Written by: Karen Suhaka | September 19, 2019

This post is written by Paul Jones, Tax Analysts and is meant as a companion piece to our Wayfair webinar, watch it on demand here.

 

Background

Introduction

What is Wayfair? In 2018 the U.S. Supreme Court in South Dakota v. Wayfair ruled that a business doesn’t need to have some sort of a physical presence in a state for that state to require the business to collect and remit the state (and local) sales tax. This changed roughly 25 years of precedent overnight, leaving businesses and states scrambling to adjust.

For a lot of businesses, this means they may now be responsible for collecting and remitting sales tax in numerous states and localities – and for penalties and interest if they fail to comply.

Let’s Talk About Sales Tax

In most states, there’s a sales tax and an alternative, equivalent “use” tax – both are different ways of taxing retail sales (generally of goods).

When an in-state retailer makes a sale to a local customer, it’s generally required to collect the sales tax on the purchase from the buyer, and then remit it to the state’s tax authority. (Notably, some states impose a tax on the retailer, not the consumer.) When a customer makes a retail purchase from an out-of-state seller with no in-state presence, he or she is usually responsible for paying an equivalent use tax to his or her state, to ensure it can still tax the transaction.

However, individual customers generally don’t pay the use tax, and states have limited ability to force them to. As a result, states want to require out-of-state businesses making sales to states’ residents to collect and remit the sales/use tax.

However, prior to 2018’s SCOTUS Wayfair decision, if a state’s tax authority wanted to require an out-of-state business to collect the sales/use tax owed on their sales to the state’s residents, the authority had to show that business had a physical presence of some sort in the state.

Under this system, “remote” sellers – those without physical presence in a state – didn’t have to collect and remit the retail sales/use tax due on the purchases the state’s residents made from them, and states had to forgo a lot of revenue, particularly as online shopping increased the number of sales made by remote sellers. Experts also argued remote sellers had an unfair advantage over in-state retailers in that they didn’t collect sales tax from customers.

Pre-Wayfair Regime

The pre-Wayfair legal regime was the result of a couple of court decisions, National Bellas Hess Inc. v. Department of Revenue of Illinois (1967), Complete Auto v. Brady (1977), and Quill Corp. v. North Dakota (1992).

  1. Bellas Hess established that unless a seller had a physical presence in a state, its connection to that state was too slight for the state to be able to impose the obligation on the seller to collect and remit the state’s sales/use tax under the Commerce Clause and the Due Process Clause.
  2. Complete Auto established that there’s a four “prong” test for determining if a state’s taxes are constitutional under the Commerce Clause, including requiring that for a state to impose a tax on a taxpayer, the taxpayer must have “substantial nexus” with the state.
  3. Lastly, Quill saw the court partially modify the precedent established by Bellas Hess when justices decided that for a state to require a seller to collect and remit sales/use tax, it wasn’t necessary for a seller to have physical presence in the state to satisfy the Due Process Clause, but that the seller did have to have a physical presence in the state to satisfy the “substantial nexus” requirement under the Commerce Clause.

At the time, in 1992, the court worried the complicated burden of compliance with numerous state and local sales tax regimes would be too great for many remote sellers and impede interstate commerce. Notably, the Quill ruling opened the door for Congressional legislation to allow states to require remote sellers to collect and remit sales/use tax, and to facilitate remote sales/use tax collection, but despite multiple legislative efforts, Congress didn’t act.

Quill subsequently became the touchstone ruling defining limits on states’ sales tax authority re remote sellers going forward.

Pressure to Revisit Quill

Following Quill, states got creative and adopted numerous rules to define when they considered a business to be “physically present.” For example, if an out-of-state retailer had an affiliated entity that was present in a state, or paid people in a state to promote the retailer’s goods to buyers via a website link, that could count as a retailer having “physical presence” in that state. Some states even adopted the premise that if a remote retailer’s website put “cookies” on an in-state computer-user’s hard-drive when they visited the site, that “cookie” represented physical presence by the business in the state.

Some states also passed laws requiring sellers and marketplaces to report information about their in-state customers and sales to state tax authorities, in part to help states seek payment of use taxes from residents. Alternatively, sellers could avoid the requirement to report customers’ information by opting to voluntarily collect and remit the sales/use tax due themselves. Some states, such as California, also approved requirements for individual taxpayers to “estimate” the use tax they owe for out-of-state purchases on their annual income tax returns.

