How to Navigate the Evolving Sales Tax Requirements for Remote Sellers
Sales tax revenues account for an average of 23.3 percent of states’ budgets (for states imposing a sales tax), according to a recent publication by the Tax Foundation. As a result, if a state is not able to collect sales tax on remote sales made to in-state purchasers, its budget can be significantly affected.
In addition, even though purchasers are required to self-assess use tax on taxable sales when the seller does not collect sales tax on those transactions, efforts to get purchasers to pay use tax are expensive and largely unsuccessful. As a result, historical efforts to close this tax gap on remote sales have primarily focused on sellers rather than buyers.
States, however, cannot simply make all remote sellers collect their sales tax. In the 1992 United States Supreme Court decision of Quill Corp. v. North Dakota, the court held that North Dakota could not require an out-of-state mail order company to collect sales tax on items delivered into North Dakota because the company did not have a physical presence there. In other words, if a company sells to consumers in a state but does not have a physical presence in that state, it does not have nexus for the purposes of collecting sales tax. Because of the Quill case, that company is commonly known as a remote seller.
However, the Quill physical presence nexus standard is currently being re-evaluated by the Supreme Court in South Dakota v. Wayfair, Inc., et al (Docket No. 17-459). On April 27, 2018, the Supreme Court heard oral arguments in this challenge over South Dakota’s so-called economic nexus standard, which requires remote sellers to collect sales tax if they meet certain sales thresholds and which on its face violates the Quill standard. The court’s decision is expected by the end of June 2018.
If the court were to overturn Quill, it could cause a dramatic change in the sales tax collection obligations of remote sellers. Regardless of the court’s decision, remote sellers are currently subject to a wide range of state laws that seek to impose a tax collection or reporting obligation on remote sellers.
Because these laws currently affect all remote sellers, the discussion that follows explains which kinds of remote sellers are currently affected by the various kinds of sales tax nexus regimes used by states, and explains how the potential outcome of the Wayfair case may differ from these regimes.
Streamlined sales and use tax agreement
In March 2000, the Streamlined Sales Tax Governing Board was created to find solutions to the complexity in state sales tax systems and encourage voluntary registration and collection, which created the Streamlined Sales and Use Tax Agreement (SSTA). Among other things, the SSTA created standardized definitions and reporting mechanisms, which were designed to make compliance easier for businesses that were required to file in more than one state.
There are currently 24 states with some level of membership in the SSTA, but there is still much work to be done to simplify the sales tax landscape for companies that sell into multiple states. As a result, states have continued to enact other kinds of sales tax nexus laws in an effort to tax remote sellers.
This type of nexus threshold applies to a remote seller if a related party or affiliate has some kind of physical presence in the state. In that situation, the state attributes the affiliate’s nexus to the remote seller in order to require it to collect its sales tax. This type of nexus standard has been used broadly among most states for many years.
This type of sales tax nexus threshold applies to situations where a seller contracts with an in-state individual or company (a “referrer”) who refers potential customers to that seller by having them click on a link from the referrer’s web page to the seller’s web page.
Under these arrangements, the seller pays the referrer a commission that is contingent upon the referred sale. In these cases, the in-state referrer is considered a sales agent of the seller and gives the seller nexus there. New York was the first state to enact this type of law back in 2008, and now approximately 23 states take this approach.
This type of sales tax nexus threshold applies to sellers based on the storage of software (including internet cookies) upon its customers’ in-state computers, in conjunction with making a certain volume of sales to in-state purchasers. States argue that this satisfies Quill’s physical presence because the seller has property (the cookies) in the state. This is a relatively new and untested standard, and in 2017 just three states (Massachusetts, Ohio, and Rhode Island) took steps towards enacting this type of approach.
In Iowa, on May 5, 2018, both houses of the Legislature passed Senate File 2417, which affects both income and sales taxes. Though this bill had not been signed into law by Governor Kim Reynolds at the time of this writing, it is expected to be enacted. Not only would this bill impose an economic nexus standard upon remote sellers (in contradiction of the Quill case), it also included cookie nexus as an alternative theory for remote sellers, as if the state was hedging its bet on the outcome of Wayfair.
Marketplace provider nexus
This approach to sales tax nexus shifts the sales tax collection obligation from the retailer to the provider of an online marketplace, such as Amazon.com. Under this type of nexus standard, if the marketplace provider has nexus in a state, then it is required to collect that state’s sales tax on the sales that retailers make by using its marketplace. This is a relatively new standard, with the first state adopting it (Arizona) in 2016. Six states have enacted this kind of standard so far, and a marketplace provider nexus bill (S.B. 417) passed the Connecticut Senate on May 8 and the House on May 9.
Washington is the most recent state to enact a marketplace provider nexus standard, having adopted it as of January 1, 2018. Recognizing the complexity of this standard, on May 3, 2018, Washington established the Marketplace Fairness Penalty Reduction Program. Remote sellers that are not in compliance with Washington’s sales or business and occupation (B&O) taxes have until June 30, 2018, to take advantage of this program.
Even businesses that have had prior contact with the revenue department may still qualify, which is unique for most amnesty or voluntary disclosure agreement (VDA) programs. Two main benefits of this program include a limited look-back period (four years as opposed to seven years) and waiver of penalties (which could be as much as 39 percent of the tax owed). Remote sellers making sales into Washington should review their compliance and determine whether or not this program would be advantageous.
Marketplace seller nexus
This relatively new approach seeks to assert nexus over a retailer that is using a marketplace provider to perform fulfillment services for the sales that the retailer makes through the marketplace, such as companies that use the Fulfilled by Amazon service. The basis for this nexus assertion is that the seller’s inventory is being held in the state by the marketplace provider.
