In its much-anticipated decision in South Dakota v. Wayfair, the U.S. Supreme Court rule, by a 5 to 4 margin, that a state may require out-of-state sellers to collect sales and use tax even if they lack a physical presence in the state. In reaching this result, the court overturned its landmark 1992 decision in Quill Corp. v. North Dakota. This article explains how the ruling affects businesses and their tax obligations.
What it means for Internet and mail-order sales
In its much-anticipated decision in South Dakota v. Wayfair, the U.S. Supreme Court ruled, by a 5 to 4 margin, that a state may require out-of-state sellers to collect sales and use tax even if they lack a physical presence in the state. In reaching this result, the court overturned its landmark 1992 decision in Quill Corp. v. North Dakota.
Ruling’s effect on businesses
What does this mean for businesses that sell their products or services across state lines? The answer, as with many questions about tax laws and regulations, is “it depends.” One thing it doesn’t mean is that you should start collecting sales tax from customers in every state which you business. That obligation depends on 1) whether a state has passed a statute requiring businesses without a physical presence to collect tax from customers in the state, and 2) if so, what level of activity is required within the state to trigger those tax collection obligations.
In the wake of Wayfair, legislation in this area is in a state of flux. So it’s important to monitor developments in the states in which you do business to determine your tax collection responsibilities.
Question of nexus
It’s important to understand that Internet and mail-order purchases from out-of state seller have always been taxable to the consumer. But collecting tax from individuals– who rarely report their purchases__is impracticable. That’s why states require sellers to collect the tax, if possible.
A state’s constitutional power to impose tax collection obligations on your business depends on your connection, or “nexus,” with the state. Nexus is established when a business “avails itself of the substantial privilege of carrying on business” in a state.
In Quill, the Supreme Court ruled that nexus requires a substantial physical presence in a state, such as brick-and-mortar stores, offices, manufacturing or distribution facilities, or employees. But in Wayfair, the Court acknowledged that in today’s digital age nexus can be established through economic and “virtual” contacts with a state.
The Court emphasized that South Dakota’s statute applied to sellers that, on an annual basis, deliver more than $100,000 in goods and services into the state. This level of business, the Court explained, “could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota.”
Now that the physical presence requirement has been eliminated, you can expect many, if not most, states to pass or begin enforcing “economic nexus” statutes– this is, statutes that impose sales and use tax obligations based on a business’s level of economic activity within the state. Some states already have such statutes on the books, with enforcement tied to Quill being overturned. Others are in the process of modifying existing laws or passing new ones to impose tax collection obligations on remote sellers that meet economic nexus requirements.
To avoid legal challenges, it’s likely that states will adopt statutes similar to South Dakota’s . States that have already passed or announced changes to their tax laws after the Wayfair decision have signaled that they’ll adopt sales threshold consistent with those applied under South Dakota law.
Do your homework
Right now it’s critical to determine your sales and use tax compliance obligations in states where you sell products and services but don’t have a physical presence. And keep an eye on legislative developments, because the requirements may change in coming months.
Jesse Brickner, CPA
Jesse began his career at Hancock & Dana in 2013 as an intern. The following year he joined the firm full-time as a staff accountant. He provides tax return preparation services for individuals, closely-held businesses, and non-profits. In addition, he performs audit, attestation and other business consulting services.