A new U.S. Supreme Court ruling paves the way for states such as Maine to require Internet sellers to collect sales tax from consumers — even when they don’t have a physical presence in the state. (South Dakota v. Wayfair, No. 17-494, June 21, 2018) With this ruling, the Court has reversed the long-standing, albeit controversial, precedent of Quill v. North Dakota. (504 U.S. 298, May 26, 1992)
This decision, reached by a narrow 5-4 vote, means online retailers are now on the same virtual sales tax footing as brick-and-mortar stores.
Sales and Use Tax Basics
Currently, 45 states and the District of Columbia levy a sales tax on businesses located within the state. (Alaska, Delaware, Montana, New Hampshire and Oregon are the exceptions.) Businesses are required to collect this sales tax from consumers when transactions happen. States with sales taxes also have a “use tax” that essentially mirrors the sales tax. The use tax applies when businesses don’t collect sales tax but have merchandise delivered into the states.
The sales tax and use tax of a state are mutually exclusive— either the sales or use tax applies to a transaction, but not both.
This was the situation for many years. Businesses — whether big-box retailers or boutiques on Main Street —collected and remitted sales and use taxes to state authorities. The proliferation of online sellers changed this landscape dramatically.
When Internet-based sales first started taking off, there was not a clear-cut consensus regarding sales tax responsibilities. But states quickly realized this was an opportunity to generate additional tax revenue. As their efforts were initially focused on large retailers like Amazon, the laws written to impose a sales tax on these sellers were often referred to as “Amazon laws.” Right now, Amazon does voluntarily collect sales tax for products it sells directly (but not on third-party purchases).
In the Quill case (1992), the U.S. Supreme Court weighed in to say that states can only force online sellers to collect and remit sales and use taxes if the business has a presence or “nexus” in the state. This physical presence might be a warehouse or delivery center. Without that, the online sellers were not legally responsible to collect and remit these taxes.
This did not make matters easier. Several states, including California and New York, increased their efforts to collect sales tax from Internet sellers by expanding on the concept of nexus. A wide variety of state laws now exist on this issue. Meanwhile, Congress fought unsuccessfully to enact legislation that would impose sales tax collections on a national basis and traditional retailers protested their competitive disadvantage. So the decision ended up with the Supreme Court.
New Tax Environment
In 2016, South Dakota enacted legislation that required all merchants to collect a 4.5% tax if they had 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 fulfill these obligations, the state sued them. In the majority opinion, written by Justice Anthony M. Kennedy, it was noted that Wayfair, in particular, had played up the lack of state sales taxes in its advertising materials.
The lower courts ruled in favor of the online sellers. Now the Supreme Court’s reversal changes everything.
Justice Kennedy stressed the ways that retail 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 mail-order 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 this new opinion, the costs of complying with different tax regimes now are largely unrelated to whether a company has a physical presence in a state.
The majority opinion does leave the possibility for some transactions to be exempt from sales tax collections if they’re tiny or random. In addition, the Court did not provide guidance as to whether individual states can seek to collect sales tax retroactively.
How Should Online Retailers Respond?
South Dakota v. Wayfair will put pressure on all online sellers, including those that also maintain physical locations in stores and businesses that operate out of basements and garages. There is no one-size-fits-all approach. Therefore, all retailers should be 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 sales tax collection obligations.
3. Develop a plan for maintaining compliance.
4. Assess the possible effects on your business, including costs associated with 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 your operation’s technology and personnel resources are appropriate 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
It will take time to unravel all the implications, and federal legislation may still be coming in this area. Fortunately, your tax advisor at Filler & Associates can help you determine how to proceed.