The U.S. Supreme Court’s review of the current nexus standards at issue in South Dakota v. Wayfair, Inc., resulted in the Court overturning Quill Corp. v. North Dakota, which established the physical presence nexus standard that formerly applied to sales tax. The old physical presence nexus standard severely limited states’ abilities to impose sales tax on an out-of-state seller. In December 2017, the U.S. Government Accountability Office estimated that state and local governments lost between $8 billion-$13 billion in revenue in 2017 because they did not have the authority to require sales tax collection from all remote sellers and because purchasers commonly fail to self-assess and remit use taxes. In addition to lost sales tax revenues, states are also losing income tax revenues because states typically impose income taxes on businesses with an in-state physical presence.
With this case, the Supreme Court decided the physical presence standard is outdated, and states can constitutionally require out-of-state retailers to charge and collect sales and use taxes from in-state consumers when the retailer has no physical presence within a state. Prior to the ruling, over a dozen states, including South Dakota, had created economic nexus legislation for out-of-state sellers, despite a lack of authorization from Congress or the High Court. Moreover, about a dozen states imposed economic nexus standards for state income tax purposes.
When the case was recently argued before the Supreme Court, Justices across party lines appeared divided. Many questioned the potential impact of retroactive applications, the cost burdens for businesses should they be required to collect sales and use taxes, and whether a signal from the Court for congressional action was the better course of action.
As a result of the ruling, companies should take the time to fully understand their business connections across states. Both retailers of tangible products and digital services providers stand to face major repercussions as a result of the change in nexus standard. While some large online retailers have already begun collecting sales taxes, this change will accelerate disruption of the balance between online retail and brick-and-mortar retail. Digital service providers are charged with the complex task of understanding how their various services are taxed (or not) across state lines.
Actions to Consider as a result of the New Nexus Standard:
- Communicate to internal and external stakeholders (e.g., CFO, Legal, Sourcing, IT, Customer Support, A/R, A/P, and customers) the new national nexus standard for sales tax and potentially state income tax.
- Maintain or invest in a system that tracks how products and services are sold throughout different states.
- Understand how products or services are taxed in all the states and localities that impose a sale and use tax. As a result of the change, many companies will face sales tax implications in jurisdiction where they have never filed before. Throughout the United States there are approx. 10,000 different sales and use tax rates and systems in different locations.
- Maintain or invest in an accounting or billing system that can handle the reporting requirements for all the states and localities in which the company conducts business.
- Identify which potential sales & use and state income tax liabilities the company may be exposed for, including both past and present liabilities, and quantify the same. Consider mitigating historical exposures through voluntary disclosure agreements. This is particularly relevant in the mergers and acquisitions arena.
In light of all these changes, all companies with business activities across state lines should evaluate the effect of the new nexus standards. Newburg & Company, LLP has assisted clients with sales and use tax planning and compliance for many years and can help your company navigate the ever-changing nexus landscape.