Sales Tax – Physical Presence No Longer Required for Nexus

by Nathan E. Sharp, CPA, MST  | Selden Fox

On June 21, 2018, the Supreme Court issued their decision in the South Dakota v Wayfair, Inc. case. The Supreme Court ruled in favor of South Dakota, overruling the physical presence/substantial nexus requirement that was upheld in Quill v North Dakota. In the majority opinion, Justice Kennedy called the physical presence rule of Quill “unsound and incorrect” and that Quill “creates rather than resolves market distortions”. By overruling physical presence requirement from the Quill decision, the Supreme Court has altered what constitutes substantial presence for state sales tax nexus.

The old standard set forth in Quill v North Dakota was that a retailer was required to have substantial nexus with a state for that state to require them to withhold and remit sales tax. Physical presence was the widely accepted means of achieving substantial nexus. Now that the Supreme Court has determined that physical presence is not required for nexus, states can set economic thresholds that will achieve substantial nexus for retailers without physical presence.

The Case

South Dakota v Wayfair, Inc was a challenge by Wayfair, Inc. of South Dakota’s law that online retailers must collect and remit sales tax when making sales to South Dakota residents once the retailer meets certain sales thresholds whether or not they have a physical presence in the state. The law created an economic nexus standard based on sales thresholds. Wayfair, Inc. won two challenges in the South Dakota court’s (including the South Dakota Supreme Court) before the United States Supreme Court granted writ of certiorari.

Before the Supreme Court, South Dakota argued that States and brick-and-mortar stores were being hurt by the Quill decision and that it was harming interstate commerce. They also argued that the physical presence test outlined in Quill was outdated since the sales landscape has changed dramatically since 1992, when the case was decided. South Dakota, citing a National Conference of State Legislatures study performed through the University of Tennessee, estimated states lose $23 billion a year in potential revenue from out-of-state sales.

The three main concerns with overruling the Quill decision were:

• the possibility of states trying to retroactively collect sales tax,
• allowing states to determine the minimum contact requirements to be subject to a law to collect and remit sales tax, and
• the compliance costs for retailers.

The Opinion

In the majority opinion, Justice Kennedy ripped into the Quill Decision calling it “wrong on its own terms when it was decided in 1992, since then the Internet revolution has made its earlier error all the more egregious and harmful”. She likened it to a “judicially created tax shelter” that allowed states to limit their sales tax exposure by limiting their physical presence in a state. Justice Kennedy even attacked one of Wayfair’s advertising campaign’s that advertised they do not have to charge sales tax as a “subtle offer to assist in tax evasion”.

The main theme of the court’s opinion was that commerce has changed and that the physical presence standard set forth in the Quill decision was no longer a valid way to regulate interstate commerce and determine nexus. The rise of e-commerce and increase in online sales has led to a greater shortfall for states and does not create an even playing field between retailers. The Court cited that “In 1992, mail-order sales in the United States totaled $180 billion. Last year, e-commerce retail sales alone were estimated at $453.5 billion.”

The Court determined that “there is nothing unfair about requiring companies that avail themselves of the State’s benefits to bear and equal share of the burden of tax collection”. By online retailers not collecting sales tax, they are placing more of the burden on customers who buy from the brick-and-mortar retailers. The opinion offers that Wayfair advertises furnishing your dream home with their products but fails to consider that the “dream home assumes solvent state and local governments”. Online retailers rely on the infrastructure and services provided by the state and local governments then they should be required to do their part in collecting the sales tax to fund the governments.

The Fallout

Even though the decision to overturn Quill removes the physical presence requirement for nexus, the decision does not give states cart blanche when it comes to requiring sales tax collection. The opinion states that South Dakota has an acceptable framework in place that allowed the Supreme Court to rule in their favor. The specifics of the framework that was citied include:

1. retailers must exceed safe harbor thresholds to be subject to the law (i.e. exceed either $100,000 in sales or 200 transactions),
2. the law is not retroactive, and
3. South Dakota is a member of the Streamlined Sales and Use Tax Agreement (SSUTA). The SSUTA helps reduce administrative and compliance costs and even provides state-funded sales tax administration software.

When states are deciding on administration of their own sales tax nexus laws, they will have to take the framework of the South Dakota law into account to make sure their law can be upheld on a challenge in court. The framework in the South Dakota law, as outlined above, has a safe harbor threshold for small online retailers and, by being a member of the SSUTA, allows for easier compliance which leads to lower administrative costs for retailers to comply with the law.

Other states have already passed economic nexus type laws, and after this decision, more states are going to rush to pass similar laws. Connecticut was the most recent state to pass an economic nexus law with law that if the retailer surpasses either $250,000 in gross receipts or 200 transactions to Connecticut residents threshold. Before the decision, various states had passed laws or adopted regulations that apps or cookies can create nexus with a state. States will have to review the laws and regulations to make sure they comply with the framework established in South Dakota v Wayfair, Inc.

The next step for online retailers is to review their sales by state and compare the sales to the economic nexus thresholds to figure out which states there may be a compliance issue for sales tax. Retailers will need to determine how to register, the filing requirements, and deadlines for each state. Online retailers will also need to be cognizant of new nexus laws that are passed in states to stay on top of any potential compliance issues.

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 Nathan Sharp, CPA, MST