From August through November 2018, the Multistate Tax Commission (MTC) coordinated a sales and income tax amnesty program for 25 states, available to retailers that owned inventory located in a marketplace provider’s warehouse. Participating states generally took the position that nonparticipating but eligible retailers were subject to audit. In fact, during the amnesty program a Massachusetts court ordered Amazon to provide records of retailers whose inventory it held in the state.
Though Indiana did not participate in the MTC’s program, it recently established its own one-time voluntary disclosure initiative for remote sellers having inventory in Indiana warehouses. Until December 31, 2018, sellers that are out of compliance with Indiana law can use this program to take advantage of a limited look-back period and waived penalties.
To qualify, the applicant must:
- Have inventory located in a third-party Indiana warehouse and make sales to Indiana customers
- Never have filed tax returns in Indiana for the tax type in question
- Never have registered in Indiana for the tax type in question
- And never have been audited or contacted by the revenue department about the tax type in question
While these benefits are typical of most states’ VDA programs, such as the one offered by Ohio, the limited look-back period for this program is only one full calendar year plus the current period. Typically, states will look back at least three years, even under a VDA or amnesty program. As a result, retailers should carefully weigh which of Indiana’s programs may be the most beneficial for reporting uncollected sales tax.
Use tax notice and reporting
This relatively new approach does not assert nexus over a remote seller with no physical presence in a state, in acknowledgement of the current Quill standard. Instead, it imposes obligations on remote sellers to send notifications to its purchasers (and corresponding notifications to the state of Colorado) of their obligations to self-assess use tax on their purchases, or face potentially hefty penalties. Twelve states currently use this type of approach, including Colorado, whose regime entails significant penalties for noncompliance.
This approach to nexus directly contradicts the Quill case and simply asserts nexus over remote sellers based on a minimum threshold of in-state sales. Alabama and South Dakota were the first states to enact this type of standard back in 2016, through what is now commonly known as a “Kill Quill Bill” that was designed specifically to bring a U.S. Supreme Court challenge to the Quill case.
Since that time, 15 additional states have enacted some type of economic nexus standard for sales tax purposes. As noted above, on May 5, 2018, Iowa’s legislature passed an economic nexus standard that requires remote sellers to collect sales tax if they make either at least $100,000 in Iowa sales or 200 separate transactions into Iowa in a calendar year.
Hybrid collection/reporting regimes
Rather than merely asserting nexus over remote sellers whose in-state sales exceed certain thresholds, some states are beginning to provide these sellers the option to provide Colorado-style use tax notice and reporting. Washington was the first state to adopt this approach, effective January 1, 2018, followed by Pennsylvania on March 1, 2018. Georgia most recently adopted this approach via House Bill 61, signed into law on May 3, 2018.
Presumably, even if Quill is upheld, these states will still enforce their economic nexus laws because they do not necessarily require these sellers to collect their tax. Rather, a seller could comply with the law by reporting use tax transactions. It’s widely thought that if Quill is not overturned, states will pass more of these use tax reporting statutes to assist with the collection of unpaid use tax. By including this as an option in its law, these states saved the time and effort of passing additional legislation should Quill be upheld.
South Dakota v. Wayfair
On April 17, 2018, the United States Supreme Court heard oral arguments for South Dakota v. Wayfair, Inc., et al (Docket No. 17-459). South Dakota argued that Quill is outdated in light of the digital economy and popularity of online shopping. Wayfair, however, argues that requiring companies to register in states where they do not have a physical presence is extremely burdensome, especially on smaller businesses.
For a more detailed discussion regarding this case, please see our previous article, U.S. Supreme Court Will Revisit Landmark Sales Tax Nexus Decision.
During the arguments, the court raised a number of concerns with overturning Quill, such as:
Burden on remote sellers
Briefs filed on each side of the case included drastically different compliance cost estimates, so it was difficult for the court to quantify what this burden may cost, especially for smaller sellers.
Congress may be better equipped to handle
Congress hasn’t acted in the 26 years since Quill, despite being invited to in the decision. Both the Marketplace Fairness Act and Remote Transactions Parity Act of 2017 bills have been repeatedly introduced before Congress, but neither have been enacted.
Quill has been the bright-line threshold for businesses for nearly three decades. The court generally defers to prior precedent, although if a case was wrongly decided, it is its job to overturn it.
There’s no way to accurately predict how the court will decide, but the decision is expected sometime in June. Regardless of the outcome, remote sellers will surely be impacted. If decided in favor of South Dakota, the court will permit enforcement of South Dakota’s economic nexus law, and likely all other similar laws throughout the country.
This will require remote sellers to quickly learn all of the different thresholds and requirements throughout the states, and begin collecting sales tax in states where required. If decided in favor of Wayfair, even though economic nexus laws likely wouldn’t be enforceable, states have other requirements such as use tax reporting, as well as alternative nexus theories such as cookie nexus, and states without one or more of these standards may rapidly enact them.
Prepare for the Wayfair outcome
- If Quill is overturned, are you prepared to collect and remit sales tax in states where your remote sales exceed a statutory economic nexus threshold?
- Alternatively, are you prepared to comply with states’ use tax reporting laws, which generally require real-time notification to the purchaser, summary reports to the state, and summary reports to the purchaser?
Evaluate, quantify, and mitigate potential sales and use tax risks
- States are becoming more and more aggressive in enforcing compliance with out-of-state sellers.
- Review your footprint throughout the country to determine whether or not you should be collecting sales tax in states where you currently are not.
How we can help
CLA’s state and local tax professionals are actively monitoring developments that affect remote sellers. We can help you determine if you have any sales tax obligations in the different states that you sell into. In addition, if you are required to register with a state and collect its sales tax, we offer a complete sales tax outsourcing solution to manage your sales tax compliance obligations from start to finish.