A recent U.S. Supreme Court decision has literally pulled the rug from beneath whatever processes or activities companies may have in place to comply with tax law in each of the 50 states.
Following the recent decision in South Dakota v. Wayfair, companies now face big uncertainty both in how to comply with existing state tax laws and in how to adapt to the expected onslaught of new statutes, regulations, and court challenges. “That’s the big question,” says Kent Johnson, a partner and national tax leader for indirect tax at KPMG. “What do I do now?”
In its recent decision upholding South Dakota’s approach to state sales tax, the Supreme Court cleared the way for South Dakota to collect sales tax on Wayfair sales into South Dakota, even though the massive online retailer of home goods has no stores, no warehouses, no offices, and no employees located in South Dakota.
The decision unraveled long-standing case law that told state governments they could only collect sales tax on commercial activity within their state borders from sellers that had a physical presence within those borders. Now the court has determined the physical presence standard was antiquated, written in an era when the mail-order-catalog model of remote selling was the only real competitor to brick-and-mortar retail establishments. Economic nexus, the standard relied upon in South Dakota’s statute, is appropriate, the court found.
“This is a landmark ruling that will have a significant impact on online businesses of all sizes,” said Valerie Dickerson, national multistate tax leader at Deloitte. “This is a pretty fundamental change in the way we think of commerce.”
States have long been hamstrung in collecting sales tax on internet transactions as a result of the Supreme Court’s earlier decisions. In its recent opinion, the high court even quantifies the lost revenue to states at $8 billion to $33 billion annually, and it ponders whether the court’s position has helped fuel the rise of internet commerce. “An erroneous decision from this Court may well have been an unintended factor contributing to the growth of e-commerce,” the opinion says.
The newest decision to do away with the physical presence standard now leaves companies facing potential tax liabilities in states where they may not have had them before, says Dickerson. “This means anyone that was relying on that standard now has to take another look,” she says. “Where do you have U.S. customers? Where are you selling? What are you selling? What are the rules in those applicable jurisdictions? Determine where you may need to start collecting or may need to prepare for additional law changes.”
Johnson is advising companies to begin by taking stock of all their business activity and determining where they may have filing obligations, state by state, as a result of the Wayfair decision. “You may find you have nexus in a lot more states than you had before, where now you have to collect and remit,” he says. That analysis should include taking stock of which specific products and services may or may not be taxable in each state.
As companies sort out what they may need to do to become compliant state by state, they will need to take stock of their current technology and resources, Johnson says. Some companies will likely have more work to do than others to adjust to the new tax liability landscape. Companies may find they not only will face new filing obligations in some states, but they may even find filing obligations that already existed and need to be cleaned up, he says.
“The big issue companies are facing now is whether to collect and remit tax, and if so how to track it, state by state. You look at prior year data and figure out if this is an issue. You look at states that have adopted legislation and see if there may be an issue in those states. And you continue to track what states are doing in this area.”
Jamie Yesnowitz, Principal, State and Local Tax, Grant Thornton
“The big issue companies are facing now is whether to collect and remit tax, and if so how to track it, state by state,” says Jamie Yesnowitz, a principal in state and local taxes at Grant Thornton. “You look at prior year data and figure out if this is an issue. You look at states that have adopted legislation and see if there may be an issue in those states. And you continue to track what states are doing in this area.”
The Wayfair decision contains some clear guidance from the nation’s highest court about the notion of physical presence and the weight it can carry in taxing business activity, says Harley Duncan, state tax managing director at KPMG. “But there are two questions it did not answer,” he says. “Where do I need to collect? And when do I need to begin?”
A group of about 15 U.S. states have already enacted laws or regulations relying on an economic nexus concept like that contained in South Dakota’s now upheld statute. Their provisions differ in a number of ways, however, and it’s not clear where they will or could withstand further court challenges, says Duncan.
Another group of states have existing statutes defining “doing business in the state” as broad enough to encompass economic nexus, says Duncan. Those states could generally be expected to provide some kind of guidance or notice to indicate how they plan to interpret the Wayfair decision, he says. And even then, those interpretations are likely to face some legal obstacles as well.
A third group of states have not enacted any kind of statutes that would depart from the boundaries set by earlier case law, says Duncan, but those states are generally expected to act in light of the Wayfair decision in some fashion. “I would be surprised if there’s a state with a sales tax that didn’t move to require remote sellers to collect tax,” he says.
Some states are already preparing legislation, and some are showing signs of restraint in terms of how aggressively they plan to seize on the opportunity created by the Wayfair decision, says Duncan. A few have hinted at using this new avenue to raise sales tax revenue as a way to provide some kind of relief in other areas, he says. “With 50 different governors and state legislatures, it’s a mixed bag,” he says.
Bob Peters, managing director at advisory firm Duff & Phelps, says companies need to act, but not panic, in light of the recent ruling. “Even though it was a broad decision, it is still somewhat limited in its actual application,” he says. It applies to the specific provisions of South Dakota’s single statute, which included some “fail safe” provisions to protect small business owners and limit retroactivity, he says. He agrees companies need to do some analysis of how their exposure may have changed in light of the recent decision and start tracking state tax law changes more closely.
Even further on the horizon, companies may even decide to review how they go to market, says Aaron Schumacher, a partner at law firm Withers Bergman. Companies may have made infrastructure and supply chain decisions based at least in part on state sales tax exposure, he says.
Contracts, storage facilities, third-party arrangements, and warehouse locations, for example, may have been established to some degree to mitigate tax liability, says Schumacher. “The existing business model has to be reviewed and revised,” he says.
Coming on the heels of tax reform in federal tax under the Tax Cuts and Jobs Act, the change in state tax law now gives tax departments yet another big change in compliance activity to manage. “In the time I’ve been around, I don’t ever remember this much change in this short of a period,” says Duncan.