Living in a Post-Wayfair World: How Failure to Comply Can Hurt Your Business
The Supreme Court’s recent South Dakota v. Wayfair decision allows states to require sellers to collect and remit sales tax based on the establishment of economic nexus. Though many businesses have taken note, they are still asking, “Does this really affect me?”
For many businesses, doing the same things this year that you did last year could mean new state tax obligations. Beyond upholding many states’ existing laws, Wayfair has inspired others to propose similar statutes or enforce existing ones more vigorously. In fact, more than 30 states have enacted or proposed economic nexus standards.
Traditional physical presence nexus rules still apply, as do state “notice and reporting” laws requiring sellers to report sales to the state and notify customers of their use tax obligations on purchased goods.
The bottom line is that if you sell products – whether those are tangible goods, services, or digital goods – into jurisdictions outside your home state, you must understand which of your activities may trigger sales tax obligations in destination states. Given the time and cost of implementing a multistate sales and use tax compliance system, this evaluation should be undertaken as soon as possible.
What triggers nexus?
“Nexus” is a connection with a jurisdiction that subjects a taxpayer to the tax regulations of the government there. Wayfair allowed states to create a new type of nexus based on sales into the state, but it also left intact established nexus rules based on a taxpayer’s physical presence in the jurisdiction:
- Physical presence. This is the traditional type of nexus standard. In many ways, states have wide latitude in interpreting this standard. Physical presence in a state can include such minimal contacts as a salesperson’s visit to a customer in a state or inventory held in a third party’s warehouse in the state.
- Economic nexus. This was the heart of Wayfair, and in most states, it is a newly enacted type of nexus standard. It may consist of a dollar threshold representing the gross income from sales sourced to a state, or it may consist of either a dollar threshold or a number of transactions sourced to the state threshold. The most common threshold is $100,000 of gross revenue from sales sourced to the state or 200 separate transactions sourced to the state.
Once your business crosses the state’s economic nexus threshold, a state typically requires that you do one of two things:
- Collect and remit sales taxes. Most states require out-of-state sellers that meet the nexus standard to collect sales taxes from their customers and remit them to the state.
- Report transactions to the state and notify the customer. Some states take the intermediate step of allowing an out-of-state seller to choose whether to collect and remit the sales tax, like above, or to report transactions to the state, notify affected taxpayers of their obligation to pay what’s called a “use” tax, and annually notify the state of a purchaser’s annual purchases from the out-of-state seller.
What can happen if we miss it?
Businesses that meet any of the state nexus tests and don’t fulfill sales tax obligations could suffer any or all of these consequences:
- Payment of taxes that should have been collected. If the state requires businesses to collect and remit taxes, it will likely hold sellers accountable for the missed taxes. Generally, sellers won’t be able to go back and collect from customers or find out whether they self-assessed use tax on the sales.
- Penalties and interest. States and localities can impose penalties and assess interest against noncompliant businesses. Businesses with substantial multistate activity can be hit hard. States that only require notice and reporting can assess significant penalties, which are generally a set sum for each failure to comply with a notice or reporting requirement, so businesses can owe substantial penalties for administrative failure even when they were never required to collect and remit taxes.
- Due diligence concerns. When a business becomes a party to a possible merger or acquisition, any noncompliance may be discovered during transactional due diligence efforts. This could mean a variety of issues, from changes in valuation to unfavorable indemnification clauses, and — in some cases — a buyer looking elsewhere.
If we don’t know we owe sales tax, how does the state know?
A business’ worst-case scenario is to hear from a state that they are liable for sales taxes on past transactions. Executives often ask, “How can the state know we owe money there when we haven’t even realized it ourselves?”
In the age of “big data,” states can identify inbound sales activity in many ways businesses don’t realize. Some states have contracted with vendors to identify out-of-state sellers who exceed its economic nexus thresholds by purchasing credit card information that details sales into the state.
But plenty of tried and true methods also drive sales tax enforcement, such as:
- Audits of other businesses or individuals. If a seller’s invoices show up in examinations of other taxpayers, states soon realize that sales taxes are owed. That can start an examination into the full extent of liability.
- Court cases or “notice and reporting” statutes. Many states target retail aggregators for information about resellers on their portals. States can pass laws – or, in some cases, sue – to identify businesses that sell through channels like Amazon Marketplace and eBay.
- Perusal of websites or social media. States’ employees may browse target business’ websites, place items in shopping carts, and begin the checkout process to see if tax is charged on the shipping address into the state. They may also peruse a target business’ Twitter feed and see a marketing photo of salespeople at a customer’s location in the state.
States have turned to stricter enforcement of sales tax rules to add revenue without raising taxes. With the acceptance of the economic nexus standard, those efforts will likely redouble. Many states chose Oct. 1, 2018, as the date they would begin to enforce laws like the one upheld in Wayfair. So businesses that sell into multiple states must understand that transactions today may trigger new obligations that would not have appeared in the past.
An ounce of prevention
Given all the risk involved in multistate sales tax compliance, you should analyze your company’s exposure to out-of-state tax liability as soon as possible. Businesses should also monitor new activities and plans in order to identify potential nexus issues before they become overwhelming or deal-breakers. For businesses selling into more than one or two states, that probably means implementing or enhancing sales tax software that manages compliance based on a matrix of products sold, states (and local jurisdictions) where they are sold, and certain categories of customers.
To discuss your specific business situation, please contact KSM’s State and Local Tax Group or your KSM advisor.
Keeping you updated on COVID-19 and its impact on businesses and individuals.