The Supreme Court Rules on Sales Tax for Online Purchases
On June 21, 2018, the U.S. Supreme Court issued a decision in South Dakota v. Wayfair, overturning the physical presence standard for sales tax collection in a state. In a strongly worded opinion, the Court held that the former physical presence rule is an "unsound and incorrect" interpretation of the US Commerce Clause that has created unfair and unjust marketplace distortions favoring remote sellers and causing states to lose out on enormous amounts of tax revenue. The Court ruled that the correct standard in determining the constitutionality of a state tax law is whether the tax applies to an activity that has "substantial nexus" with the taxing state. In overturning its prior precedents, the Court determined that a physical presence is not required to meet the “substantial nexus” requirement laid out in previous cases.
The previous test for whether a state can require an out-of-state retailer to collect and remit sales tax has been physical presence in that state. An out-of-state seller used to had to have property, people, or some other physical connection with a state to be required to collect and remit that state’s sales tax. With the rise of the digital economy, states began to lose out on significant sales tax revenues because they were unable to tax online/internet sales under physical presence nexus standards.
Substantial nexus now exists when a taxpayer "avails itself of the substantial privilege of carrying on a business in that jurisdiction." It can be established on the basis of both "economic and virtual contacts" with a state. The Court not only overruled the physical presence standards but eviscerated the rule that physical presence is required for sales tax nexus.
What does this mean for my business?
While this decision clearly overturns the physical presence requirement for a state, it does not provide states carte blanche to enact or enforce all forms of economic nexus laws. However, we can expect to see a change in many states’ sales tax and income tax rules. Given the Court's conclusion that "physical presence is not necessary to create substantial nexus," this decision will impact other state taxes, such as income taxes, which could apply to the income of an entity conducting significant business activities in a state without having a physical presence there.
A number of states have also enacted detailed notice and reporting laws for out-of-state sellers. Often these are tied to a dollar threshold of taxable sales into the state. Many are cumbersome and impose stiff penalties for noncompliance. Colorado pioneered this approach, and a handful of other states (Georgia, Oklahoma, Pennsylvania, Rhode Island, and Washington) have notice and reporting requirements that are explicitly the default alternative to registering to collect and remit the tax under elective economic nexus provisions.
We will continue to monitor these developments for our clients. If you want to discuss further, please contact a Whittlesey advisor.
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