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Wayfair: Where are we now?

While June 21, 2018 – the day the U.S. Supreme Court discarded the physical presence nexus requirement for sales tax collection – was the end of a 50+ year battle by the states, it really was just the beginning of so much more. It was the beginning of confusion, frustration, panic, increased costs, etc. for small and mid-sized businesses across the country. It was the beginning of the next phase of the states’ efforts to require sales tax collections on behalf of even the country’s smallest online retailers. And it was the beginning of questions, questions, and more questions.

Here are just a few:


The challenges are really still just beginning for businesses to navigate the new nexus landscape after Wayfair. This is a fast-moving area of tax law, it is prudent to be aware of the issues so that you can properly consider them as they arise — our team is ready to assist.

 

 

Is the physical presence nexus requirement really dead? I thought there were going to be more court cases after South Dakota v. Wayfair that might blunt the impact of that decision?

The U.S. Supreme Court said the physical presence requirement was dead – in fact, the court said it was an incorrect nexus interpretation all along – but it seemed that where they closed a door, they opened a window. That is, the Court never specifically said the thresholds of $100,000 of sales or 200 separate transactions were valid in South Dakota, let alone all other states. They remanded the case back to the South Dakota courts to make the determination of whether these thresholds, or any other aspect of South Dakota’s law, violated the U.S. Constitution’s Commerce Clause restrictions against a state placing undue burdens on interstate commerce. In addition, there is a thought that the U.S. Constitution’s Due Process Clause could be used as a protection for businesses that states are pursuing for sales tax collection.

Although the window was opened, it has already partially shut, and, so far, no one is trying to climb through the narrow opening that remains. Instead of the South Dakota courts deciding on remand whether South Dakota’s law was constitutional, Wayfair (and the other defendants) settled with the state. This means we will never get a ruling in the case that started it all whether the laws being challenged by Wayfair are, in fact, constitutionally permissible. This settlement deprives other taxpayers and other states of a reasoned analysis by the courts as to the burdens placed on interstate commerce by these new laws, and whether such burdens are “undue” and thus unlawful. Instead, the business community will need to wait for a potential challenge regarding undue burdens to take place in another state. The most likely states in which this challenge would arise are Colorado or Louisiana, because of their complex local taxing jurisdictions, or Oklahoma, Pennsylvania or Washington, because of their low $10,000 sales thresholds for purposes of electing to collect sales tax or engage in use tax reporting. If a business were to challenge one of these states, the Court’s ruling in that case could lay the groundwork for challenges to other states’ laws, but, so far, it appears no business has initiated any court cases on the issue of undue burdens.

Regarding the thought of a Due Process Clause challenge to the constitutionality of these new economic nexus laws, again, no business has yet initiated a court case. One may do so on the theory that either: a) they are not similar to Wayfair in the sense of being an Internet retailer with, from the U.S. Supreme Court’s ruling, “virtual contacts” and “extensive virtual presence” in the state attempting to require them to collect sales tax, or b) they may have sold to customers in the state, but they did not intentionally target the market in the state, which seems to generally be required in non-tax Due Process Clause cases. While the small and mid-sized business community is hopeful that a business with deeper pockets will take up this battle, it appears that the smaller businesses would be the ones more likely to meet the criteria to argue protection under the Due Process Clause.

 

 

It sounds like the states are now free to pretty much do what they want. What is the status on states implementing economic thresholds?

As of February 12, 2019, these states have announced some form of economic nexus for sales tax collection purposes.

Although the linked table makes the economic nexus rules look fairly simple, that information is just the tip of the iceberg. The following issues also need to be considered for determining whether a business has economic nexus in a state.

