Sales Tax Compliance after Wayfair: “Heads up!” to businesses delivering products or services out of state
In the months since the U.S. Supreme Court’s landmark 2018 decision in South Dakota v. Wayfair, most states have enacted, begun enforcing or proposed “economic nexus” statutes. These statutes impose sales tax collection obligations on out-of-state sellers based on their economic activities in the state, regardless of whether they have a physical presence in that state.
The impact of these changes will be felt most by online and mail-order sellers that, before Wayfair, weren’t obligated to comply with sales tax laws in states where they lacked a physical presence. Here’s an overview of the case and the steps businesses should take to ensure compliance with these statutes.
Constitutionally speaking, a state’s power to impose tax obligations on a company is derived from the business’s connection, or “nexus,” within its borders. A business establishes such a nexus when it “avails itself of the substantial privilege of carrying on business” in the state. Before Wayfair, that meant maintaining a substantial physical presence in the state, such as offices, stores, plants, warehouses, employees or sales reps.
In Wayfair, however, the Court recognized that modern technology makes it possible to establish nexus in a state solely through economic contacts, such as e-commerce sales or digital services. The Court declined to rule on the level of economic activity required to establish nexus, but in this case it found that the thresholds set by South Dakota’s economic nexus statute were sufficient.
The South Dakota statute requires out-of-state businesses to collect and remit South Dakota sales tax if, in the current or previous calendar year, they have either:
- More than $100,000 in gross sales of products or services delivered into the state, or
- 200 or more separate transactions for the delivery of goods or services into the state.
Wayfair opened the door for other states to enact similar statutes, or to begin enforcing laws already on the books. Most states have now enacted, or proposed, such statutes. Typically, to avoid legal challenges, these laws incorporate thresholds identical or similar to those upheld in Wayfair — $100,000 in sales or 200 transactions. Some states, however, have established more aggressive thresholds.
Steps to take
If your business delivers products or services across state lines, it’s critical to review your activities. Then take steps to ensure compliance with rapidly evolving sales tax requirements.
The first step is to take inventory: Compile data on all your sales transactions over the last two years or so on a state-by-state basis. Next, review any existing or proposed economic nexus statutes in the states in which you do business. Then look at whether your level of activity in those states exceeds applicable thresholds. If it does, determine the effective or enforcement date of each statute.
Many states’ nexus statutes are already in effect. Some become enforceable later this year or beyond. For states whose enforcement dates have passed, register as a vendor and begin collecting sales taxes from customers as soon as possible to minimize liability for back taxes. Also, inquire whether these states have voluntary disclosure agreement programs or other procedures that allow you to limit your tax liability for past sales.
For other states, be prepared to comply starting on the enforcement date. Be sure to familiarize yourself with each state’s sales tax laws. If any of your sales are exempt from tax, you’ll need to collect exemption certificates from customers to avoid charging the tax. Common exemptions in many states include sales of products intended for resale, sales to tax-exempt organizations and sales of certain items used or consumed in a manufacturing process.
Weigh the costs and benefits
As you consider your options, weigh the costs and benefits of doing business in a state. If you exceed a state’s transaction threshold but have a small amount of sales (for example, 200 sales of $2 each), the cost of registering with the state and collecting tax on those sales may exceed your potential profits.
Don’t ignore purchases
Although the Wayfair decision’s biggest impact is on out-of-state sales, it also can affect your purchases. For example, if you purchase equipment, materials or supplies from out-of-state sellers, those vendors may not have collected sales tax from you in the past. But if your state enacts an economic nexus statute, they may begin to do so. If these purchases qualify for a sales tax exemption, such as a resale or manufacturing exemption, you’ll need to furnish exemption certificates to the sellers.
Also, if you’ve been paying use taxes on any purchases for which no sales tax was collected, be sure to review your use tax policies and procedures to avoid double taxation if vendors begin to collect sales tax.
Please contact Glenn Schwier, CPA on 973-298-8500 if you have additional questions.