Physical presence may no longer be a necessary element of sales tax nexus, but that doesn’t mean issues in this area will be greatly simplified, according to Mark Friedlich, senior director of Tax & Accounting North America for Wolters Kluwer and a member of the Senate Finance Committee Chief Counsel’s Tax Advisory Committee on Tax Reform.
The effect of the Supreme Court’s recent decision in South Dakota v. Wayfair, which removed the physical presence test as a requirement to impose sales tax nexus, will have multiple implications for states and merchants alike, he suggested.
“The move from physical presence to an economic nexus standard is likely to generate $10 to $25 billion per year in additional revenue for the states,” he said. “It has an incredible impact, particularly on those states that don’t impose state and local income taxes, because it’s their primary source of tax revenue,” he said.
“And it will have incredible legs,” he added. “Once you eliminate the physical presence requirement, it opens up so many other things – such as corporate income tax, to which the new standard may eventually be extended to.”
“Right now there are 45 states that have various forms of sales tax laws,” Friedlich said. “Thirty-one of those have laws which will allow them to expand their tax collection beyond the physical presence standard. Sixteen of those states have laws similar to South Dakota. It’s a safe bet that if they follow the South Dakota model, they won’t be challenged by retailers or anybody else.”
“Those 16 states have very simple sales tax laws,” he observed. “They have single rates, they collect on only the state level, and they have a threshold that essentially protects the moms and pops from the imposition of sales tax obligation, which could effectively put them out of business. And of the states that don’t have a sales and use tax, virtually all of them have bills in their legislature which will be impacted by the Wayfair decision. For example, legislative leaders in Texas have told me that they are going to act quickly in passing legislation that is similar to South Dakota’s legislation.”
Many states already have these laws in place, according to Friedlich: “They haven’t been collecting because of Quill [the 1992 Supreme Court decision which set the physical presence test as a requirement for sales tax nexus]. It will take them months to get their collection systems up and running. This is not likely to take place until January 2019 for most jurisdictions.”
The potential retroactive application of the decision concerns Friedlich. “A key feature of the South Dakota law was that there would be no retroactive imposition of sales tax on ecommerce sellers,” he noted. “Justice Kennedy in the majority opinion did not deal directly with the issue of retroactivity, but did mention that retroactive application could presumably be dealt with by using existing tools and legal recourse. Theoretically, states can impose sales tax retroactively as far back as 10 years, but most states would not go in that direction, because it would be challenged.”
“It’s important to note that the Wayfair decision does not give states carte blanche by any means,” he said. “What they’ve done is eliminate the physical presence requirement and effectively authorized South Dakota’s economic presence standard. States that have an economic nexus standards law in place that are more complex than South Dakota’s, or that don’t provide protection for small businesses, are likely to simplify their statutes by following the South Dakota model. Doing so would effectively give them a free pass.”
“It’s a win for the states, particularly the smaller, less populous states with fewer brick-and-mortar retailers,” he said. “But states like New York and California, which have very complex statutes on the books, will have to make some significant changes to their laws. For example, there’s the requirement that sellers remit taxes to each and every locality as well as the state. That doesn’t meet the Wayfair standard, and retailers are likely to take the issue to court. There’s a lot more activity in this area which will have to take place in order to have the sales and use tax regimes in place that will meet the Wayfair standard and provide New York and California with that protection provided by the Wayfair holding to collect additional tax revenue in this area.”
Nevertheless, Friedlich foresees the possibility of congressional action to iron out the differences between the state and local taxing jurisdictions.
“The decision is a lightning rod. There will be a confusing hodgepodge of different state laws with which many retailers will need to comply. This will impose an undue burden on all sellers, large and small,” he said. “Congress will have to act, even though they haven’t done so for 26 years. It won’t happen before the November midterms, but there will be a lot of pressure for them to step in and simplify the sales tax collection and compliance process by providing one set of rates and standards that apply to all states that impose the sales tax.”
Gary Bingel, CPA, JD, partner-in-charge of state and local taxes at Top 100 Firm EisnerAmper, agreed.
“The court may have been trying to force congressional action, but it won’t happen until after midterms,” he said. “The impact of Wayfair could be greater than the Tax Cuts and Jobs Act, especially on small to medium-sized businesses that do interstate sales.”
“In theory there are impediments to the states running roughshod and saying, ‘Everyone has nexus everywhere,’ but the impediments are more theoretical than actual,” he said. “Smaller companies need money to fight in court, and may end up just giving in.”
Smaller companies will also take a big hit in technology expenses, according to Bingel: “A $20 million company with a 5 percent profit margin might have to pay several hundred thousand dollars to get their systems up and start complying. That’s a big hit.”
There could also be some consequences well beyond the sales tax arena, according to Bingel. “The decision solidifies economic nexus in the income tax area,” he said. “The decision may impact net worth and income type taxes.”
