What the Wayfair Decision Means for Out-of-State Sellers
The Supreme Court of the United States made headlines this summer when it announced a decision that would dramatically affect how states impose sales tax collection responsibilities. The court’s ruling in South Dakota v. Wayfair allowed states to require that sellers collect and remit sales tax based on the establishment of an “economic nexus,” doing away with the previous “physical presence” test.
The ruling has significantly expanded the states’ authority in the sales tax arena, and businesses in every state will likely be impacted.
What is nexus and why does it matter?
In its simplest form, nexus is a link or a connector. For tax purposes, nexus is the connection to a jurisdiction that gives that jurisdiction the right to regulate businesses and individuals. Within certain limits, each state gets to define what type of activities within its borders will create nexus that will require a taxpayer to comply with its regulations. It’s important that businesses with activities in multiple jurisdictions be aware of the obligations that may arise as a result.
How Wayfair changes things:
The ability of any state to regulate an out-of-state business is limited by the Commerce Clause of the U.S. Constitution. Before Wayfair, the Supreme Court held that states could only require a seller to collect and remit sales tax on transactions if the seller had a “physical presence” within the jurisdiction. That rule made it harder for a state to impose sales tax collection obligations on sellers who merely ship goods to customers within the state’s borders.
Wayfair overruled the previous holdings and allowed states to require out-of-state businesses to collect sales taxes based solely on the connection created by selling goods to residents. This new standard is known as an “economic nexus.” The court ruled that a state’s attempt to enact an economic nexus standard would be permitted under the Commerce Clause so long as the rule did not create an undue burden on interstate commerce.
The court did not provide a specific set of requirements that a state law must meet in order to be constitutional. However, it pointed to several features of South Dakota’s law that helped keep it from becoming unduly burdensome:
- A safe harbor for businesses that have only a small number of transactions or low dollar-volume sales in the state
- A prohibition against applying the law retroactively
- Adoption of a “Streamlined Sales and Use Tax Agreement” that standardizes taxes and reduces administrative and compliance costs
- Access to sales tax administration software paid for by the state
How Wayfair affects businesses:
Many news stories created the impression that the decision amounts to a tax on Internet retailers, but it’s much more than that. Companies that have out-of-state sales without selling over the Internet will be equally impacted. Thirty states (and counting) have enacted or proposed economic nexus standards. Beyond that, previous physical presence rules still apply, as do state notice and reporting laws that require sellers to report sales to the state and notify customers of their obligation to pay tax on goods they purchase.
These rules apply to any business that meets an economic nexus threshold, not just retailers who sell over the Internet. If a business sells products into jurisdictions outside its home state, that business needs to understand which activities will trigger obligations in the destination states.
What happens to businesses that do not comply?
First, the jurisdiction will hold the seller accountable for the taxes owed. Because the transactions in question are typically already completed, most sellers won’t be able to collect from their customers.
Second, the states can impose penalties and interest. Depending on how long the business has operated without collecting the taxes, these penalties can be significant.
What is next?
Any business with sales outside its home state should review its sales by state to understand in which states it operates and to what extent. Additionally, businesses need to gain an understanding of the taxability of its sales by jurisdiction and shore up its documentation of exempt customers. To the extent they meet economic nexus thresholds and their transactions are taxable, businesses operating in more than a handful of states must seriously consider automating the calculation and collection of sales tax as much as possible.
From a sales tax compliance perspective, the impact of Wayfair will continue to have a ripple effect on businesses. To discuss your specific business situation, please contact KSM’s State and Local Tax Group or your KSM advisor.
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