  • States are defining their measurement periods for the thresholds differently. There are a handful that use an easy test based on the prior calendar year, but most states have imposed a “previous or current calendar year” measurement period. This requires many businesses to continuously measure their activity against the thresholds. If a business exceeds the threshold only in the current year, the challenges will be to first recognize the threshold has been exceeded and, second, to register and begin collecting within the timeframe allowed by the state. Some states are unrealistically imposing a collection requirement on the very next sale a business makes once it crosses the threshold, while others are allowing a more reasonable time period of, for instance, 60 days to get registered and begin collecting. In addition, some states are not using calendar year measurement periods at all but have either a rolling 12-month period or some other specifically defined 12-month period.
  • States are not consistent regarding which sales/transactions count for the threshold tests. Some states only require taxable sales to be counted, while others require tax-exempt sales to be counted. Of those that require tax-exempt sales to be counted, there is a further split amongst the states in that some require all tax-exempt sales to be counted, while others still allow sales for resale to be excluded from the tests. Furthermore, many states have not directly issued guidance on which sales get counted for the thresholds, so the determination of this issue is subject to the interpretation of taxpayers and their advisors, which may ultimately be contradicted by the states when their taxing authorities finally do issue guidance.
  • Some states have additional legal criteria that a business must meet before it has nexus. For instance, at least Alabama, Mississippi, Nebraska, and North Carolina have a requirement that, in addition to exceeding the $100k or 200 transactions threshold, the business must also at least advertise into the state. This appears to be a nod to the Due Process Clause issue discussed above of whether a business has intentionally targeted a state’s market. But even though these states each have this requirement, they define it differently, with some appearing to include Internet-based advertising as meeting the requirement, while others appear to only include TV, radio, telemarketing and/or direct mailing as meeting the requirement.
  • Several states, most notably Colorado, Louisiana, Oklahoma, Pennsylvania, and Washington, have use tax reporting requirements that may have different “nexus” thresholds than that presented above, and/or the thresholds presented above require a business to elect to do sales tax collection or use tax reporting. The use tax reporting rules, of course, differ by state, but generally consist of notices to customers that the business did not collect sales tax on a transaction for which the customer may now be required to self-remit use tax and notices to the state of to whom the business sold potentially taxable products. Failure to comply with use tax reporting requirements can result in penalties potentially exceeding the amount of sales a business made into the state. Oklahoma, Pennsylvania, and Washington have use tax reporting requirements with a $10,000 “nexus” threshold; in Washington, for instance, the penalties start at $20,000 per year for failure to comply with the requirements.

 

 

Isn’t the Streamlined Sales Tax Project supposed to make compliance easy for remote sellers?

The U.S. Supreme Court in its Wayfair decision brought up the fact that South Dakota was a Streamlined Sales Tax (SST) state, indicating that membership in that program can reduce some of the compliance burden on sellers. But the Court stopped short of saying that a state must be an SST state in order for that state to impose economic nexus. Thus, no additional states have joined SST since Wayfair, and there do not appear to be any states moving in that direction.

While it does not appear that the Streamlined Sales Tax Project will ever become the nation-wide solution that some hoped for back in the early 2000s, there is one primary benefit available to remote sellers in the form of the SST Volunteer Seller Program. This program allows remote sellers that meet certain criteria to obtain sales tax registration, calculation, filing, and remittance services for free from SST’s cCertified sService pProviders. Depending on the transactional volume of the business, this free service can easily save a business $10,000+ in annual compliance costs. Thanks to a recent revision to the Streamlined Sales Tax Agreement, it is our understanding that volunteer sellers no longer have to begin compliance in all 23 SST states. Previously, even if the business does not exceed the thresholds in all of the SST states, they had to register and collect in all of them to obtain volunteer seller status; now it appears a business can become a volunteer seller in only the states in which it exceeds the economic nexus thresholds.

 

 

Does Wayfair have any impact beyond collecting and remitting sales tax?

The permissibility of economic nexus for sales tax collection has the potential to directly impact GAAP financial statements and indirect impact on income/franchise taxes. In addition, not properly considering all these impacts can have negative consequences for businesses in the merger & acquisition arena.

For businesses that issue GAAP financial statements, FASB Accounting Standards Codification Section 450 (ASC 450) requires disclosure and/or accrual of certain loss contingencies, which are defined as existing conditions involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Essentially, if a business is uncertain about whether it is required to collect sales tax (e.g. uncertain whether they have nexus or uncertain whether the product they sell is taxable) and chooses not to do so, that business has to presume they will get audited by the state in question, and the business has to determine whether it is unlikely, reasonably possible, or probable that they should have collected sales tax. If it is reasonably possible they should have collected sales tax, they will at least have to disclose the loss contingency that results from not having collected sales tax. If it is probable that they should have collected sales tax, they will possibly have to accrue a liability for the uncollected sales tax.

