By William R. Stromsem, J.D., CPA, Assistant Professor, Department of Accountancy, George Washington University School of Business
With the pandemic came major shifts in state sales and income tax nexus rules. States needed to make up for lost revenue from individual and business taxes during a period of lower economic activity. At the same time, states needed more money to cover increased health care and unemployment costs. With budget needs and the South Dakota v. Wayfair Supreme Court decision (585 U.S.____(2018), the states have aggressively changed nexus laws to apply to more out-of-state businesses. Texas practitioners need to keep up to date on developments to be able to advise clients on the changing nexus rules for online sales.
Sales Tax Nexus
The Supreme Court’s Wayfair decision blessed South Dakota’s assertion of “economic nexus” for sales tax purposes, allowing a state to tax sales without the previously required physical presence by prior law under the Supreme Court’s decision in Quill v. North Dakota, 504 U.S. 298 (1992). The opportunity to tax out-of-state vendors was particularly appealing to states as consumers shifted to online purchases to avoid in-person shopping during the pandemic. Today, just three years after the Wayfair decision, all states that collect sales taxes have enacted economic nexus statutes.
In the Wayfair case, the Court approved South Dakota nexus statute that required out-of-state vendors to collect and remit sales taxes if they had more than $100,000 in sales or 200 or more separate transactions in the state. This could be burdensome on small businesses that have a small number of low-dollar sales in a state; e.g., 500 widgets sold for $5 at a 6% sales tax rate would require the vendor to collect and remit $150 in taxes. The cost to comply might be 10 times that figure and smaller businesses might be tempted to skip the tax, particularly because states do not have the resources to pursue them. However, not filing a return may result in penalties, an open statute of limitation and ethical issues for the business and its tax professional. And the issue could be much larger if there are omitted taxes in other states, to say nothing of the approximately 10,000 local sales tax jurisdictions.
Compliance can be complex, with some states modifying the Supreme Court-blessed Wayfair nexus standard. Some states have modified the South Dakota rules to require both $100,000 and 200 sales or have raised one threshold or the other. States also have different requirements for registration if there is a sales tax liability, and the frequency and due dates vary from state to state. To further increase complexity, the laws are constantly changing and there is no software that handles sales taxes with just a few clicks. A good guide for state sales tax nexus rules that is frequently updated is provided by the Sales Tax Institute.
Income Tax Nexus
Over 20 states have enacted economic nexus statutes for business income taxes after the Wayfair decision. However, Public Law 86-272 (15 USC 381-384), which limits states’ income tax power in interstate commerce is still in place, along with court decisions construing it. Generally, this federal statute permits certain limited solicitation activities within a state without subjecting the seller to a state’s income taxes. With new economic nexus statutes in place, states may increasingly challenge businesses that claim they are exempt under P.L. 86-272. And courts may interpret P.L. 86-272 narrowly as potentially out of touch with the e-commerce world as the 1992 Quill sales tax case that the Supreme Court overturned. Also, the statute does not protect certain types of sales; e.g., sales of tangible personal property where services are provided or sales of intangibles.
To further complicate matters, the online delivery of services creates confusion to the taxpayer and the state. What is being sold via online delivery? Is it tangible personal property subject to the P.L. 86-272 limitations or does the state now define it as the sale of a service or intangible?
In addition, franchise taxes may be impacted by economic nexus statutes, as not all the states have added a quantitative measure to aid in defining “doing business” in the state. As a franchise tax, the P.L. 86-272 provisions are not applicable and the business may become subject to franchise tax in more states without any physical presence.
In any case, practitioners and their clients will have to wrestle with sourcing e-commerce revenues and expenses to apportion them to particular states. Practitioners need to be able to advise their clients about online sales as the law develops further. If there were a bright side, it would be that some states have provided rules for allocation and apportionment in their economic nexus statutes.