Tax Strategy

Ned A. Lenhart, MBA CPA | https://www.salestaxstrategies.com

What is Nexus?

Nexus is the term commonly used to mean the legal connection a non-resident company (seller) has with another state (taxing state) that allows the taxing state to legally force seller to obey a variety of state taxing state laws concerning sales tax, income tax, or franchise tax.  Nexus has nothing to do with the actual taxation of the property or service being sold.  Nexus only refers to the ability a taxing state has over a non-resident seller to legally compel or force the seller to comply with the taxing state law.

Old Nexus Rule (Quill):

U.S. Supreme Court ruled in 1992 that non-resident sellers must have some minimum physical presence in the state before creating sales tax nexus in taxing state. Allowed many e-commerce companies to legally avoid collecting sales tax in customer state.  States took dramatic steps to change laws on what constituted physical nexus.

New Nexus Rule (Wayfair):

U.S. Supreme Court on June 21, 2018 overturned Quill.  Stated that rule was unfair and created an unintended benefit for e-commerce companies. Ruled that states no longer need to prove a physical connection before nexus is created.  Ruled that the South Dakota statute that created ‘economic nexus’ provided a balanced approach to a non-physical nexus rule. South Dakota rule stated that remote sellers with $100,000 of sales or 200 transactions in the state had nexus and were obligated to comply with sales tax law.  26 states have similar laws and it is expected that most states will adopt similar rules.  U.S. Congress may also develop uniformity rules and rules on retroactivity.  Allows states to use both the physical nexus rule and the economic nexus rule.

Who is impacted?

Wayfair rule applies to all companies with customers and revenue in multiple states, not just e-commerce remote sellers. Retailers, wholesalers, service providers, technology companies, etc.

What is the Significance of the South Dakota vs Wayfair Case for Auditors?

The South Dakota vs Wayfair case is crucial for auditors as it has significant implications for businesses. After this ruling, auditors must inform their clients about the new tax laws and regulations affecting their operations. A wayfair client letter must clearly outline the potential impact on their financial reporting and compliance requirements.

How Does Wayfair’s Drop Shipment Change Impact Auditors’ Understanding of South Dakota vs Wayfair?

Wayfair drop shipment changes have significant implications for auditors’ understanding of the South Dakota vs Wayfair case. These changes may require auditors to reevaluate how they assess sales tax nexus and compliance, as well as understand the impact of drop shipment arrangements on Wayfair’s tax obligations.

Questions to ask?

Client responsibitlies Risks Affected industries  

Dear Client: On June 21, 2018, the U.S. Supreme Court issued its opinion in South Dakota v. Wayfair, a landmark sales and use tax nexus case that will have implications for many online sellers and multistate businesses. The Court ruled, in a 5-4 decision, that a state can require an out-of-state seller to collect sales or use tax on sales to customers in that state, even though the seller lacks an in-state physical presence. Under certain circumstances, an economic or virtual presence can create nexus (a sufficient connection with the state), subjecting a seller to tax collection and remittance requirements in a state. In some cases, a company’s electronic apps or website tracking “cookies” may be considered a nexus-creating presence in a state.

Background

In Wayfair, the U.S. Supreme Court considered the constitutionality of a South Dakota law (S.D. Codified Laws § 10-64-1, et al.) that requires certain remote sellers to register for, collect, and remit South Dakota sales tax. Under the law, a remote seller has sales tax nexus with South Dakota if the seller, in the current or previous calendar year:

• had gross revenue from sales of taxable goods and services delivered into the state exceeding $100,000; or
• sold taxable goods and services for delivery into the state in 200 or more separate transactions.¹

The Commerce Clause of the U.S. Constitution requires that a seller have “substantial nexus” with a state before the state can require the seller to collect and remit sales and use taxes. Historically, under a precedent affirmed in the 1992 case of Quill Corp. v. North Dakota, this nexus depended on whether the seller had a physical presence in the state. The presence could be through the company’s activities or property, or through the activities of its agents in the state. Over time, states have stretched the boundary of this standard by asserting “click through” nexus and affiliate nexus. Now “economic” nexus policies, like the South Dakota law in Wayfair, stretch it further still, with states asserting jurisdiction to impose sales tax collection responsibilities on companies that meet certain sales thresholds. In some states, the use of a company’s apps or website tracking “cookies” by in-state customers may create nexus.