It needs to be understood, though, that ASC 450 does not even apply in situations where a business knows it should collect sales tax (the business has nexus in a state and its sales are taxable) but fails to do so, whether intentionally or not. As a result of Wayfair, many businesses now have many more jurisdictions in which they have nexus. For each jurisdiction in which they have nexus and taxable sales, the business is required to accrue the sales tax they should be collecting, as that is now a liability that will come out of their own pocket if they get audited by that jurisdiction.

In the income/franchise tax realm, while most states (other than Delaware and Texas, and possibly a couple others) had already begun using the concept of economic nexus prior to Wayfair, there was some debate about the constitutionality of this. The U.S. Supreme Court had not directly opined on that issue, and state courts were not uniform in ruling it constitutional. With the elimination of the physical presence nexus requirement for sales tax collection – the last tax area in which physical presence nexus had clearly been required – it is now generally understood that economic nexus can be applied to any type of tax.

This means that, unless a business is protected by Federal Public Law 86-272 from a net income tax because they sell only tangible personal property and do not engage in activities beyond solicitation of sales in a state, the states now clearly do not have any constitutional restrictions against imposing an income/franchise tax against any business. That said, some states may need statutory updates and/or a change in mindset by their tax departments before there is a significant push to impose income/franchise taxes against businesses not protected by P.L. 86-272. Prior to that push by the states, businesses need to consider their exposure for income/franchise taxes in regards to whether they will voluntarily comply or whether they need to disclose or accrue any liability on their financial statements under ASC 740 because they have taken an uncertain tax position of not filing a particular state’s income/franchise tax return.

Finally in this discussion of “collateral damages” from the Wayfair decision, businesses that are expecting to sell to external buyers need to consider the impact that failing to comply with all sales tax laws could have on the valuation (or even the salability) of the business. Many states have successor liability laws that can cause a buyer of a business to be responsible for pre-acquisition unpaid taxes, even if the tax was not collected from another party and even if the buyer purchases assets of the business instead of the stock/membership interests. With these laws, and the expanded nexus of Wayfair, the buyer due diligence process while considering the acquisition of a business will become more robust, and sellers should expect that any non-compliance with the post-Wayfair economic nexus laws will be found by potential buyers.

 

 

What is the next step for states now that they can require remote sellers to collect sales tax?

The Wayfair case was never about imposing new taxes on businesses or their customers. Every state that has a sales tax also has a corresponding use tax that applies to the customer if the seller did not collect sales tax. The problem has been that many customers, especially individuals, don’t know they have a use tax remittance obligation, or choose not to fulfill that obligation. The goal of the states via Wayfair was to force a relatively limited number of businesses to collect the sales tax instead of the states having to rely on (or try to enforce) a relatively significant number of individual customers to self-remit their use tax. The states got what they wanted, but that was just step one.

Step two is to try to move the collection responsibility from a relatively significant number of small remote sellers to a relatively limited number of large online marketplaces (e.g. Amazon Marketplace, eBay, Etsy, etc.). As with economic nexus for remote sellers, states have been approaching marketplace collection responsibilities in a variety of ways. While about a dozen states have announced marketplace collection requirements, not all have done so via legislation, and the marketplaces appear to be generally only complying with the states in which legislation has been passed. For instance, both Amazon and eBay indicate they are collecting sales tax on behalf of their marketplace sellers in eight states.

For pure marketplace sellers, this next step by the states is a blessing, since it could reduce, and possibly ultimately eliminate, their compliance obligations by moving those obligations up to large entities that can handle sales tax compliance more efficiently. However, this shift toward marketplace collection does come with its own set of complications. For instance, even for pure marketplace sellers, it is not clear yet to what extent the marketplaces will allow them to accept exemption certificates from customers, thus possibly putting some customers in the position of being forced to pay a tax they do not owe and then having a cumbersome process to get that tax refunded, if they are able to at all. Also, for sellers who sell both on marketplaces and via their own website, there are uncertainties about how those sales are to be integrated for various purposes – Do the marketplace sales count toward the thresholds for whether the seller has to collect tax on sales via their own website? Do the marketplaces and the remote sellers have to integrate any information for the periodic tax reporting/remittance requirements? When states audit sellers that sell via both channels, how will they handle the disparate treatment of sales when trying to reconcile the total activity of the business?

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