The Wayfair case deals with a new law that imposes a sales tax collection responsibility solely due to reaching a certain level of sales or number of sales transactions within the current or preceding calendar year.
The States’ Struggles
For decades, states have lamented the loss of sales tax revenue as a result of residents largely buying from out-of-state companies. That concern has grown immensely due to an incredible surge of online shopping, causing more and more goods and services to be purchased without state sales tax. The reason for this is that the U.S. Supreme Court in Quill v. North Dakota (1992) prohibited a state from requiring an out-of-state company to collect their state’s sales tax unless that company had some sort of physical presence in the state (i.e. “the physical presence standard”).
Therefore, states have focused their efforts on trying to find grounds to classify online and other out-of-state businesses as having a local physical presence. States would target companies with a temporary presence of employees or independent representatives in the state, as well as those making deliveries in company-owned or leased vehicles. In addition, states could pursue businesses that owned inventory in the state or had relationships with related parties that are physically present in the state. Some states even required out-of-state companies with no physical presence in the state to be subject to excessive use tax notification reporting responsibilities in order to persuade more companies to voluntarily register for and collect their state’s sales taxes.
While states were aggressively trying to find ways to assert a physical presence on out-of-state companies, many of them also worked to try to overturn the “physical presence standard” established in Quill. This occurred when several states came together in March 2000 to standardize and simplify their state sales tax structures with the hope that either Congress – or ultimately the U.S. Supreme Court – would repeal the Quill physical presence standard. That goal was accomplished in June 2018 when the U.S. Supreme Court did just that in Wayfair v. South Dakota.
A Breakdown of Wayfair v. South Dakota
The South Dakota law at issue was similar to legislation that a few other states were beginning to enact. The South Dakota law required businesses to bear a sales tax collection responsibility upon reaching $100,000 worth of sales or 200 or more transactions regardless of any in-state physical presence. In its Wayfair decision, the U.S. Supreme Court not only rejected the Quill physical presence standard it previously established, but also identified three key factors that they felt would support upholding the South Dakota law as constitutional (the case was remanded and ultimately settled before an actual ruling was made by the U.S. Supreme Court on the constitutionality of the South Dakota law):
- The law was not imposed retroactively;
- The law provided for a small business exception ($100,000 sales/200 order thresholds);
- The South Dakota sales tax scheme was fairly straightforward (local sales taxes were administered by the state and South Dakota was a member of the streamlined sales tax program).
Since the Wayfair ruling, all but two states (Missouri and Florida) have adopted either through legislation or department guidance rules similar to the South Dakota law. For more details on the state’s economic nexus provisions, including their effective dates, thresholds and how the thresholds are applied (gross, retail or taxable sales), please see the streamlined sales tax remote seller guidelines chart at: https://www.streamlinedsalestax.org/for-businesses/remote-seller-faqs/remote-seller-state-guidance.
Exemption Certificate Maintenance More Essential Than Ever
On the surface, it seems that the Wayfair case would not have much impact, if any, on manufacturers or many distributors for two key reasons:
- Such companies often already have physical presence in other states through use of visiting sales personnel, independent representatives, deliveries in company-owned vehicles and/or ownership of consignment inventory; or
- Sales are typically exempt under the state’s resale exemption.
However, thanks to Wayfair most states are going to expect just about all out-of-state companies to register, collect and remit sales taxes to their states. It is therefore expected that the auditing of out-of-state companies is going to become much more aggressive. As a result, it is imperative that manufacturers and distributors, even if not making any taxable sales, secure timely and properly completed exemption certificates.