Considerations for Sellers

Sales and Use Tax Obligations The Wayfair decision affects companies doing business in thousands of state and local tax-collecting jurisdictions across the country. The most immediate impact will be on sellers with a significant virtual or economic presence in a state that asserts economic nexus. Sellers delivering taxable products or services into South Dakota (and other economic nexus states) will need to determine if they surpassed the dollar amount or transaction volume thresholds for establishing nexus with the state. Sellers will need to do this analysis for each state that has adopted an economic nexus threshold policy, including determining whether each product sold is taxable or nontaxable. Some of these economic nexus policies may be vulnerable to attack under the Court’s analysis in Wayfair, and companies may wish to consult with tax advisors who can help them make the decision whether to comply with or challenge the rules. In addition, some states are beginning to enact laws targeting so-called “marketplace facilitators” and requiring that they collect tax on sales made by third-party sellers on the facilitator’s platform if the gross receipts from those transactions exceeds an annual threshold and other conditions are met. Sellers should be prepared for states to adopt and aggressively enforce expanded nexus provisions, although future legal challenges or Congressional action could limit the scope of the Court’s decision. Notice and Reporting Requirements A growing number of states, led by Colorado, recently enacted complex use tax notice and reporting requirements for remote sellers. Under these laws, remote sellers must provide information to customers about potential use tax liability and report transaction data to the state. Noncompliance can result in stiff per-occurrence penalties. A few states, such as Pennsylvania, explicitly provide an election between the notice and reporting regime and voluntary sales tax registration.

Other Considerations

Expanded sales tax nexus may have far-reaching effects for businesses, beyond collection and remittance of the sales tax itself. In the realm of business acquisitions, state “successor liability” laws typically impose notice, withholding, and tax clearance requirements that limit the purchaser’s liability for unpaid sales tax liabilities of the seller in certain business asset acquisitions. As states begin to more aggressively assert sales tax nexus, companies contemplating business acquisitions should consult with a tax professional for assistance in navigating complex successor liability laws. Companies should also consider potential financial statement impacts related to sales tax nexus issues.

How Does the South Dakota vs. Wayfair Supreme Court Case Affect Wayfair Clients?

The South Dakota vs. Wayfair Supreme Court case has significant implications for Wayfair clients. The ruling allows states to require online retailers to collect and remit sales tax, impacting Wayfair’s customers’ cost of purchases. This decision changes how Wayfair operates and may affect the prices their clients pay.

Next Steps

We expect state revenue departments to issue guidance regarding the South Dakota v. Wayfair decision in the coming weeks and months, and we will be following those developments closely. In the meantime, if you would like to discuss how the decision may impact your business, please do not hesitate to contact me at the number or email below. Sincerely,     ¹S.D. Codified Laws § 10-64-2.

Frequently Asked Questions Related to South Dakota vs. Wayfair Supreme Court Case by Interstate Tax Strategies On June 21, 2018, the U.S. Supreme Court issued is opinion in the landmark case of South Dakota vs. Wayfair. The Court’s decision in Wayfair overturned almost 50 years of precedence concerning sales tax nexus for sellers that do not have a physical location in the customer’s state. I will refer to these companies as ‘remote sellers’. The dust continues to settle on the fallout from this case as both sellers and state tax administrators adjust to these new rules. The following are some common questions that have been asked and my responses to them as it pertains to the new economic nexus rules embraced by the Supreme Court. These changes have the potential to impact every business that has customers in multiple states.

Q: What change to sales tax nexus does the Wayfair decision make?

