News & Resource CenterTax Impact Newsletter
In its much-anticipated decision in South Dakota v. Wayfair, the U.S. Supreme Court ruled, by a 5 to 4 margin, that a state may require out-of-state sellers to collect sales and use tax even if they lack a physical presence in the state. In reaching this result, the court overturned its landmark 1992 decision in Quill Corp. v. North Dakota.
Ruling’s effect on businesses
What does this mean for businesses that sell their products or services across state lines? The answer, as with so many questions about tax laws and regulations, is “it depends.” One thing it doesn’t mean is that you should start collecting sales tax from customers in every state in which you do business. That obligation depends on 1) whether a state has passed a statute requiring businesses without a physical presence to collect tax from customers in the state, and 2) if so, what level of activity is required within the state to trigger those tax collection obligations.
In the wake of Wayfair, legislation in this area is in a state of flux. So it’s important to monitor developments in the states in which you do business to determine your tax collection responsibilities.
Question of nexus
It’s important to understand that Internet and mail-order purchases from out-of-state sellers have always been taxable to the consumer. But collecting tax from individuals — who rarely report their purchases — is impracticable. That’s why states require sellers to collect the tax, if possible.
A state’s constitutional power to impose tax collection obligations on your business depends on your connection, or “nexus,” with the state. Nexus is established when a business “avails itself of the substantial privilege of carrying on business” in a state.
In Quill, the Supreme Court ruled that nexus requires a substantial physical presence in a state, such as brick-and-mortar stores, offices, manufacturing or distribution facilities, or employees. But in Wayfair, the Court acknowledged that in today’s digital age nexus can be established through economic and “virtual” contacts with a state.
The Court emphasized that South Dakota’s statute applied to sellers that, on an annual basis, deliver more than $100,000 in goods or services into the state or engage in 200 or more separate transactions for the delivery of goods and services into the state. This level of business, the Court explained, “could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota.”
Now that the physical presence requirement has been eliminated, you can expect many, if not most, states to pass or begin enforcing “economic nexus” statutes — that is, statutes that impose sales and use tax obligations based on a business’s level of economic activity within the state. Some states already have such statutes on the books, with enforcement tied to Quill being overturned. Others are in the process of modifying existing laws or passing new ones to impose tax collection obligations on remote sellers that meet economic nexus requirements.
To avoid legal challenges, it’s likely that states will adopt statutes similar to South Dakota’s. (See “Will other states follow South Dakota’s lead?”) States that have already passed or announced changes to their tax laws after the Wayfair decision have signaled that they’ll adopt sales thresholds consistent with those applied under South Dakota law.
Do your homework
Right now it’s critical to determine your sales and use tax compliance obligations in states where you sell products and services but don’t have a physical presence. And keep an eye on legislative developments, because the requirements may change in coming months.
Sidebar: Will other states follow South Dakota’s lead?
In South Dakota v. Wayfair, the Supreme Court found that the South Dakota statute’s annual sales thresholds ($100,000 in sales or 200 separate transactions) were sufficient to satisfy constitutional requirements. Those thresholds established the substantial nexus required before a state can regulate interstate commerce.
The court didn’t rule on whether any of the statute’s provisions unconstitutionally discriminated against or placed an undue burden on interstate commerce. But it did comment that three features of the statute appeared to be designed to avoid such a result:
- The annual sales thresholds essentially created a “safe harbor” for businesses that had limited contact with the state.
- The statute couldn’t be applied retroactively — that is, the state couldn’t hold out-of-state sellers liable for failure to collect taxes on past sales.
- South Dakota was one of more than 20 states that had adopted the Streamlined Sales and Use Tax Agreement, which reduces out-of-state sellers’ administrative and compliance costs.
This doesn’t necessarily mean that states establishing lower thresholds or applying their statutes retroactively won’t pass constitutional muster. But doing so opens them up to potential legal challenges. To avoid litigation, it’s expected that most states will follow the South Dakota formula closely.