Thirty-four states have announced they will enforce rules based on the precedent established in the South Dakota v. Wayfair Supreme Court decision. The vast majority have adopted the South Dakota standard approved in the ruling of $100,000 in sales or 200 transactions. However, many states have special rules that must be taken into account as vendors begin to assess their sales in each state and plan for registration and collection.
Threshold Comparisons Among States
The Wayfair case famously left the central question of the South Dakota statute’s constitutionality to be answered by the lower courts. However, because South Dakota’s statute was non-retroactive and contained a small-seller safe harbor, and as South Dakota is a member of the Streamlined Sales Tax Governing Board (SSUTA), the court suggested the statute was likely constitutional.
Most states have taken that answer to mean they can adopt the same standard as South Dakota. However, most states have a larger market and more complex sales tax systems, so it’s not clear whether the same standards will work. Some states have indicated they believe larger states should adopt higher thresholds. For example, Texas has adopted a $500,000 sales threshold. California initially considered a $500,000 threshold, abandoned that idea and adopted the standard $100,000 threshold, but is now reconsidering adopting the $500,000 threshold.
It seems reasonable that larger states should adopt higher thresholds, as the same compliance burden on a seller represents a smaller benefit to a large state as a percentage of collections than it does to a small state. Comparing nationwide sales by market, a vendor making $100,000 in sales in California projects out to nationwide sales of just over $700,000. A vendor making $100,000 of sales in South Dakota projects out to nationwide sales of over $38 million, meaning a smaller vendor would hit California’s $100,000 threshold sooner than South Dakota’s similar standard.
More critically, states with more complex sales tax systems than South Dakota’s have adopted the same set of thresholds as South Dakota, and appear to have concluded that they’re sufficiently simplified and may adopt economic nexus. It’s not yet clear if that’s true.
The court appears to have indicated a state’s need for revenue must be balanced against a vendor’s right to operate in interstate commerce without undue burdens. A burden is undue—and therefore constitutionally suspect—if the burden on the vendor in comparison to the benefit to the state is overly tilted in favor of the state. This reading of the case would suggest states with more complex sales tax systems than South Dakota are still free to adopt economic nexus collection requirements, but they must exclude a larger proportion of sellers, meaning they must adopt a higher threshold. It seems clear that the largest internet vendors, making millions or tens or hundreds of millions of dollars of sales into a state can be required to comply with the most complex sales tax systems. But, by the same token, it seems equally clear that a seller who barely crosses the threshold in South Dakota can’t be expected to be able to comply with more complicated sales tax systems.
With all of the changes and activity, as well as the possibility of future court decisions regarding the legality of these different approaches, it can be difficult to understand and navigate all of the changes and requirements of the post-Wayfair world. It’s worth taking a step back to examine some of the major outstanding questions, now that we have an idea of some state responses to Wayfair.
We will look at three main questions:
- What are the primary considerations for sellers?
- What effect does this have on marketplace sales?
- Should states larger or more complex than South Dakota adopt higher thresholds?
When evaluating their obligation to collect, sellers should begin by considering two broad questions relating to the thresholds.
First, where a state appears to present two different collection dates, which date is a vendor obligated to follow? For example, the state of Kentucky’s statute required collection on January 1, 2018, but the state’s guidance requires collection from October 1, 2018. This disconnect is a result of the Wayfair case ultimately suggesting retroactive enforcement of a state’s collection obligation could be problematic. Because the Quill physical presence standard was still in effect until June 21, 2018, Kentucky isn’t requiring collection until October 1, 2018.
In general, vendors can safely rely on guidance issued by administrative agencies because of the Supreme Court’s admonition to the states against retroactive enforcement. Interestingly, this issue may be present again in New York’s recent and apparently immediate collection requirement implemented in early January of 2019. It remains to be seen if New York will provide further clarification.
The next consideration involves states that had reporting requirements before Wayfair. What’s the interaction between these reporting requirements and the newly-enacted collection requirements? Some states, such as Oklahoma and Rhode Island, had previously required either collection or reporting, and have explicitly not adopted a collection requirement on the theory that a retailer must comply with one or the other. However, other states that had reporting statutes before Wayfair—such as Alabama and Colorado—have issued guidance requiring collection. In these states, reporting would only be an option below the threshold amount or prior to the threshold implementation date.
Even if a seller knows that a state has adopted a set of thresholds and what those thresholds are, it’s still left with a number of critical questions related to its obligation to collect, before it can even consider the registration, collection, and remittance process.
Other questions to consider include:
- Over what period should sales be measured, and what sales and transaction thresholds apply?
- Does the vendor look backwards from the date of implementation to determine if it meets the threshold, or is the measurement period itself prospective?
- Do taxable and exempt sales count toward the threshold, or is it specific to only taxable sales?
- Do sales made on both the vendor’s website and any marketplaces count toward the threshold, or is the threshold only applicable to sales made on the vendor’s website?
- Does a monthly recurring charge count as one transaction per year, or twelve?