A: For at least the past 26 years, state tax authorities were barred from forcing sellers of property or taxable services from collecting sales tax on these sales unless the seller had some minimal physical connection with the state. Physical presence could be created by: sending employees or independent contractors into the state to make sales, owning inventory in the state, renting an office in the state, performing services in the state, or delivering property on company vehicles into the state. With the explosion of e-commerce over the past decade, thousands of businesses could make sales of property using internet commerce without having a physical presence outside of their home state. There is also a huge number of foreign sellers that operate in the U.S. Because of the physical nexus requirement established in 1992 in the North Dakota vs. Quill (“Quill”), states could not force these sellers to collect tax. To overcome this problem, several states adopted and enforced laws deeming nexus to exist under an ‘economic nexus’ test rather than a physical nexus test. The states knew these laws would be challenged and that the Supreme Court would eventually weigh in on the issue. The South Dakota law which was reviewed by the Supreme Court deems nexus to exist for remote sellers if they have over $100,000 of South Dakota sales or 200 separate South Dakota transactions during the prior calendar year. If so, these companies must register to collect sales tax. Failure to do so will result in assessment of tax and penalty by the state. To the surprise of most, the U.S. Supreme Court ruled that this economic nexus test was valid. The Court further stated the Quill decision was no longer valid and the state did not have to prove that taxpayers had a physical presence in their state before they could require tax be collected.

Q. When is the Wayfair decision effective?

A. States that had economic nexus laws on their books when the Wayfair decision was issued are free to being enforcing these laws as they wish. Several states have gone on record that they will not begin enforcing their economic nexus rules until October 1, 2018. This gives companies a chance to evaluate their sales levels in these states and to register in the state if required. Several states have laws that go into effect on January 1, 2019 and these will likely be enforced from that point forward. Many states are planning special legislative sessions to pass some type of economic nexus standard so that they can begin collecting sales tax from qualified remote sellers.

Q. What other states have laws similar to the South Dakota law?

A: As of July 1, 2018, the following states had some type of economic nexus rule in their state: Alabama, Georgia, Indiana, Minnesota, Massachusetts, Mississippi, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Washington, and Wyoming. More states are expected to be added by the end of 2018.

Q. Does the Wayfair decision only apply to e-commerce sellers?

A: NO! This may be the most important issue to understand. The Wayfair decision applies to all business not just online sellers of property. By eliminating the physical nexus requirement, states that pass some form of economic nexus law are free to require any business that meets the economic nexus test to comply with the sales tax laws of that state. In some cases, this may mean that sales tax must be collected on taxable sales. In other situations, it may mean that remote sellers must collect resale exemption certificates from customers in that state who are not taxable on their purchases in that state. The elimination of the physical nexus requirement will allow states to require some type of compliance from all sellers that meet the economic nexus test of their state. Just because your company does not make taxable sales, does not mean you are not impacted by the Wayfair decision. This decision applies to wholesalers and retailers.

Q. Does physical presence still create nexus under Wayfair?

A: Yes! It appears that the Wayfair decision allows states two opportunities to require remote sellers to collect sales tax or comply in some other way with their state’s sales tax law. For remote sellers with a physical connection in the state, the rules have not likely changed. If a seller does not have physical nexus but exceeds the economic threshold of the state, then nexus may also be created. It appears that the economic nexus thresholds laws are drafted to only apply when some other type of physical nexus does not exist. In fact, the Wayfair case seems to allow states to develop any type of physical nexus requirement they want. Massachusetts has adopted the ‘cookie’ nexus test which deems software ‘cookies’ to create a physical presence in the state if the program is loaded onto the customer’s computer.

Q. Did the Supreme Court automatically adopt the South Dakota economic nexus standard that each state must adopt?

A: Not really. It is beyond the scope of the Court to formally impose a uniform standard on this sort of issue. The Court noted that there must be a balance between the benefit the state receives (tax revenue) and the cost incurred by the out-of-state business to provide that benefit. The Court, while not specifically outlining that balancing test, stated that the features of the South Dakota law met this balancing test. I think that most states will do their best to model the South Dakota law, but states are free to set higher standards if they wish. Some states have set revenue thresholds of $200,000, $250,000, and $500,000. A couple of sates have thresholds of $10,000! Wayfair is not going to be the last court case on the validity of these economic nexus rules.

Q. Does Wayfair only apply to sales tax?

A: No. The physical nexus rules of Quill also applied to taxes that were not based on income, such as franchise taxes, gross receipts taxes, and similar taxes. Under Wayfair, states that have such taxes could easily apply the economic nexus rules to these taxes. Further, many states have used economic nexus tests for income taxes when related to revenue from services or from revenue from intangible property. Many states have adopted these ‘factor present’ test for income tax.

