It’s Wayfair’s First Anniversary—New and Developing Trends
A look back over the past year and a sneak peek into the future.
The Supreme Court of the United States (SCOTUS) in Wayfair v South Dakota (Wayfair) on June 21, 2018 greatly expanded the reach of states across the country to impose sales and use tax obligations on retail and other businesses (so-called economic nexus). We predicted then that there would be many state tax changes to come as a result of Wayfair. Late June is the first anniversary of Wayfair–a good time not only to look back on key Wayfair-related developments, but also to look forward to key trends and activities we predict are likely to happen during the second half of 2019 and beyond.
Comment. The SCOTUS in Wayfair effectively gave the ok to states to tax sales by retailers and others across state lines even where the seller had no physical presence in that state. This was a seismic shift in the cost of doing business and regulatory compliance obligations for “sellers.”
1. Growth of Economic Nexus States
At this writing, 40 states and DC, have adopted some form of economic nexus with various start-collection dates.
Trend. We expect that by the end of 2019/early 2020, most or all of the remaining states will fall in the Wayfair-line. This means that businesses across the country are likely to be facing sales and use tax requirements in many more states than ever before. These new, often complex requirements include the obligation to register, to keep records, and to collect and remit sales and use taxes in many states in which they do not have a physical presence. These challenges will affect businesses, not only in the retail online and brick-and-mortar sector, but in other industries across business types and up and down the supply chain; including wholesale, manufacturing, distribution and construction.
2. Changes to the Wayfair-South Dakota economic nexus “model”
Most states that implemented an economic nexus standard soon after Wayfair basically cloned the South Dakota law that Wayfair reviewed. That law provided for a minimum level of economic activity (safe harbor) in the state before economic nexus would kick in. The elements of the safe harbor are: (1) the volume of business generated in the state and (2) the number of “transactions” in the state.
Trend: States are now adopting other models and will do so going forward. Most states will continue to put their own stamps on their economic nexus laws as their legislatures move to pass “economic nexus” laws. So, for example, both New York and California have raised the volume threshold to $500,000. In other states, additional conditions are added to the language of the statute. For example, Tennessee adds “and systematic solicitation of sales,” and Mississippi adds “systematic exploitation of the market.”
3. Alternative Nexus Laws Still on the Books
Before Wayfair, which “paved the way” for economic nexus, states aggressively stretched the limits of the meaning of the Quill “physical presence” test under several legal approaches currently on the books, including: (1) Click-thru Nexus, (2) Affiliate Nexus, (3) Marketplace Nexus, (4) Cookie Nexus and (5) Use Tax Notice/Reporting Law. [Link to our State Nexus map].
Trend: Many of these “alternative” laws attempting to get around the Quill physical-presence requirement are being challenged in court and so the prospects of continuing litigation and the accompanying drain on state legal resources may cast a shadow on the state’s primary objective—finding new sources of revenue to fund state programs. So, as more and more states adopt economic nexus, look for these alternative nexus statutes to continue to be reviewed by the applicable states to determine if the costs of retaining them are outweighed by the benefits (e.g, revenue) of keeping them.
That said, past-year liabilities under these laws then in effect will remain a real and continuing risk for businesses in all these states even though these laws may not be carried forward into the future.
4. Marketplace Facilitators Laws
Probably the most significant recent development in state tax collection efforts is the rise of marketplace facilitator laws. These laws shift the sales tax collection and remittance obligations from a third-party seller to the marketplace facilitator.
Putting the burden of sales and use tax compliance on the marketplace provider and not the seller, means that the states can reduce the cost of compliance while also collecting more revenue efficiently—a win-win for the states.
Trend. Marketplace facilitator state rules have not only survived Wayfair but in fact will continue to flourish. Although a rapidly moving target, at this writing, many states and DC already have statutes in place and many others have proposed legislation in process. We expect most states to have such laws in place by the end of 2019/early 2020.
Of course, sellers are not completely off the hook. They still have to track any sales that are not made on the marketplace facility. In addition, it remains their responsibility to ensure that compliance rules and requirements are being met. This can result in significant and unexpected expenses to hit businesses.
5. Use Tax Notice/Reporting Laws
Before the Wayfair decision, states like Washington, for example, were passing laws to get around the limitations of the physical presence standard. Those states were requiring remote vendors who did not collect sales tax from their customers to notify those customers in writing of the customer’s use tax reporting and payment responsibilities and also to report information on the customer’s purchase to the customer’s states directly—so-called “ratting” on their customers.