Some states also worked out deals with Amazon, which agreed to voluntarily collect taxes on the sales it made into states (but not those made by its third party sellers). Notably, Amazon also had an increasingly physical presence in states at this time.

 

The pressure to address Quill kept building. The physical presence requirement put a unique limit on states’ tax authority with respect to sales tax. Many critics argued the “physical presence” requirement was arbitrary, and increasingly didn’t reflect the nature and growth of remote, online commerce. They noted that some companies – such as Avalara – had developed software services that could calculate the sales/use tax owed on sales automatically, reducing the burden on remote sellers of complying with state and local sales taxes. They argued it was unfair for states to impose sales tax obligations on local retailers, but not on out-of-state sellers.

Remote seller groups argued the existence of sales tax technology didn’t address all of the burdens – particularly for smaller sellers – of complying with states’ sales/use taxes. They argued registering with numerous tax authorities, complying with different rules, and the risk of tax disputes and penalties in multiple jurisdictions would still be too difficult, and posed a threat to interstate commerce.

Many states got together to work to reduce the burden of compliance for remote retailers, adopting the Streamlined Sales and Use Tax Agreement. Members of the agreement hoped by taking steps including simplifying their codes and centralizing their sales tax administration, as well as helping sellers with the cost of tax compliance services, and relieving sellers of liability for errors if they use approved service providers, they could get Congress and the court to consider allowing remote sales taxation. Just under than half of U.S. states are full members of the SSUTA. (AR, GA, IN, IA, KS, KY, MI, MN, NE, NV, NJ, NC, ND, OH, OK, RI, SD, UT, VT, WA, WV, WI, WY.)

SSUTA States 2019

At the same time, different Congressional legislation was considered that would require remote sellers to collect and remit sales tax to states, and establish uniform rules for states to follow – however, none of these proposals ever passed into law.

Wayfair Decision

Setting the Scene

Direct Marketing Assn. v. Brohl was a suit over Colorado’s law requiring remote sellers to either provide the state with information about their sales to in-state buyers so it could pursue the use tax that residents owed on their purchases, or else sellers could voluntarily collect and remit the sales/use tax themselves. In 2015, when the matter came before the U.S. Supreme Court, then-Justice Anthony Kennedy suggested in a concurring opinion that it might be time for the court to revisit its Quill decision in light of how the U.S. retail economy was evolving.

In response, states began to plan a challenge to the Quill precedent. Several states passed laws effectively designed to spark a legal fight that could be used to overturn Quill at the Supreme Court. One of the so-called “kill Quill” laws was South Dakota’s S.B. 106, a law expressly requiring states to collect and remit sales tax once they made a certain number or dollars’ worth of sales into the state, regardless of whether they had any physical presence there. South Dakota’s law was challenged, and the Supreme Court accepted review upon appeal.

The Supreme Court’s Wayfair Decision

SOUTH DAKOTA v. WAYFAIR, INC., ET AL. 2018

As noted, the court decided in Wayfair to do something rare, and overturned its precedent in Quill. The court’s majority opinion by Kennedy decided that requiring physical presence didn’t reflect the reality of the modern U.S. economy, and that physical presence ISN’T required under the Commerce Clause to establish substantial nexus for sales tax purposes.

However, the court didn’t lay out what IS required to satisfy substantial nexus under the Commerce Clause for sales tax purposes – or specify what compliance burdens on remote sellers might violate the Commerce Clause. Instead, in the majority opinion, justices merely implied that they were favorably disposed towards certain aspects of South Dakota’s law that “appear designed to prevent discrimination against or undue burdens upon interstate commerce,” including:

  • South Dakota’s law established a minimum threshold of sales a seller has to make into the state before it has “economic nexus” requiring it to collect and remit sales/use tax. This threshold is sometimes called a small seller “safe harbor.” Specifically, under South Dakota’s law, only sellers with at least $100,000 in annual retail sales into the state, or at least 200 unique transactions, must collect and remit the state’s tax.
  • S.B. 106 wasn’t applied retroactively, and thus didn’t seek taxes on previous sales that hadn’t been taxed. Such a requirement would have been difficult for sellers to comply with, and also would have required sellers to pay the tax on sales that they had never collected from buyers in the first place.
  • South Dakota is a full member of the SSUTA, and has a relatively simplified state and local sales tax regime. It also provides assistance to sellers including for the cost of certain technology services to automatically calculate the sales tax due on transactions, and legal protections for sellers complying in good-faith.

