Sales Tax: Why Collection Obligations May Become More Burdensome

Since the introduction of e-commerce, companies have expanded where they sell their products. However, whether a company was required to collect and remit any sales tax has been dependent on if the company has a physical location in the relevant taxing jurisdiction.

Under constitutional jurisprudence, a state or local taxing authority can only tax a person or company if there is substantial nexus with that state or local taxing authority. Nevertheless, the nexus standard was applied differently for income tax purposes as compared to sales tax. Under prior interpretation of substantial nexus, a company could have income tax nexus but not sales tax nexus if the company had enough economic activity in the state or local taxing authority but no physical presence.

This dichotomy did not make much sense and the Supreme Court recently agreed. In South Dakota v. Wayfair, Inc.,[1] the Court overturned longstanding precedent and held that physical presence is not necessary to meet the substantial nexus requirements. The Wayfair decision has vast ramifications for online and remote sellers. Wayfair will also ensure that many states will change their sales and use tax laws to require sellers with enough sales to collect and remit sales tax, if they have not already done so. Some states had previously adopted notice and report laws or economic nexus laws even before Wayfai

On the surface, this is a big win for the states and will enable the states to collect revenues from online and remote sellers that they otherwise would not have been able to receive. The states are constantly looking for ways to expand their taxing authority and to increase the revenues that go into their coffers. It will be interesting to see if the states will test the limits of Wayfair, as they have done in the past with income tax laws. Nonetheless, Wayfair does have its critics. In fact, a bill titled the Stop Taxing Our Potential Act of 2018 was introduced in the Senate in July 2018 that would reverse Wayfair and permanently codify the physical presence standard for sales tax.

Even if Congress does not get involved to overturn Wayfair, states will still have to tailor their sales and use tax laws so not to discriminate against or place undue burdens upon interstate commerce. The key to whether a state or local sales tax law will pass constitutional scrutiny now after Wayfair is whether the law allows for relatively easy compliance by out-of-state sellers. The South Dakota law that was challenged in Wayfairprovides sufficient safeguards. The Court in Wayfair specifically focused on the fact that South Dakota adopted the Streamlined Sales and Use Tax Agreement (SSUTA). As a result, states that have not adopted the SSUTA may now choose to do so. The Court also considered the following factors to be in South Dakota’s favor:

• the law provided a safe harbor threshold of $100,000 or 200 transactions;
• it applied prospectively;
• the state has one centralized collection agency; and
• the state provided out-of-state retailers with free compliance software.

State laws that are lacking these elements may not meet constitutional scrutiny, especially laws that have lower safe harbor thresholds.

In light of Wayfair, companies will have an increased sales tax compliance obligation. Companies should become more cognizant of where they have sales and where they look to expand their businesses. Companies should make a conscious effort to track sales by state (and by local jurisdiction) and to keep abreast of all legislative changes in states in which the company has sales or projected to have sales. It is important that companies keep close legal counsel to evaluate each company’s respective obligations and liabilities in each state and local jurisdiction. If a company does not otherwise use sales tax compliance software such as Taxify or TaxJar, or has limited access to such software, it should consider purchasing or expanding the software it owns to alleviate the potential compliance burdens.

If you have any further questions, please contact the author or another Woods Oviatt attorney in the Tax Department.

[1] 201 L. Ed. 403 (2018).