By Brandon McCafferty, JD/MBA Senior Manager
On June 21, 2018, in South Dakota v. Wayfair Inc., the Supreme Court ruled that South Dakota could compel out-of-state vendors to collect in-state sales tax if they had more than 200 transactions or $100,000 in sales over a 12-month period. The Court believed that this level of sales was a reasonable “safe harbor” to insulate small businesses. This degree of business activity is called economic nexus. Prior to the Wayfair decision, a state could only compel sales tax collection if a vendor had physical nexus in the state (employees, contractors, inventory, assets, etc.). Now merely having a certain level of sales in a state will suffice. Since Wayfair, nearly every state has adopted an economic nexus law and will soon be aggressively pursuing out-of-state vendors for uncollected taxes. While the economic nexus thresholds vary by state, many states have adopted a threshold of $100,000 in sales during the current or prior year or 200 transactions. Unfortunately, many small to mid-size businesses exceed the 200 transactions threshold well before they approach the $100,000 mark.
How Did We Get Here?
States had been trying for years to circumvent the limitations of physical nexus by, for example, forcing remote sellers to report in-state customer purchases, enacting click-through nexus laws, or claiming internet cookies constitute physical presence. This was necessary, they argued, because they estimated that they were each losing tens of millions or hundreds of millions in annual sales tax revenue. During the Wayfair proceedings, South Dakota’s lawyers and supporting amicus briefs suggested states were losing upwards of $34 billion annually because the internet had “changed the dynamics of the national economy”. The Court was persuaded by these arguments and accepted the grossly inflated revenue losses to justify ignoring the stare decisis reasoning in the previous Quill decision that adhering to the physical nexus rule was “made easier by the fact that the underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve.”
In the Wayfair dissent, Chief Justice Roberts questioned the accuracy of the projected revenue losses by noting that, of the Top 100 internet retailers, the sales tax collection rate was between 87 and 96 percent. Moreover, he wrote that “states and local governments are already able to collect approximately 80 percent of the tax revenue that would be available if there were no physical-presence rule.” As it turns out, Chief Justice Roberts was right.
Small and medium businesses have been hugely affected by the drastic enlargement of sales tax nexus, a burden that the majority of Supreme Court Justices casually dismissed as something that could be easily handled by nebulous software. Is there software that can automate the sales tax compliance process? Yes, but there are a myriad of problems and limitations to that software, from the accuracy of rates to incorrectly taxing products or services, and the cost of compliance can be steep, especially for smaller businesses. Moreover, a study conducted more than a year after Wayfair suggests that the expected revenue windfall used to justify the staggering new compliance requirements never materialized. Prior to Wayfair, the National Conference of State Legislatures (NCSL) and the federal Government Accountability Office (GAO) conducted a study in 32 states where the NCSL projected revenue losses of $19 billion while GAO’s projected nearly $8.6 billion. However, the National Taxpayers Union Foundation (NTUF) found that the “median official estimate was just 21.81 percent of NCSL’s projections and 46.75 percent of GAO’s.” In fact, the NTUF found that “official estimates have turned up just $3.627 billion” in additional sales tax revenue for those 32 states after Wayfair. That’s a far cry from estimates as high as $34 billion cited by the Court.
Sales tax audits are coming. Most states have a 3-year statute of limitations to audit for uncollected sales taxes and the 3-year anniversary of the Wayfair decision is June 21, 2021. Many states enacted their economic nexus laws within six months of the decision so the time to begin auditing for a full 3-year period is quickly approaching. In addition, the ongoing pandemic has stripped the states of much needed tax revenue meaning that they are more likely to aggressively audit remote sellers when the time comes. If businesses have not already addressed potential sales tax liabilities in other states, the time to act is now. If large liabilities exist in states where businesses have not registered, it may be possible to avoid penalties as high as 50% by participating in the state’s Voluntary Disclosure Program which allows taxpayers to pay uncollected taxes with either some or all of the associated interest. If your business needs assistance, Hancock Askew can help. Our sales tax services include:
|· Voluntary Disclosure Agreements||· Due Diligence Reviews|
|· Sales Tax Audit Defense||· Sales Tax Overpayment Recovery|
|· Exposure Analyses||· Credits and Incentives Analyses|
|· Certified Sales Tax Audits||· Private Letter Rulings|
|· Nexus Reviews||· Sales Tax Compliance|
|· Taxability Analyses||· Registrations|
If you have any questions please contact:
Brandon McCafferty, JD/MBA Senior Manager