A new U.S. Supreme Court ruling paves the way for states to require Internet sellers to collect sales tax from consumers — even if they don’t have a physical presence in the state. (South Dakota v. Wayfair, No. 17-494, June 21, 2018) In doing so, the Court has reversed the long-standing, but controversial, precedent in Quill v. North Dakota. (504 U.S. 298, May 26, 1992)
This landmark decision, reached by a narrow 5-4 vote, puts online retailers on the same virtual sales tax footing as brick-and-mortar stores.
Sales and Use Tax Basics
At last check, 45 states plus the District of Columbia impose a sales tax on businesses located within the state. (Only Alaska, Delaware, Montana, New Hampshire and Oregon don’t.) Each business is required to collect this sales tax from consumers when transactions happen. In addition, states with sales taxes have a “use tax” that effectively mirrors the sales tax. The use tax applies when businesses don’t collect sales tax, but have merchandise delivered into the states.
Thus, the sales tax and use tax of a state are mutually exclusive. In other words, either the sales or use tax applies to a transaction, but not both.
For many years, businesses — from big-box retailers to boutiques on Main Street — have collected and remitted sales and use taxes to state authorities. But then the landscape changed dramatically with the proliferation of online sellers.
Initially, there was no clear-cut consensus about sales tax responsibilities for Internet-based sellers. However, states quickly recognized an opportunity to generate tax revenue. Because their efforts were aimed mainly at merchandising giants like Amazon, the laws designed to impose sales tax on these sellers were often dubbed “Amazon laws.” Currently, Amazon voluntarily collects sales tax for products it sells directly (but not on third-party purchases).
In the 1992 Quill case, the U.S. Supreme Court ruled that states can force online sellers to collect and remit sales and use taxes only if the business has a presence or “nexus” in the state. Generally, this required the entity to maintain a physical presence in the state, such as a warehouse or delivery center. Otherwise, the online sellers weren’t legally responsible for this obligation.
To further complicate matters, several states — including California and New York — ramped up their efforts to collect sales tax from Internet sellers by expanding on the basic concept of nexus. This has led to a bewildering quilt of state laws on this issue. At the same time, Congress wrestled with proposed legislation that would impose sales tax collections on a national basis, while traditional brick-and-mortar store owners protested their competitive disadvantage. However, no legislation has been enacted by Congress. So, the decision was left up to the Supreme Court.
New Tax Environment
South Dakota enacted legislation in 2016 that requires all merchants to collect a 4.5% tax if they received more than $100,000 in annual sales or more than 200 individual transactions from residents within the state. When three large online retailers — Wayfair, Overstock.com and Newegg — failed to comply with these standards, the state sued them. Justice Anthony M. Kennedy, who wrote the majority opinion, noted that online retailer Wayfair, in particular, has played up the omission of state sales taxes in its advertising materials.
The lower courts ruled in favor of the online sellers. Now the Supreme Court’s reversal turns the tide.
Justice Kennedy emphasized the way that the retail marketplace has changed since Quill was decided back in 1992. At that time, mail-order sales totaled $180 billion. In 2017, e-commerce retail sales alone were estimated at $453.5 billion. Combined with traditional remote sellers, the total exceeded $500 billion last year.
“When it decided Quill, the Court could not have envisioned a world in which the world’s largest retailer would be a remote seller,” the opinion states. “…The Internet’s prevalence and power have changed the dynamics of the national economy.”
According to the Court opinion, the costs of complying with different tax regimes in this electronic age are largely unrelated to whether a company happens to have a physical presence in a state.
However, the majority opinion leaves the door open for some transactions to be exempt from sales tax collections if they’re tiny or random. In addition, the Court offered no guidance as to whether the individual states can seek to collect sales tax retroactively.
How Should Online Retailers Respond?
The new ruling will exert pressure on online sellers, including those that also maintain physical locations in stores and businesses that operate out of basements and garages. There’s no one-size-fits-all approach. Accordingly, retailers should consider taking these seven steps in the wake of the Wayfair decision:
1. Consult with your tax and legal advisors for guidance.
2. Review business activities to assess collection obligations.
3. Develop a plan for maintaining sales tax compliance.
4. Assess the possible effects on your business, including additional costs for technology updates and compliance measures.
5. Analyze the means for collecting taxes in the appropriate states, including bundling of taxable and nontaxable products.
6. Determine if the operation’s technology and personnel resources are sufficient to handle tax analysis and compliance, document retention and audits. If not, you may need to outsource some of these tasks.
7. Establish procedures for monitoring sales tax changes — such as tax rates, law changes and fulfillment practices — in various jurisdictions
Dissenting Point-of-View Focuses on the Struggles of Small Retailers
Chief Justice John G. Roberts wrote the dissenting opinion in the Wayfair case. He acknowledged that prior rulings in this area, including the Quill decision, were flawed. But the Chief Justice concluded that there was insufficient cause for the top court to overturn the precedents.
The dissenting opinion says, “E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule. Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.”
Justice Roberts also notes that the ruling is significant for businesses of all sizes. But smaller operations may have more difficulty complying with the complexity of the wide variety of sales tax rules around the country.
“Texas taxes sales of plain deodorant at 6.25 percent but imposes no tax on deodorant with antiperspirant. Illinois categorizes Twix and Snickers bars — chocolate-and-caramel confections usually displayed side-by-side in the candy aisle — as food and candy, respectively (Twix have flour; Snickers don’t), and taxes them differently.”
Justice Roberts noted that the Internet allows evens the smallest operations to connect with customers nationwide, but the sales tax collection requirement could be a severe detriment. “People starting a business selling their embroidered pillowcases or carved decoys can offer their wares throughout the country — but probably not if they have to figure out the tax due on every sale,” says the dissenting opinion.
It will take time to unravel all the implications, and federal legislation may still be coming in this area. Fortunately, your tax advisor can help you determine how to proceed.