Trend. Washington state dropped its reporting law in October 2018 after their economic nexus law became effective, and other states may follow. Why? To the extent that the “collect or report” election would limit a state’s authority to require sales and use tax collection under economic nexus, the election provision might conflict with the change in federal law. Other states with these “Notice/Reporting” laws, may follow suit in similar fashion in 2019 and beyond.
6. Federal Legislation to Address Nexus in the States
Prior to the Wayfair decision, many thought that if the SCOTUS were to overturn Quill, that might spur Congress to act. The thinking was that if the SCOTUS got rid of the physical presence test, states would go back to a very minimum test that increases the likelihood that most would be taxable, significantly hurting “mom and pop” businesses. This taxable “expansion” might then raise enough Congressional concern expressed by taxpayers to result in federal legislation to “reign in the states.”
To be sure, every state is putting its own unique stamp on nexus in general, and economic nexus in particular, leading to a meteoric rise in state “guidance” on economic nexus. Whether the states need to be “reigned in” at this point is an open question. However, historically, Congress has been unwilling to get involved. All past attempts to legislate rules on a federal level have failed.
Bottom line-federal legislation creating sales and use tax uniformity among the states is dead in the water for the foreseeable future.
7. Wayfair Effect on State Income tax Nexus
Although the Wayfair case was technically only about use tax nexus–that physical presence is not required to have nexus–some commentators have continued to speculate on the potential impact that Wayfair might have on income tax nexus laws.
There are currently many states that have their own “law” confirming that an economic presence is sufficient to establish a substantial nexus for corporate income taxes. Some of these statutes provide that corporate income tax nexus is established when a corporation has a “substantial economic presence” or “significant economic presence.” The SCOTUS has never agreed to review these laws. We don’t expect either the SCOTUS or Congress to intervene here in the foreseeable future.
Trend: At a minimum, this unwillingness on the part of the SCOTUS to review these laws, coupled with the Wayfair holding that physical presence is not required to have nexus, have many believing that there is now tangible support for the constitutionality of these income tax nexus statutes. So, for states that do not currently have such income tax nexus laws, Wayfair may now provide an impetus for them to pass such laws in the future using the argument that they now have a constitutional “green light” to do so.
8. The Taxation of Cloud-Based Services will be on the increase, accelerated by the effects of Wayfair
More and more of the nation’s GNP comes from “services.” And yet, services are not taxed nearly as much as tangible personal property. However, according to the National Conference of State Legislatures (NCSL), the use of cloud services has greatly increased over the past decade, especially SAAS. As a result, states have taken a wide range of legislative and administrative positions regarding the way they characterize cloud-based services for purposes of applying sales and use tax rules.
Trend: A perfect storm of (1) the growth in cloud-based services, (2) the expansion of state taxing power brought about by Wayfair, and (3) the states’ needs to find new sources of revenue, almost certainly will lead to more taxation of cloud-based and other technology-related services in 2019 and beyond. What is not clear is whether that increased taxation will take the form of explicit statutes or administrative interpretation.
9. Businesses can expect a greater frequency of sales and use tax audits and more complexity and risk
Trend: Since businesses may now be subject to sales and use tax compliance obligations in more states, they can expect not only a greater number of audits, but those audits will become more aggressive and comprehensive as states struggle to find new resources to support growing demand for state-provided services, especially in infrastructure and higher education and health. An area that might not have been a particularly major focus of audits in the past—tax exemptions—will likely now become one. And state auditors can be expected to use more sophisticated tools and data analytics to get more “bang for the buck” in their audit targets. Businesses and their advisors need to take heed and increase their use of software and other technologies to ensure they accurately comply. The risks and potential cost of incorrect compliance is growing and can be a huge, unexpected financial burden on any business.
The Bottom Line: What should companies do to prepare for all these changes?
Businesses need to take steps to ensure that they reduce the substantial financial and other risks associated with failure to accurately comply with sales and use taxes rules:
- Understand their nexus profile — where do they have a sales and use tax obligation based on evolving standards, like economic nexus under Wayfair?
- Assess their capability to accurately, consistently and efficiently meet their obligations—sales and use tax competencies.
- Adopt and deploy best practices to ensure decreased risk and increased efficiency and productivity.