The New Reality of Collecting Tax on Online Sales
For many years, when startups asked me to whether they needed to collect sales tax for online sales to their out-of-state customers, I could say with a high degree of confidence that the answer, for the most part, was “no”. That is no longer the case. The U.S. Supreme Court’s decision in South Dakota v. Wayfair issued last June changed the landscape on online sales tax collection and I find myself having to give the much less satisfactory answer of “maybe”. As advisors and small businesses become more acquainted with this new legal reality, here’s what you should know:
What was the law before the Wayfair case?
Under the Constitution, Congress has the primary power to regulate interstate commerce. However, the court has long recognized that in some instances, the power to regulate commerce is shared by both individual states and Congress, such as in the case of taxing sales on goods and services.
In the case of sales taxes, the court had ruled that states may tax interstate commerce so long as the tax applies to an activity with a substantial nexus with the taxing state; is fairly apportioned; does not discriminate against interstate commerce; and is fairly related to the services the state provides.
“Substantial nexus” refers to the depth or quality of connection that an out-of-state seller has with a particular state. Historically, the Supreme Court defined “substantial nexus” as requiring a physical presence, such as offices, employees or warehouses in a particular state. Out-of-state sellers who merely mailed or shipped goods to customers into a taxing state, without maintaining a physical presence, had no responsibility to collect and remit sales tax to a consumer’s state.
Until Wayfair, physical presence had been the accepted standard for determining substantial nexus with a state for taxing purposes.
What happened in the Wayfair case?
South Dakota, concerned about its eroding sales tax base, enacted a law requiring online retailers to collect and remit sales tax “as if the seller had a physical presence in the state,” The law covers only those online retailers that, on an annual basis, deliver more than $100,000 of goods or services into the state or engage in 200 or more separate transactions for the delivery of goods or services there.
South Dakota took the position that online retailers doing significant amounts of business with its residents have a substantial nexus with the state even if they don’t have a physical presence there. Some 41 states, two territories and the District of Columbia filed supporting briefs agreeing with South Dakota’s position. The court ultimately agreed and overruled the previous cases that required physical presence in order for states to impose sales tax on online sales.
Where do things stand now?
Currently, 37 states have adopted some form of law requiring the collection of sales tax for online sales transactions with residents of their state, most of which are currently in effect or will go into effect shortly. Many of those laws have the same sort small business exemption as adopted by South Dakota but the minimal dollar thresholds and transaction thresholds can vary. Keep in mind that these thresholds can be met either by total sales volume or a minimum number of transactions in a state. This means that even if you sell something fairly inexpensive but you sell a lot of it in another state, you may meet the annual minimum number of transactions threshold and need to start collecting and remitting sales tax for that state.
What’s happening in New Hampshire?
In an effort to provide protections for New Hampshire businesses that may be caught up in the regulatory uncertainty created by Wayfair, Governor Sununu called a special legislative session with the goal of crafting legislation that creates permissible and legal hurdles to prevent other states from trying to impose the collection of sales taxes on New Hampshire businesses.
This well-intended action raises two potential impacts of such legislation to consider:
First, many state tax laws allow the taxing authority to impose penalties and interest per day for being late on sales tax remission.
If an out-of-state taxing authority ultimately makes its way through the New Hampshire legal hurdles and prevails, will that delay have created an even bigger fine owed by the New Hampshire business, based on per-day penalties and interest?
Second, failure to collect a sales tax may be construed as a criminal act of tax fraud under some state laws.
If the New Hampshire enforcement process is too onerous, will a taxing authority look to criminal enforcement procedures that could result in executives of that business having criminal warrants in other states?
The burden for small online retailers to stay informed as new laws and regulations going into effect and to adjust their business practices accordingly is real but is still evolving. There are a number of software solutions on the market that promote their products as simplifying sales tax administration for e-commerce businesses. Costs of such software solutions can range from $10 to $50 per month and may provide useful assistance to businesses.
Still, startups and small business owners should continue to have regular conversations with their tax and legal advisors to stay informed as business owners will ultimately be responsible for updating their operational strategies as a result of the Wayfair decision.