The Wayfair Decision — Additional Sales Tax Collection and Reporting for Out-of-State Sales May Be Required
The Supreme Court’s decision in South Dakota v. Wayfair, Inc. (“Wayfair”) gives rise to a new era and enhanced complexities with respect to sales tax compliance. In this June 2018 landmark case, the Supreme Court ruled that states can require remote sellers to collect and remit the applicable sales or use tax on sales delivered to locations within their state, regardless of whether the seller has a physical presence in the state. The Wayfair decision clearly undermines decades of precedent with prior state tax cases that supported and required a "physical presence" standard.
The full implications of this ruling are not fully understood, but it is clear that it will likely impact more than just large Internet retailers; implications will be felt by small businesses, entrepreneurs, and consumers, as well.
Generally, states that impose sales tax require sellers with "sufficient contact" for purpose of "sales tax nexus" with the state to collect and remit state and local sales tax on remote sales. At the heart of the Wayfair decision is a redefinition of what is deemed to be "sufficient contact" for purposes of sales tax nexus. Prior to the Wayfair decision, sellers were required to have a physical presence (property and/or payroll) in the state before the duty to collect and remit sales tax could apply. The physical presence requirement was affirmed back in 1992 by the Supreme Court in Quill Corp. v. North Dakota ("Quill"). While Quill was the law until June 2018, over the years, several states enacted laws that further expand what constitutes physical presence.
States that impose a sales tax invariably impose a corresponding use tax that is imposed on consumers in cases where the seller has not collected sales tax. Although Internet purchases are not exempt from sales tax, remote sellers often do not have physical presence in most of the states in which they have sales and were not required to collect and remit the tax in those states. Coupled with the fact that consumers often do not remit use tax to their state of residence for out-of-state purchases, remote sellers enjoyed a competitive edge over sellers required to collect and remit sales tax.
The Wayfair decision recognized the fact that states do not receive sales/use tax from many Internet-based sales and found the physical presence requirement unworkable. Thus, the Supreme Court eliminated the physical presence requirement and ruled that the correct standard in determining the constitutionality of a state sales tax law is whether the tax applies to an activity that has "substantial nexus" (sometimes referred to as "economic nexus") with the taxing state.
In Wayfair, the Court found that the South Dakota law contained adequate safeguards as it expressly prohibited retroactive liability and required remote sellers to collect sales tax only where the seller had at least:
a. $100,000 in sales to South Dakota customers in a year, or
b. 200 sales transactions to South Dakota customers in a year.
Although the Court ruled that South Dakota law met the "substantial nexus" requirement and thus was constitutional, it did not further define the term. Thus, the Wayfair decision serves as a guide for other states attempting to broaden their tax base and as a warning to remote sellers wishing to retain a competitive advantage by not collecting sales tax.
For an existing business, the decision to register, report and comply as the states reposition their tax reporting requirements to fit Wayfair is extremely important, but not always easy to understand. Many states have already passed legislation to address how remote sellers should comply with their updated sales tax regulations after Wayfair, but those new rules can create problems when it potentially becomes necessary for a business to report.
Given the number of decisions to be made and processes to be implemented, taxpayers will need as much lead time as possible to become sales tax compliant so it is extremely important to warn and advise clients that may be impacted.
Risk Management GuidanceCAMICO strongly recommends that policyholders consider the following risk management steps. This list is not meant to be all-inclusive.
- Send a notification letter to business clients that may be impacted by the Wayfair case to "warn and advise" of potential sales tax collection and remittance requirements. The letter should include advice and encourage clients to contact the firm if they have out-of-state sales. For defensive documentation purposes, CAMICO recommends maintaining and retaining a list detailing to whom this letter was sent. Refer to CAMICO’s sample client notification letter, titled "Business Client Notification Letter — Out-of-State Sales (Wayfair Decision)," which is available to download from the Members-Only Site under Knowledge Tree —> CAMICO Publications —> IMPACT —> 2018 —> IMPACT 113 or from the Engagement Letter Resource Center in the list of "Other Tax Letters" within the Tax Letters section.
- For all tax engagements, CAMICO recommends that firms have an annual engagement letter in place detailing the scope and limits of the specific engagement including language that any additional services will be covered under a separate engagement letter. CAMICO recommends that firms include language in their tax engagement letter confirming that clients will furnish all information necessary to identify all states in which the client does business or derives income and the extent of business operations in each relevant state.
- If the firm is engaged to prepare sales tax returns and/or engaged to assess the client’s potential sales tax exposure, CAMICO recommends that the firm have an engagement letter in place listing the specific states including language that the client is confirming that the states listed include all states from which the client derives sales. As with all engagements, other than audits, CAMICO strongly recommends firms include language in engagement letters that the firm will not audit or verify data submitted. Refer to CAMICO’s sample engagement letter, titled "Tax Consulting - Sales and Use Tax Nexus - Wayfair," which is available to download from the Members-Only Site under Knowledge Tree —> CAMICO Publications —> IMPACT —> 2018 —> IMPACT 113 or from the Engagement Letter Resource Center in the list of "Other Tax Letters" within the Tax Letters section.
Additional information on the Wayfair decision can be found at: