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State Tax Earthquake: U.S. Supreme Court Upends Sales Tax

by Mark Hugh, CPA | Jun 22, 2018
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On June 21, 2018, the U.S. Supreme Court issued its decision in the case South Dakota v. Wayfair Inc. The court overturned its own prior precedents that required an in-state physical presence before a seller was compelled to register and collect and remit the sales tax on all transactions with in-state residents. As a result, within the next year, all business organizations that sell sales taxable goods or services into any state with a sales tax will be required to register and remit the tax.

As a matter of background, 45 states and the District of Columbia impose a sales tax. In 1992, in Quill v. North Dakota, the U.S. Supreme Court held that an out-of-state seller must have a physical presence in a state, such as property, an employee, or an agent, before the state could compel the out-of-state seller to register and collect the sales tax from in-state residents. Since that time, Quill has been the target of much reverse engineering by states, who, for example, found physical presence using affiliates as agents, software cookies as property, or alternatively, imposing onerous use tax notification and reporting requirements on out-of-state sellers.

In 2016, South Dakota passed a law that directly challenged the physical presence test and Quill. South Dakota Senate Bill 106 required out of-state sellers with no physical presence to remit sales tax if annual South Dakota sales exceed $100,000, or 200 or more annual South Dakota transactions. The case was challenged in South Dakota court by internet sellers Wayfair, Overstock, and Newegg. The decision was accepted for review by the U.S. Supreme Court, and on June 21, 2018, the Court ruled in favor of South Dakota.

What does this mean for sellers with a multi-state presence?

  • It is prospective only, as the U.S. Supreme Court said its prior precedents, particularly Quill, were flawed in their interpretation of the Interstate Commerce Clause and over-ruled them.
  • Many states do not statutorily impose sales tax on out-of-state sellers with no physical presence, because the U.S. Supreme Court’s prior precedents, including Quill, did not allow it. Therefore, the states need to create legislation to impose the reporting and collection requirement. That means within a year, once all the state legislatures have met depending on their session cycles, certainly all states with sales taxes will statutorily impose the sales tax on all out-of-state sellers.
  • Some states already have these requirements in their statute, but the statutes note they will not be effective until the U.S. Supreme Court overrules prior precedents. That moment has occurred, and for these states it is immediate. However, it is reasonable to assume that these states will offer some type of administrative grace period.
  • It also means use tax notification requirements will disappear, because states no longer need them as a Quill workaround. They can now force the out-of-state seller to collect the tax regardless of physical presence.
  • Unless the U.S. Congress acts, states will have differing thresholds at which sales tax would need to be collected, considered a small business exception. South Dakota, who won the case, required tax be collected if annual South Dakota sales exceeded $100,000, or 200 annual transactions in the state. However, other states will be less generous, for example both Washington and Pennsylvania use a $10,000 annual threshold for use tax notification requirements and other forms of nexus, so it is highly likely those will be the thresholds for mandatory sales tax registration and compliance.
  • This does not reduce any contingent sales tax liabilities for prior periods, because those would have been based on other contacts and other nexus creating events, other than just in-state sales. During the registration process, if a truthful date is put when the entity began business or first had nexus with a state, that will surface the issue with the state taxing authority. Therefore, voluntarily disclosure programs, which limit prior years and eliminate penalties are still a viable option.
  • There is no direct impact of the decision on state income taxes or other state business activity taxes, such as gross receipt taxes. Quill was overturned on its analysis under the Commerce Clause of the U.S. Constitution, but Quill itself held that a seller did not need to have physical presence to be subject to income taxes or gross receipts taxes. Since Quill, this has led to many states adopting “economic nexus” principles for state income taxes or gross receipt tax purposes.

Download a copy of the Court’s decision here.

Mark Hugh headshotMark Hugh, CPA, is the principal of Mark Hugh PLLC. He is a CPA member of the Washington State Board of Accountancy. You can contact him at mark@markhugh.com.

Mark discusses the outcomes of this case in his State Tax Nexus and New Developments webcasts and live presentations. Learn more here.

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