The many wrinkles of Wayfair
The U.S. Supreme Court’s June 21, 2018, ruling in Wayfair concluded that states can impose sales tax-collecting requirements on out-of-state retailers, even those that do not have a physical presence in the state.
The court addressed South Dakota’s direct challenge to Quill, the 1992 decision that established the physical presence test for sales and use tax nexus. South Dakota’s challenge lay in the enactment of an economic nexus test that requires remote sellers, without a physical presence in the state, to collect sales tax if certain gross revenue or transaction thresholds were met — more than $100,000 of goods sold or 200 transactions. In Quill, the court held that a state could not require an out-of-state seller to collect sales tax on a sale to a resident of the state. That decision predated the surge of online sales, and since then states have been looking to find constitutional ways to collect tax revenue from remote sellers.
The decision, written for the majority by Justice Anthony Kennedy just before his retirement, left some unanswered questions.
“Basically, the only real holding by the Supreme Court was that the state is not limited to physical presence when trying to impose sales and use tax collection responsibility,” said Chuck Moll, head of the nationwide state and local tax practice of law firm Winston & Strawn. “There are lots of unanswered questions, some of which will be answered on remand.”
The decision does not address retroactive application of the collection requirement other than to note favorably that South Dakota’s statute was drafted to be prospective only. “Undoubtedly, other states will try to impose retroactivity,” he predicted.
The new standard used by the court is a “significant quantity of business,” noted Moll. “My guess is that on remand the lower court will find that this particular plaintiff exceeded those thresholds. We will see other states follow South Dakota and use the same thresholds, but other states might use lower or higher numbers,” he said.
Some states, expecting the outcome, have already enacted legislation similar to South Dakota’s, according to Valerie Dickerson, national multistate tax leader at Big Four firm Deloitte.
“A number of states have anticipated the ruling due to Justice Kennedy’s remarks,” she said. “Those states that are within the mitigating factors will now decide how to proceed with collecting the tax. The majority decision allows for the possibility that there may be some types of taxpayers with other burdens or reasons to litigate further — a sign that the door is not shut on future challenges.”
“In the meantime, companies engaged in e-commerce may have to revise their business models, their IT systems and their internal processes for calculating their tax obligations,” she continued. “One key question is whether they have the required customer data to determine how to properly source sales.”
Dickerson believes that the states will take into account the compliance hardships faced by smaller firms and mom-and-pops. “Hopefully, states will take a reasonable approach and factor in small-business burdens,” she said.
Brian Kelley, managing director of state and local tax services at Top 100 Firm Sikich, agreed: “Most states will be reasonable. In fact, a lot have already enacted legislation similar to South Dakota’s, and more will follow.”
“Don’t panic,” he advised. “It’s not necessarily a situation where a small or medium-size business will have to go out and register in every state. To the extent they don’t have that many transactions, the safe harbor in most state legislation may mitigate the burden.”
‘Good luck with that!’
Although there was nothing about protecting small business in the actual holding of the Wayfair decision, it did have a lot of vague ideas on the subject, observed Dean Zerbe, alliantgroup’s national managing director and former senior counsel with the Senate Finance Committee. “Good luck with that! I don’t think states will show a restraining hand,” he said.
“Right after they have sales tax nexus, they’ll try to extend it to business activity tax,” Zerbe predicted. “You’re here for sales tax — guess what? You’re also here for BAT,” he said. “Nothing makes states happier than taxing people that don’t vote or live there.”
The decision paves the way for the “big boys” to get even bigger, suggested Zerbe. “It’s a chance for them to crush their small and medium-size competitors. Congress will really need to listen to the smaller retailers, and step in to protect them. They need to set a standard safe harbor.”
With the vastly increased revenue that will come into state coffers, will they now lower their rates? Not likely, Zerbe indicated. “Most will say ‘Hot dog! We have plenty of ideas on what to do with this.’”
“This is all being thrown back to Congress,” said Jeff Cohen of Top 100 Firm Grassi & Co. “Technology has replaced the sales person with the briefcase and brochures. Congress will have to look at it and set a uniform standard, or we’ll go back to the Wild West. It’s back to where we started, just a different kind of crazy.”
Cohen cautioned that the obligation to collect and remit “pierces the corporate veil.”
“There is no corporate protection,” he said. “Withholding is a personal liability. Anytime you have federal or state withholding on behalf of a government agency, there’s no corporate protection. They’ll just sell your house for you, but you can keep your underwear.”
“Even if the state provides the software, you have to match it with the ERP system currently in use, to physically start remitting each and every transaction on a quarterly basis,” he said. “That’s a big challenge. It gives exposure to hiding the money — you have to track and monitor and make sure all the money is going to exactly where it’s supposed to go. You might have internal accountants taking a lie detector test.”
An issue left undecided is how low a nexus threshold would still be constitutional, noted Eric Fader, managing director of sales & use tax at Top 7 Firm BDO. “We’ll see state assemblies generally enacting legislation similar to South Dakota’s, because the Supreme Court said that $100,000 or 200 transactions does not create an undue burden. But we’ll also see states, in time, see if they can test the waters and have a threshold below South Dakota’s threshold.”
The process of enacting legislation and setting up procedures — for both the states and businesses — does not happen overnight, observed Brad Weisert, a tax services partner at OUM & Co. “There will be a period of time when it will be unclear whether a state has stepped over the Wayfair line, unless Congress passes the Mainstreet Fairness Act or a version of it,” he said. “We’re all fortune tellers at this point.”
Costs, immediate and otherwise
As a result of the decision, both sellers and consumers are likely to see added costs, according to Jeff Glickman, partner-in-charge of the SALT practice at Top 100 Firm Aprio. “Many consumers who made purchases where sales tax was not charged may not have realized that they were required to self-remit use tax to the state — in fact, this is one of the reasons that the states almost unanimously asked the Court to overturn Quill,” he said. “Now, sales tax will likely be charged upfront, adding to the cost of goods and services purchased.“
“For sellers, there will be the immediate costs associated with working with advisors to understand their compliance obligations,” he said. “This includes updating systems and processes as necessary, deciding where they need to collect and remit, and whether their products or services are taxable and at what rates. Then there are the ongoing additional costs of compliance such as preparing and filing sales tax returns, maintaining exemption documentation, and handling more audits and notices.”
“The decision is a lightning rod,” said Mark Friedlich, CPA, Esq., senior director for tax & accounting for North America for Wolters Kluwer and a member of the Senate Finance Committee Chief Counsel’s Tax Advisory Committee on Tax Reform.
“There will be a confusing hodgepodge of different laws, which will impose an undue burden on all sellers, large and small,” he said. “Congress will have to act, even though they haven’t done so for 26 years. It won’t happen before the November midterms, but there will be a lot of pressure for them to step in and simplify the sales tax collections and compliance process by providing one set of rates and standards that apply to all states that impose the sales tax.”