For the past 26 years, sellers of goods across state lines have been protected from state sales tax laws by the 1992 Supreme Court decision in Quill v. North Dakota, which held that out-of-state sellers cannot be required to collect state sales taxes if they do not have a physical presence in the state. That decision has now been overruled by a divided Supreme Court in South Dakota v. Wayfair. The Wayfair opinion abandons Quill’s bright-line, physical presence rule, deemed by the majority to be “artificial,” “anachronistic” and out of line with “modern e-commerce.” So, what happens next? A lot.
Before the Court was a 2016 South Dakota law, Senate Bill 106, identified by Justice Alito in oral argument as “the most reasonable incarnation…” of economic nexus laws. SB106 requires remote sellers to register with the state and collect sales tax if their sales thresholds in the state exceed either $100,000 in in-state sales or 200 or more separate transactions. In a 5-4 decision, the Supreme Court held that South Dakota’s “economic presence” test satisfied the nexus requirements of the U.S. Constitution’s Commerce Clause and thus was not unconstitutional.
States Given a Checklist
Despite the strong language in the majority opinion proclaiming the States’ sovereign taxing power, the ruling is not without its limits. The Court outlines safeguards provided in the South Dakota law that keeps it within permissible limits of the Commerce Clause. This checklist, shown below, can guide states in their implementation of post-Quill economic nexus laws. It incorporates standards for collecting sales taxes agreed to by states that have adopted the Streamlined Sales and Use Tax Agreement, a cooperative effort by state and local governments to standardize state laws.
- Safe Harbor. The law provides a safe harbor for sellers who transact limited business in South Dakota with its de minimis sales thresholds.
- No Retroactivity. The South Dakota law is prospective only.
- Central Administration. South Dakota requires single, state-level tax administration.
- Uniform Definitions. The South Dakota law provides uniform definitions of products and services subject to sales taxes.
- Simplified Tax Rate Structures.
- Software and Immunity. The law mandates access to sales tax administration software paid for by the State and immunity from audit liability if a seller’s computation is wrong when using the software.
Going forward, states planning to enact nexus legislation will need to incorporate the above safeguards to ensure their laws pass constitutional muster under the Wayfair ruling.
Implications for State Tax Reform
The Wayfair decision’s effect could extend beyond state sales and use tax into broader efforts of states to reform their tax codes. States that want to decrease their corporate and individual income tax rates may now have a way to do it using increased revenues from taxing online sales; however, states must first determine just how much revenue they can raise. It may take states a couple of years to track their actual revenues from online sales before they can count on this revenue stream.
Effect on Retailers and Consumers
With the demise of Quill’s physical presence test, both online retailers and consumers should get ready for a rapid expansion of state online sales tax collection. Sellers will need to develop compliance systems to calculate, collect, and remit taxes on internet sales. Even though states may offer software as mandated by the Streamlined Sales Tax agreement, it is not a magic bullet. Fifty different software programs are no simplification, even if they are similar. It is unlikely that one software package will properly calculate all the different state and local sales taxes across the country, with their custom exemptions and their nuanced distinctions. Just consider the many different types of sales taxes on sodas and other sweetened beverages.
Compliance Software, Small Business
Tax compliance companies, such as Avalara® and TaxJar® are likely to step up their product offerings, but what about small businesses that cannot afford expensive compliance systems? The microeconomy, made up of small sellers on eBay® and Etsy®, could be most at risk from the Wayfair decision. If states adopt low minimum threshold for sales tax collections, the vibrant microeconomy, made up of sole proprietors selling handcrafted items or antiques, could be priced out of the market. South Dakota’s law requires sales tax collection for 200 in-state sales, but small sellers could reach that number quickly with a lot of small, individual sales in high-population states.
Etsy’s amicus brief in the Wayfair case notes that, in 2017, 1.9 million microentrepreneurs earned $3.25 billion through Etsy, including from sales across state and country lines. Eighty-seven percent of Etsy sellers are women and most are home-based businesses, Etsy reported. At what point will states decide to tax these transactions?
With the current state thresholds hovering around $100,000 to $200,000 and 200 transactions, mid-market businesses that have not been collecting state taxes will have a more difficult time competing with big sellers like Amazon and Walmart that already collect taxes and can afford expensive compliance systems.
Tax Increase for Consumers
For consumers, as states enact Wayfair-sanctioned nexus laws, it will become more and more difficult to shop around to find vendors that do not charge state sales tax. In short, Wayfair will result in an overall tax increase on consumers.
That being said, states need to take a measured approach when enacting and implementing their economic nexus laws, paying careful attention to the Supreme Court’s enumerated guidelines in the Wayfair opinion. Otherwise, they may face further litigation and possible invalidation of their laws or negative action by Congress limiting their ability to collect online sales taxes. In short, it will take time to know the exact implications of Wayfair, but it is clear that court-sanctioned state online sales tax collection is a game-changer in state taxation.
Lucia Nasuti Smeal is a guest blogger on tax topics for Frazier & Deeter. Smeal is an attorney, a tax professor with Georgia State University’s J. Mack Robinson College of Business and former editor of Tax Notes Today, published by Tax Analysts. Smeal also worked as a legislative analyst for the Congressional Research Service and is a former member of the U.S. House Periodical Press Corps. She is a frequent speaker on current tax developments.