Wayfair may bring to mind peppy commercials filled with bright throw pillows. But, it is also a complex and changing tax topic, relevant to nearly all businesses today.
A little legal background
In 1992, the U.S. Supreme Court ruled on Quill Corp. v North Dakota. They determined states could not levy sales taxes on their residents for purchases made from out-of-state vendors without a physical presence in that state. In other words, if you lived in Illinois and purchased a hat online from a company with a physical location in Texas, you did not have to pay sales tax.
The issue had been resolved, and life went on in the 90’s. Boy bands dominated the radio waves, beanie babies flew off the store shelves and we were all too busy watching Titanic to think about state and local taxes. However by 2010, nearly two decades after the Quill decision, we had gone from buying minutes of internet on a CD each month to having unlimited data on our smartphones. This change meant we were using the internet for many things – especially commerce.
Many states saw a loss of potential tax revenue which prompted Colorado pass a law to track out-of-state vendors’ sales activity to in-state residents. Colorado was then able to collect sales tax on these transactions. Court cases and similar legislation then started to pop up across the country. The time had arrived to revisit the discussion of state sales tax practices.
Wayfair vs. South Dakota
In 2015, South Dakota also passed a bill to begin collecting sales tax from certain out-of-state vendors on purchases shipped into the state. In early 2016, the state notified the largest affected vendors, including Wayfair. Wayfair refused to comply, and the case quickly escalated to the U.S. Supreme Court.
The 5-4 majority rule overturned the Quill case in favor of South Dakota. It determined that the physical presence rule previously dictating nexus requirements was “unsound and incorrect.” The “internet’s prevalence and power have changed the dynamics of the national economy,” including affording vendors a virtual presence with the potential to vastly outweigh any physical presence. In other words, state could now charge sales tax on goods and services being sold into their jurisdiction.
In addition, it was ruled the benefit of tax avoidance had given internet sales an unfair advantage over brick-and-motor stores, especially in states with high sales taxes, and the numbers were staggering. By 2017, e-commerce retail sales were over $450 billion. At the time Quill was decided in 1992, revenue for mail order products (the only material source of out-of-state sales) was less than $200 million.
What Wayfair meant for businesses?
“Wayfair” now refers to a state’s ability to mandate that businesses without a physical presence in a state collect and remit sales taxes on transactions in that state. When a company has a certain number or amount of transactions in a specific state, they are deemed to have “economic nexus” in that state. And nexus means taxes!
In South Dakota, where the original court case was decided, the limits are at least 200 transactions or $100,000 of in-state sales. But these guardrails are not universal. Today, 43 out of 45 of the state with sales tax have enacted similar legislation. While many state adopted the guardrails set by South Dakota, there are many others that are different, with thresholds ranging from $100,000 - $250,000. This can mean a series of complex and complicated tax filings around the country.
Commonly asked questions
As is always the case with state and local taxation, the rules are complex, the questions are many, and the answers are not always easy to come by. Economic nexus is no exception. To help, we’ve compiled a short FAQ list.
- What is economic nexus?
The easiest way to think of nexus is as “presence”. In this case, rather than a physical presence – such as a factory or distribution center – we are talking about the presence of revenue.
- How do I apply the thresholds?
If you have reached the revenue threshold sales within a state, you should assume you have economic nexus. The transaction threshold is typically based on the number of invoices to out of state customers. It is important to note some states require you meet BOTH the revenue and transaction thresholds for nexus to apply and taxes to be due. But, then again, others do not.
- How do I comply with economic nexus requirements?
To remain in the good graces of the various state taxing authorities, you should register with and remit sales tax to each state in which you believe you will meet the thresholds. The bottom line is if you are doing business in multiple states and are unsure, it’s a good idea to work with an accountant on a wayfair tax analysis.
- If our sales fall below the economic thresholds in a state, do we still have to collect and remit sales tax?
The short answer is maybe. If you have other activities that trigger nexus, such as a physical presence (warehouse, office), employees or provide services to residents in the state, you may still be obligated.
- If a state has not passed economic nexus legislation, should I assume there is no requirement?
No! Many states have reinterpreted their existing legislation in response to the Wayfair
- How are states measuring whether a vendor has exceeded the thresholds if they do not receive reporting?
Some states are issuing a questionnaire to remote sellers, some are using evidence gathered when auditing their customers. Other states are planning to simply extrapolate based on similar companies doing business there. The bottom line is you should always pay the taxes due to avoid penalties now or in the future.
- Would a Federal ruling override individual state rulings?
Yes, that is possible. There is little evidence we should expect a Federal ruling on the subject. For now, assume each state’s individual economic nexus rulings are effective unless they are subject to any legal challenges.