Notably, the Wayfair decision only overturned the physical presence requirement, and did not precedentially establish that S.B. 106’s provisions satisfy other constitutional requirements. However, the majority’s favorable discussion of S.B. 106’s elements has caused many states to interpret them as basic requirements to follow in crafting their own remote sales tax laws.

Wayfair’s Aftermath

States Jump In

Once the court issued its decision, states responded quickly. Many passed their own “remote seller laws” similar to South Dakota’s in 2018. Others issued regulations asserting their existing statutory authority to require remote sellers to collect and remit sales/use tax “to the fullest extent permitted” by federal law and the Constitution, which tax authorities generally asserted as being synonymous with the requirements of South Dakota’s law. Some laws and regulations were effective as early as late summer and fall of 2018. (see map here)

The Sales Tax Institute has compiled a list of state remote seller laws including compliance dates: https://www.salestaxinstitute.com/resources/economic-nexus-state-guide

Many states have emulated the $100,000 or 200 sales threshold – some have required both $100,000 and 200 sales, some have scrapped the 200 sales threshold and settled on a simple dollar amount. Some states have legislated a higher dollar threshold – California, for instance, has set the threshold at $500,000, due in part to its population/market size.

Most states have not applied their laws retroactively. However, Massachusetts has attempted some limited retroactivity for a single year, resulting in a legal fight.

While they’ve emulated other aspects of South Dakota’s law, many states haven’t adopted many or all of the simplification measures implemented by South Dakota and other SSUTA states. The SSUTA hasn’t seen an increase in members, and many other states haven’t significantly simplified their sales tax regimes. Many, however, have offered limited grace periods and some protections for errors made by retailers complying in good faith.

Many states have also begun repealing or mothballing older, pre-Wayfair laws that sought to establish that out-of-state sellers had physical presence under various circumstances.

A few states lack a state sales tax, such as Alaska, where municipalities are working together with the Alaska Municipal League to create their own, statewide system for enforcing and administering remote sellers’ compliance with local sales/use taxes in light of the Wayfair decision. Additionally, New Hampshire has taken an anti-Wayfair stance, and is attempting to impose conditions on states’ efforts to subject its businesses to their remote seller laws.

Notably, Kansas, an SSUTA state, recently put out rules requiring all remote sellers – regardless of how many sales they make into the state – to collect and remit sales tax due on their sales to Kansas residents. Experts say the state’s lack of a minimum sales threshold could be challenged in court. It’s possible Kansas will alter the rules with legislation next year – two bills setting a minimum sales threshold for remote sellers were vetoed by the governor earlier this year for unrelated reasons.

Business groups react

Local business groups, including many state and local chambers of commerce, are generally supportive of moves to require remote sellers to collect and remit sales/use tax, since remote seller laws level the playing field between online retailers and traditional brick-and-mortar (local) businesses. But the push by states to adopt those laws has caused concern among remote seller advocacy organizations such as the American Catalog Mailers Association (ACMA) and NetChoice.

Remote seller groups continue to sound the alarm about the burden of compliance, particularly for smaller, less-sophisticated sellers. They argue that some states’ thresholds are too low, and that the diversity of minimum thresholds between states, the variety of state and local sales tax rules and definitions, etc., all mean that the time and cost to small sellers of complying is too great, and that small sellers are at risk of accidental noncompliance that could lead to audits and hefty back tax liabilities and penalties.

There has been limited litigation over remote seller laws to date – as noted, Massachusetts’s effort to apply its remote seller rules retroactively triggered a lawsuit by several online retailers including Newegg. However, the laws are still fairly new, so there hasn’t been much time for legal challenges to arise – for example, over whether the burden of complying with a given state’s rules raises Commerce Clause issues.

Another development – Marketplace Facilitator Laws

Despite the Wayfair decision overturning the physical presence requirement, and South Dakota’s law establishing a model for remote seller laws, states still face a logistical challenge trying to collect the sales/use tax due on remote sellers’ sales to their residents. The key problem is this – many large, online sellers are easy for state tax authorities to track and sophisticated enough to comply with remote seller rules, but many small sellers may fail to do so, either accidentally, or willfully. Pursuing tax enforcement against numerous small sellers is time-consuming, expensive, and virtually impossible to do in all cases, and may cost states more than it brings in.

