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U. S. Supreme Court Rules Physical Presence Not Required for Sales Tax Collection Responsibility

In a 5-4 decision on June 21, the U.S. Supreme Court in South Dakota v. Wayfair, Inc., et al overruled a 50+-year old rule that physical presence in a state is required before a business must collect that state’s sales tax. The Court said the rule was incorrect at least as far back as 1992, and that it should not be maintained now considering the changing national economy with more remote sales over the internet.

What is the new nexus standard for sales tax collection?

We don’t clearly know yet. While the Court rejected the physical presence standard broadly for all taxpayers, they did not definitively establish a new nexus standard for all taxpayers. In that context, they ruled specifically regarding the taxpayers in the case that they have nexus “based on both the economic and virtual contacts respondents have with the State.” The economic standard South Dakota implemented for sales tax collection is annual activity of $100,000 of sales or 200 separate transactions. The Court did not say that these thresholds will now apply to all taxpayers in all states. Further, the Court arguably muddied the water by referencing the taxpayers’ “virtual contacts” and “extensive virtual presence” in South Dakota without clearly saying whether they view the virtual contacts/presence as a requirement for establishing nexus in addition to the economic thresholds. The Court may have simply been acknowledging that these taxpayers have these virtual contacts/presence which served as the mechanism for the taxpayers to meet the economic standard for nexus.

Is this issue done in the courts now?

No. Even though the Court ruled that nexus exists in South Dakota for these taxpayers, they indicated that the case must go back to lower courts for determinations of whether South Dakota’s law (and, by implication, laws like it in other states) might violate the U.S. Commerce Clause in other ways. The primary way the law could otherwise violate the Commerce Clause is that it could place undue burdens on interstate commerce. Therefore, although the states broadly won the nexus battle, they could still lose the collection war if their sales tax compliance system is too burdensome. A court could find a system too burdensome if, for example, a large state like New York applies the same thresholds as South Dakota for creation of nexus, or a state has many local taxing jurisdictions for which sellers would have to collect tax.

How should a business respond?

Carefully, on a case-by-case basis. This case does open up the ability of states to require remote businesses to collect their sales tax, but it did not immediately convert things to a new regime of every business having to collect sales tax in every state. First, a business needs to consider its positions on the issues discussed above of: a) whether they think virtual contacts/presence are required for nexus (including what is a virtual contact/presence), and b) whether they think the states will win on the issue discussed above regarding undue burdens on interstate commerce. Second, it should be recognized that not all states yet have a law like South Dakota’s that would require immediate action. That is, most states will still need to pass a law, or interpret their existing law as, applying an economic nexus standard for sales tax collection purposes. Currently, only about 1/3 of states have a law or regulation other than the historical physical presence requirement.

How to start complying with expanded requirements for sales tax collection?

For a business that determines it is immediately affected by the Supreme Court’s decision, we suggest the following need to be addressed to move forward:

  1. Consider whether you already had physical presence nexus in certain states. This will have implications on whether you can register and begin collecting/remitting prospectively vs. whether you have prior exposure that should be addressed through voluntary disclosures.
  2. Review your annual volume of sales/transactions by state in comparison to the thresholds established by the roughly 1/3 of states that now say nexus is created by exceeding those thresholds.
  3. Consider whether items you sell tax-exempt in your existing state(s) for which you are subject to sales tax compliance requirements are also tax-exempt in other states in which you may now be subject to sales tax compliance. For instance, not all states have as broad of an industrial processing sales tax exemption as Michigan, so the same item you sell to customers in other states as you sell to customers in Michigan now may require some sales tax collection in those other states.
  4. Decide on your approach to compliance, whether in-house or using a third-party solution, for both tax rate determinations and return filing requirements.
  5. Register to collect and remit sales tax prospectively only and/or initiate voluntary disclosure requests to mitigate past exposure based on the old physical presence nexus standard. (Note that the indication from states appears to be that they will not pursue taxpayers retroactively based on a new economic nexus standard for sales tax, but that is a different issue than whether they will review new sales tax filers to determine whether those filers had nexus under the old physical presence standard.)

It is a new day for state taxes under the Supreme Court’s ruling in Wayfair. Rehmann will continue to analyze the implications of this for our clients. All businesses should proceed with caution and consult their tax advisor before making any changes to their sales tax compliance processes.