The resale exemption certificate should be for the state in which the goods are sourced and can be an exemption certificate from that state, a completed multistate tax commission certificate, or possibly a customized exemption certificate that meets all of the applicable state’s requirements Most often, sales are sourced to the state to which the goods are shipped, regardless of who arranges for the freight. However, that is not always the case—so it is important to make sure the property sourcing of the sale for both (the state the product is shipped from and the state the product is shipped to) is determined. If the sale is exempt for a different reason (for example, a customer is tax-exempt or a manufacturing exemption applies), then you’ll need to obtain the appropriate state’s exemption certificate. Some state exemption certificates expire after a set number of years, so it is also a good practice to periodically request new exemption certificates (for example, every three years).
Receiving timely and properly completed exemption certificates is key as many states will then consider the seller protected from an assessment on the sales covered by those certificates. If an exemption certificate is not procured on time, most states will allow additional time upon audit. However, in these situations, the certificates do undergo a more strict good faith standard review and, if a customer is no longer in business, then the sales may be treated as taxable even if it is generally understood that the sales were likely exempt sales for resale. Finally, make sure the exemption certificate is fully completed, signed (if required) and includes the appropriate state sales tax permit or account number (often the company’s FEIN# is not acceptable).
Sales Tax Registration and Filings May Be Required
Whether or not sales tax registration and collection responsibility exist depends on if, and to what extent, any taxable sales are made to the state and how that state imposes their filing thresholds. Please note, however, that states still consider any physical presence as likely creating a sales tax filing requirement. Thus, if there exists any physical presence in a state — and taxable sales are made — then it is likely that a sales tax registration and collection requirement exists (regardless of whether the economic Wayfair type nexus threshold for that state has been met).
As previously stated, states typically impose their Wayfair economic sales tax filing requirement thresholds by using either gross sales, retail sales or taxable sales. If the company’s sales are all exempt for resale, then it is only required to have a registration requirement in those states that use gross sales. Some such states (for example, Illinois and Wisconsin) will not require a sales tax registration as long as 100 percent of the company’s sales to that state are exempt.
For the states that require registration even when no taxable sales are made, there may be some flat dollar penalties that apply. Otherwise late filing/payment penalties are usually based on a percentage of the taxes owed so there would not be any significant penalties expected in situations where all sales are exempt.
If taxable sales are made through third-parties, like Amazon’s FBA program, then it’s possible no sales tax registration or filing requirements will exist — as many states have or will soon enforce requirements for marketplace facilitators to collect the sales taxes on the sales a company makes through their platform. However, states vary as to whether a company needs to include sales made through a marketplace facilitator in determining if they have a sales tax registration and filing requirement of their own.
Pay Close Attention to Sales Taxes Charged by Vendors
One of the results of the Wayfair decision is that many suppliers will likely collect sales taxes, whereas they had not done so before. At this point, suppliers may not yet be knowledgeable in other state sales tax rules or in how sales are properly sourced and could easily collect the wrong state and/or local sales tax. Therefore, manufacturers and distributors should review their purchases to make sure the correct state and local sales taxes are charged — and if exempt, that they are providing the proper exemption certificates to their suppliers.
Is Sales Tax Exposure an Issue? – Consider Voluntary Disclosure or Similar State Programs
If taxable sales are made or there is potential exposure due to noncompliance with state use tax notification reporting responsibilities, then you may want to consider reaching out anonymously with the states to make arrangements to voluntarily come forward and have penalties abated and (if applicable) provide for a limited lookback period.
From these developments, one thing is clear: sales tax rules are complicated and burdensome. Even the U.S. Supreme Court has somewhat admitted to this when stating, “These burdens may pose legitimate concerns in some instances, particularly for small businesses that make a small volume of sales to customers in many States. State taxes differ, not only in the rate imposed but also in the category of goods that are taxed and, sometimes, the relevant date of purchase” (Wayfair, page 21). Consequently, it is important for manufacturers and distributors to determine where they may have sales tax nexus, confirm if they are making any taxable sales, collect timely complete exemption certificates for all exempt sales and consider approaches to come forward and possibly begin filing sales tax returns if registration requirements exist.
Please contact us to discuss your specific case and how the Wayfair decision impacts your business.