However, many such sellers make most or all of their sales through online marketplace facilitators such as Amazon and Ebay. In recognition of that, many states have adopted new legislation that requires any marketplace facilitator that has substantial nexus with a state to collect and remit sales/use tax due on sales made into the state by that marketplaces’ third-party sellers (as well as the tax due on sales the marketplace itself makes into the state).

This strategy is somewhat similar in its approach to laws adopted by some states pre-Wayfair that require marketplaces to either report information to state tax authorities about in-state buyers who made retail purchases through their platforms, or else collect and remit the tax due on the sales they make or facilitate in a state.

Many of the new marketplace facilitator laws were passed in 2019 legislative sessions – as of late June, 33 states had some form of marketplace facilitator law. Many such laws are relatively similar between states, like states’ remote seller laws.

Amazon and Ebay appear to not be fighting these laws, and have provided input to state legislatures during debate over the legislation. Features of the laws include grace periods to facilitate marketplaces’ compliance with the new requirements, as well as temporary and long-term accommodations, such as tax liability forgiveness for incorrect payments made as a result of incorrect information provided to the facilitator by sellers, among others.

(A separate, notable development regarding marketplaces’ responsibility vis-a-vis their third-party sellers comes from South Carolina, where an administrative law judge recently ruled that Amazon has a consignment-style relationship with its third-party sellers, and is responsible for collecting taxes on their sales into the state.)

The growth of marketplace facilitator collection laws means some small remote sellers that don’t meet various states’ minimum thresholds, and sell through marketplaces, will lose their sales tax advantage over brick-and-mortar retailers. However, for many small sellers it’s a good thing, since it frees them from the cost and obligation of compliance with numerous states’ remote sales tax rules, and the risk of enforcement for noncompliance.

Notably, Verizon is seeking to be able to collect and remit sales tax on its own sales made through marketplaces so it can have control over its own sales tax remittance. Some marketplace laws allow sellers and marketplaces to come to agreements where the seller handles its own remote sales tax payments.

The Future

Clarity needed for remote seller, marketplace laws

Marketplace laws and remote seller laws were adopted very quickly after Wayfair and may be revised in future legislative sessions.

  1. States may increase their remote seller laws’ minimum sales thresholds.
  2. Some states have, and other states could, consider getting rid of the threshold triggered by the number of transactions into a state, instead focusing exclusively on a sellers’ gross receipts from retail sales.
  3. Some non-SSUTA states may seek to simplify their sales tax rules for remote sellers. For example, Arizona in its remote seller/marketplace collection legislation this year sought to reduce the complexity of complying with local sales tax codes as part of its remote seller/marketplace legislation. States may also create programs – as SSUTA states have – to help cover the cost for remote sellers of software services that calculate sales tax due on their sales.
  4. Lawmakers and regulators might also review the timing of their states’ requirements for sellers who meet minimum sales thresholds in a given year to register to collect and remit sales tax. Not every state has the same deadline, and the exact amount of time a seller must collect after meeting a state’s sales threshold isn’t necessarily the same for each state.
  5. Marketplace laws may also require review – and a Multistate Tax Commission group has been formed to review and develop recommendations for how such laws might be modified (also the NCSL is reviewing them).

To the last point, the definitions of what even constitutes a “marketplace facilitator” may be expanded or further clarified. An entity like Amazon, that lists sellers’ products, processes payments and facilitates shipping, is obviously covered. However, there are other entities, such as “referrers” that only list items for sale online and connect sellers and buyers, that may be treated differently. For example, Nevada requires referrers whose referrals result in enough in-state sales to meet Nevada’s remote seller threshold to collect and remit use tax on the in-state sales they arrange, but unlike marketplace facilitators, if they provide sales data to the state’s tax authority, including information about Nevada buyers, they can opt-out of that requirement.

