Two years ago, the Supreme Court in South Dakota v. Wayfair expanded the reach of states across the country to impose sales and use tax obligations on retail and other businesses. That’s if the businesses have a certain level of economic activity in a state (so-called economic nexus), no longer requiring a physical presence. As of now, 43 of the 45 states that have sales taxes have adopted the economic nexus standard. Florida and Missouri are the two holdouts. Sales tax bills are likely to be on the agendas of legislatures in both states when they return later this year.
As if that wasn’t enough bad news for retailers and other remote online sellers, shopping behavior changed dramatically as the COVID-19 pandemic spread across the U.S. and brick-and-mortar stores were ordered to close. Many retailers and others quickly adopted new strategies and established or greatly expanded their online selling presence and capabilities. Adobe Analytics recently reported that U.S. online sales increased 49 percent in April over the prior year.
Many consumer surveys show that the shift to online shopping will continue for at least as long as COVID-19 remains a threat. A survey of 1,200 consumers in late March 2020 by consulting firm Retail Systems Research found that 45 percent expected online shopping would be a necessity for them during the crisis. In fact, online shopping was growing before the pandemic hit. COVID-19 has accelerated that trend to super-speed mode.
Marketplace facilitator laws
Most states that impose general sales taxes have adopted marketplace facilitator laws. Florida, Kansas, Mississippi and Missouri are the states that have yet to pass such laws. Legislatures in each of these states are expected to introduce marketplace facilitator bills when they return to take advantage of the substantial revenue they desperately need.
The explosion in e-commerce since early March has resulted in a significant increase in online sales tax revenues in most states. State revenue officials have reported to me that sales tax collections from online sellers are up 30% and more in some states. An example of how seismic this change has been can be seen in North Dakota, where state sales taxes from remote sellers grew by more than 500 percent to $2.9 million, up from $475,000 just one year ago. The increase in online sales tax collections has been the one bright spot for state tax revenue collections during the pandemic.
What does all this mean to businesses?
As more and more online businesses sell into new states and municipalities and increase their sales into new markets so they can meet economic nexus thresholds, they become subject to sales tax collection and remittance rules in those states and municipalities. For many of these businesses, sales tax compliance hasn’t been a consideration or even something that has occurred to them as they focus on building a new business model or try to handle a surge in new business during the pandemic. The result is likely to be a significant increase in risk and unanticipated tax liability, particularly where sales tax compliance has been ignored or done inaccurately. Many of these remote sellers will be targets for state sales tax audits over the next 12 months. For many small businesses struggling to survive during the pandemic, failure to plan for sales tax liability could be the crowning blow to their very existence.
It is critical for businesses to consult with their tax advisers as soon as possible to make certain they are performing their due diligence to determine where they do have economic nexus for sales tax compliance purposes, registering in those states and properly complying with sales tax collection and remittance obligations.
What can we expect going forward?
States and municipalities across the nation are estimating they will need well over $1 trillion to shore up revenue shortfalls and expense increases, primarily related to the COVID-19 pandemic. Many have called their situations dire and have expressed the need for significant federal funding that has yet to come. In addition, a few states have begun to expand their tax reach using “economic nexus” for income tax purposes and attempting to expand the obligation for sales tax to digital advertising and services. Other states are considering the imposition of new taxes such as gross receipts taxes that go beyond digital advertising. We can expect states and municipalities to attempt to expand their state sales tax base as well as sales and use tax rates to help make up for revenue shortfalls.
In the first half of 2020, there were just over 150 sales tax rate changes at the municipality level, most of which were increases. There were no state sales tax changes. Many state legislatures cut short their sessions because of the pandemic. When they return, state sales tax rate increases are likely to be top of mind.
As government employees return to work, we will see a focus on enforcement as states and municipalities try to recoup lost tax revenues. Tax officials are likely to follow the money; remote selling into their states has greatly increased, resulting in many more sellers meeting the economic nexus thresholds and having the obligation to collect and remit sales tax. Many will be unaware of this or will have done so incorrectly. That’s fertile territory for tax auditors.
