22, 2016, South Dakota passed Senate Bill 106, which requires out-of-state retailers to collect South Dakota sales tax, even in the absence of physical presence, if the retailer had either a) annual gross revenue from sales delivered into South Dakota that exceeds $100,000 or b) two hundred (200) or more separate transactions in the state. This law passed even though it was clearly inconsistent with the Supreme Court’s holding in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) (“Quill”). The new law took effect May 1, 2016 and the state began seeking judgments against several out-of-state sellers.
In one such instance, the state sought declaratory judgments against several large online retailers when it was discovered that they met the law’s new nexus requirements but had failed to register. The cases went to the South Dakota circuit court in January 2017. The sellers argued that the law was unconstitutional under the Commerce Clause due to the lack of physical presence mandated by Supreme Court precedent in National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967) (“Bellas Hess”) and Quill. (A state is prohibited from collecting tax from remote sellers with no physical presence in the taxing jurisdiction.) The district court found in favor of the sellers and the South Dakota Supreme Court agreed, following holding in Quill. The State of South Dakota appealed to the US Supreme Court arguing that the Supreme Court should reconsider Quill. The state’s appeal was heard on April 17, 2018.
The Supreme Court Decision
The Court, in ruling for South Dakota, overturned the physical presence nexus requirements laid out in Quill and Bellas Hess. The Court found that the 50-year-old physical presence standard was unsound and an incorrect interpretation of the Commerce Clause. The Court held that the “substantial nexus” requirement articulated in Complete Auto can be met with a “substantial virtual connection.” The Court decided that other factors for determining a minimum connection were sufficient without the bright-line rule of physical presence.
While the Court clearly overturned the physical presence requirement that would have rendered the South Dakota law unconstitutional, it did not hold that the Act is, in fact, constitutional. Instead, it remanded the case back to the lower courts to determine if the Act runs afoul of the Commerce Clause on other grounds. The Court did tip its hand and indicated that the Act is likely not an undue burden on interstate commerce based on three factors: 1) the Act contains a safe harbor exception for small retailers; 2) the Act cannot be applied retroactively; 3) South Dakota is a member of the Streamlined Sales and Use Tax Agreement – making compliance easier and allowing access to sales tax administration software paid for by the State.
Much has been made about the retroactivity of the Act by retailers who would be affected and the answer remains somewhat of an open question. In Wayfair, the Court took note of the South Dakota law provision that “The Act ensures that no obligation to remit sales tax may be applied retroactively.” Although South Dakota took this position, other states could try a more aggressive approach. In the dissenting opinion, the Justices noted that a law which did attempt to apply retroactively might not be upheld and suggested that Congress might need to intervene on the issue.
Although the current standard of “substantial nexus” seems extremely broad, it does afford a reasonable degree of protection to small businesses. The safe harbor provision in the South Dakota law requires a considerable amount of business ($100,00) or transactions (200) within the state before subjecting the retailer to the state’s registration and collection requirements. Other states with an economic nexus law have similar (if not identical) thresholds.
More than thirty states have enacted their own interpretation of what is considered “substantial nexus” within their state. Barring further input from the Court or Congress, the laws previously set forth by these states will remain in effect and will be applied either the earlier of the state law’s effective date or the Supreme Court’s recent decision. The types of laws that states have enacted can be broken into a few different categories, which are discussed below.
Economic Nexus generally associates presence within a state with a set level of sales or gross receipts activity within a state. No physical presence is required. While we expect this number to increase, there are currently 18 states with economic nexus laws on the books – most with safe harbors that are similar or identical to South Dakota’s ($100k of sales or 200 separate sales transactions): Alabama, Connecticut, Hawaii, Iowa, Illinois, Indiana, Kentucky, Louisiana, Massachusetts, Maine, Minnesota, Mississippi, North Dakota, Ohio, South Dakota, Tennessee, Vermont, and Wyoming.
Affiliate nexus refers to a connection between a seller and another entity that may be related in some way or that performs certain work that can be attributed to the seller which causes that seller to have nexus in the taxing jurisdiction. Prior to Quill being overturned, states used affiliate nexus as a way to impute physical presence nexus on to sellers. While Wayfair doesn’t affect them directly, any challenges to the constitutionality of these laws would be likely to fail in a post-Wayfair review. However, given the administrative burden of proving affiliate status over mere gross receipts thresholds, we would expect states to move towards economic nexus and rely less on affiliate nexus. There are 42 states with affiliate nexus laws including Alabama, Arkansas, California, Colorado, Connecticut, Washington DC, Florida, Georgia, Hawaii, Iowa, Indiana, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Maryland, Maine, Michigan, Minnesota, Missouri, North Carolina, North Dakota, Nebraska, New Jersey, New Mexico, Nevada, New York, Ohio, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Vermont, Washington, Wisconsin, West Virginia, and Wyoming.
As with affiliate nexus, click-through nexus was a way to impute physical nexus to sellers. It includes sellers that have contractual agreements with residents in a taxing jurisdiction to pay a commission for sales made through an internet link on the in-state resident’s website. Additionally, click-through nexus is often more difficult to demonstrate than affiliate nexus, so we would also anticipate that states move away from relying on click-through nexus to reach out to out-of-state sellers. There are 22 states with click-through nexus laws: Arkansas,
California, Connecticut, Georgia, Idaho, Illinois, Kansas, Louisiana, Maine, Michigan, Minnesota, Missouri, North Carolina, New Jersey, Nevada, New York, Ohio, Pennsylvania, Rhode Island, Tennessee, Vermont, and Washington.
As a catch-all, a handful of states that don’t have formal economic nexus laws on the books do have nexus laws stating that they will apply nexus in accordance with the Commerce Clause or “to the extent permissible under the U.S. Constitution.” Applying Wayfair, these states could say that sellers meeting the requirements of the South Dakota law also meet the nexus requirements for their states. There are 6 states with this kind of general catch-all type nexus statutes including Florida, Idaho, Kansas, Maryland, New York, and Texas.
States with notice/reporting laws require retailers to alert customers to their tax liabilities at the time of sale. As with economic nexus laws, the reporting requirement laws have safe harbors, but they vary between $10k and $250k per year. Additionally, most of these states offer reporting as an alternative to complying with an economic nexus standard. There are 5 states with reporting requirements: Colorado, Georgia, Pennsylvania, Rhode Island, and Washington.
The Supreme Court’s decision should cause sellers to revisit their nexus posture for each state where they have sales and determine if changes to their sales tax process is necessary in order to respond to the different nexus requirements set forth by each state. In states where nexus and sales exist, sellers will need to consider registering and then collecting/remitting sales tax. Sellers that primarily make nontaxable sales could now be required to register and maintain customer provided exemption documentation to support their untaxed sales. In addition to the extensive reporting requirements, sellers will likely be exposed to a much higher risk of audits in all states where they transact business. It is important to contact your tax consultants to ensure you are well prepared and in compliance with each state requirement.
If you have any questions or concerns about how this applies to you, please don’t hesitate to contact us.