Other questions with respect to marketplace facilitator laws is how they impact individual sellers in certain circumstances. For example, for a seller that makes sales through a marketplace and also independently, do its marketplace sales into a given state count towards that state’s minimum sales threshold, potentially helping to trigger sales/use tax compliance obligations on the seller’s independent sales in that state? Who gets audited under what circumstances when tax collected and remitted by a marketplace on a third party sellers’ sale is incorrect? What information are sellers responsible for providing to marketplaces around their sales? By the same token, if sales tax is overcharged on a third-party sale facilitated by a marketplace, does the tax authority return money to the marketplace, or the remote seller? Who do customers go to for refunds?

On the Radar

States may move to simplify their existing sales tax rules for remote sellers in order to encourage compliance, and also to prevent legal challenges and federal interference with their sales tax authority.

NetChoice and the ACMA are currently seeking to raise funds to challenge particularly non-SSUTA states’ remote seller laws, alleging that “Few states … have paid any mind to Wayfair’s direction to simplify tax regimes via the Streamlined Sales Tax project or similar measures.” Such a suit could allege that despite the Supreme Court’s overturning of the physical presence requirement, states that haven’t substantially simplified and standardized their remote sales tax rules are nonetheless imposing too great a burden on remote sellers and violating the Commerce Clause.

There could also be litigation over whether a state’s sales thresholds for sales/use tax compliance are high enough to establish that a seller has substantial nexus. Notably, Kansas’s rule – which doesn’t set a minimum threshold for sales by remote sellers – could also be litigated if the state doesn’t set a threshold in its next legislative session. That might result in a suit that could clarify how states should set their “minimum sales” thresholds. (However, observers anticipate lawmakers will address the rule in the near future.)

Some experts have also raised the possibility that remote sellers in certain circumstances might raise a claim under the Due Process Clause – for instance, alleging that inadvertent sales into a state by a seller that simply lists products online – without doing any deliberate advertising to a state’s residents – don’t represent “purposeful availment” of that state’s marketplace (even if they meet a state’s minimum threshold).

Congress could also consider legislation that would impact states’ remote sales tax authority, but like before, it’s unclear if federal lawmakers have sufficient motivation to pursue federal legislation that would preempt new state laws. The Online Sales Simplicity and Small Business Relief Act of 2019 would provide protections to “small sellers” with less than $10 million in annual U.S. gross receipts, and also seeks to require states to join a national compact similar to the SSUTA.

Separately, another federal bill introduced in reaction to Wayfair, the Business Activity Tax Simplification Act, would limit states’ authority to apply “business activity taxes,” such as income taxes, to only those businesses with a “meaningful” in-state physical presence.

Broader Fallout

Remote sales tax collection laws may be a benefit to brick-and-mortar retailers, and a new burden for online sellers. But it remains to be seen if foreign online sellers making retail sales to U.S. consumers will comply. Some tax experts argue that many foreign retailers sell through marketplace facilitators that will comply with states’ sales/use collection requirements, resulting in taxation of foreign retail sales. Also, larger foreign remote sellers may not want to risk the hefty back taxes and fines that could accrue if they engage in long-term noncompliance, since this can complicate their business in the U.S. in the long-term. However, it remains to be seen whether remote seller rules will be generally followed by foreign retailers.

Experts have also noted that by eliminating the “physical presence” requirement for sales taxation, the court’s decision in Wayfair essentially has validated the use of economic nexus across the board for all business taxes. Already, Washington and Hawaii have adopted the same in-state sales thresholds they established to require remote sellers to collect and remit their sales/use taxes to also assert sellers’ obligations to pay other state business taxes, including Hawaii’s income tax and Washington’s Business & Occupation tax (the state’s gross receipts tax).

Remote sellers making retail sales into states must therefore be on watch – it’s possible that their retail activity in certain states could also result in other business activity tax (BAT) liability in the future. Public Law 86-272 forbids states from applying income taxation to remote retailers that limit their in-state activities to “soliciting sales.” However, some remote retailers’ business models may exceed this narrow exemption. Additionally, experts say Public Law 86-272 doesn’t protect sellers from non-income BATs, like gross receipts taxes.

(This issue is what the Business Activity Tax Simplification Act appears to be aimed at addressing.)

Also, notably, the Multistate Tax Commission has recently suggested that retailers with “cookies” on people’s computers in a state may not be protected by PL 86-272.

Resources

Guides and Statements

Brick and mortar resources:

Remote/online seller resources

SSUTA compliance providers

Other Helpful Info

Additional Reading

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