Can You Provide More Information about the South Dakota vs. Wayfair Supreme Court Case?

In the summary of South Dakota vs Wayfair, the Supreme Court ruled in favor of South Dakota, allowing states to require online retailers to collect sales tax. This decision has significant implications for e-commerce and has sparked debates about the role of states in regulating online sales.

Q: What should remote sellers do now?

A: Every business situation is different. I would first recommend that remote sellers analyze in which states they may have even the slightest physical presence. Under Wayfair, states appear to be able to legally enforce any type of physical nexus with the state, regardless how minor. I would then recommend that remote sellers evaluate their sales levels in all states where they are not currently registered and where they don’t have a physical connection. If sales in those states exceeds $100,000, then further analysis of the state law will be needed to determine any compliance obligation. I would also recommend that wholesalers begin collecting resale certificates from all customers in all states regardless of the sales volume. Failure to have a valid resale certificate on audit could present some serious problems.

From Ned Lenhart, CPA, Interstate Tax Strategies, P.C.

Overview

On June 21, 2018, the U.S. Supreme Court issued its opinion in South Dakota vs. Wayfair, Inc. In this opinion, the Supreme Court stated that the physical nexus requirement established in 1992 in the case of North Dakota vs Quill was not valid. The Quill decision prevented states from requiring remote sellers from collecting sales tax in their states unless the seller had some physical connection with the state.  In most cases, this meant that the seller needed to have salesmen or other employees working in the state, own inventory in the state, or perform services in the state. Some states even adopted statutes that the presence of in electronic ‘cookie’ that resides on the customer’s computer would be enough to create nexus.  In the Wayfairdecision, the Court said that the physical nexus requirement in Quill was no longer a valid basis for preventing a state from legally forcing a remote seller from collecting sales tax in that state on taxable sales made to customers located in that state. The Court endorsed the South Dakota economic nexus rule (but did not necessarily mandate this rule be used) that requires sellers with $100,000 of annual sales or 200 separate transactions be held responsible for collecting and remitting sales tax on taxable sales sent into South Dakota. The Court indicated that states must have a statute in place that balances the cost of compliance against the valid interest the state is attempting to regulate.  As such, the Court indicated that the South Dakota rule, on its face, appears to meet this balancing test.

What Became of the Physical Presence Test?

Over the past 26 years, states have adopted a variety of rules on what constitutes a physical presence in their state for purposes of meeting the Quilltest.  Most of these have been found to be constitutional and have been used by the states to require remote sellers to collect tax. From my reading of the Wayfairopinion, these rules are still valid.  As such, states may require remote sellers with any type of physical nexus to register to collect tax and, for sellers without a physical connection, the states may also adopt various economic nexus rules such as the one adopted by South Dakota.  Even though the Court held that the physical requirement under Quillwas not valid, it did not say that physical presence in the state would   prevent a state from requiring compliance. States now have two options for requiring compliance; the physical standard and the economic standard.

States with Economic nexus rules

The following states have rules like the South Dakota rule; there are state specific nuances, however.   Alabama, Connecticut, Georgia, Hawaii, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Massachusetts, Mississippi, New Jersey, Ohio, Pennsylvania, Rhode Island, Tennessee, Vermont, Washington, and Wyoming.  More states will be added in the coming months as they adopt legislation.

What Are the Key Points in the Summary Bulletin of South Dakota vs Wayfair?

The summary bulletin of South Dakota vs Wayfair highlights the key points that auditors understanding South Dakota Wayfair need to know. These include the impact of the decision on economic nexus, the threshold for sales tax collection, and the need for businesses to comply with state tax laws.

What to do now?

The actions to take now are unique to each company.   I recommend companies reexamine where they have a physical presence of any kind.  If physical presence does not exist, then examine states where revenue is at least $100,000 per-year.  If sales exceed $100,000, determine if the customers you sell to are taxable and if the products and services you sell are taxable in the state. For exempt customers, begin collecting exemption certificates for all exempt sales. If your company has over $100,000 of taxable sales in any of the 21 states listed above, you should consider any historical exposure you may have since the economic nexus standards were adopted and the possibility of registering for prospective registration.