Determination and Measurement Dates
The other major consideration for vendors in the post-Wayfair sales tax landscape is the measurement date for the states it does business in. The measurement date refers to the amount of time a vendor should track sales to determine if it meets the threshold, and is particularly important for vendors close to the threshold. Most will likely either be far below or above the state thresholds, but for vendors near the threshold, it’s important to know how states measure the threshold.
So far, many states have directed sellers to measure by the prior calendar year. In other cases, the direction is to either measure by the prior calendar year or determine if the retailer reasonably expects to meet the threshold in the current year. For example, if a retailer enters a state midyear or late in the year and sales for the year exceed the threshold if extrapolated backwards over the year, it could reasonably expect to meet the threshold. Alternately, a few states have adopted a rolling 12-month measurement period, and several states don’t explicitly address the measurement period at all.
A retailer approaching a state’s threshold should determine when it will meet it, and plan accordingly. Most retailers won’t be able to wait until December 31 to see what their holiday sales are and then turn on collection on January 1, because the implementation burden will simply be too great in too short a period of time.
Projecting sales made over the busiest time of the year and planning to turn on or potentially turn off collection on the first of the year could be a safer strategy.
The 200 transaction threshold originally set forth in the Wayfair decision created some questions for sellers. It’s difficult to parse exactly what one transaction consists of. For instance, recurring billing could be treated as a single transaction or as multiple transactions. While these transactions represent multiple contacts by retailers with the state, they only represent a single sale to the vendor as every subsequent charge is automatic.
Small transactions could also create special considerations. A retailer making 200 individual sales of 99 cents into a state is only doing $200 of business in the state. Based on the Wayfair discussion, it seems unlikely this level of activity would trigger a collection responsibility. Where a retailer is likely to have to incur thousands of dollars of compliance costs to collect $20 in taxes, the Wayfair analysis suggests this would be an unconstitutional burden.
Similarly, if a retailer has 20 monthly subscriptions for an app for which it charges $2.99 a month, that amounts to less than $750 in sales. By contrast, if a retailer has 20 monthly subscriptions for wine delivery at $299 a month, that amounts to almost $75,000 in sales. A state is unlikely to assert the former meets the 200 transactions threshold, but far more likely to assert that the latter does.
Interestingly, some states appear to have recognized the number of transactions threshold as problematic. Some states are now considering abandoning the 200 transactions threshold and asserting only a dollar threshold.
Most states have asserted that all sales, both taxable and exempt, count toward the threshold. Taxable or not, a sale represents the same level of vendor contact with the state. And, although an exempt sale doesn’t necessarily mean a tax collection obligation, a seller must still determine if the sale is exempt. As a result, it seems unlikely that states will distinguish between taxable sales and exempt sales when measuring the threshold. However, a few states—such as Illinois and possibly Nevada, which currently measure by retail sales—have indicated they will only count taxable sales toward their thresholds.
When a business is losing sales, it must decide if and how it should stop collecting sales tax if it falls below the threshold. This issue isn’t new to the post-Wayfair world, because the termination of the physical presence nexus raised similar questions. In general, state guidance typically says retailers must continue to collect for a period of time—usually one year—after the termination of the physical presence. Here, the rule will presumably operate similarly.
Whether a state’s lookback period is a rolling 12 months or a calendar year, once that period passes and a retailer’s sales are below the relevant threshold, the retailer may deregister and stop collecting. However, most retailers will be better served to evaluate whether there are truly fundamental changes in their market that are driving their sales down below the threshold, or if they expect to recover that market share. The transactional costs of registering and deregistering, as well as turning collection off and on again, are likely to far exceed any market benefit that could be gained from not collecting.
Sales made by retailers on marketplaces are more difficult to account for. A marketplace refers to the electronic marketplaces many retailers use to advertise and sell their goods and services. The role of the marketplaces themselves can vary. In some arrangements, the marketplace takes possession of the inventory, advertises, sells, and ships the goods, and then simply remits the proceeds—minus fees—back to the retailer. Other marketplaces are more about advertising and listing goods with everything related to the sale actually done by the retailer.
Few states have explicitly addressed if these sales count toward the thresholds for the retailer; what little guidance exists appears to point in both directions. The tax itself can only be collected by the marketplace or the retailer, not both, but there’s no theoretical reason why the sale couldn’t be counted twice for purposes of the threshold. It represents market activity in the state by both parties, which means it would appear to count toward both thresholds.
Some marketplaces are little more than advertising spaces where vendors link to their goods and websites. These marketplaces are often compensated on a per-click basis. In an attempt to be sweeping, some state definitions of marketplaces include these kinds of advertising marketplaces. However, any attempt to place the collection burden on these marketplaces raises significant practical and constitutional questions.
This kind of marketplace is unlikely to know whether a sale has actually taken place. And even if it does, because it doesn’t operate or even link to the payment processor, it’s unlikely to know the amount of the sale, and therefore the amount of sales tax. In addition to a lack of certainty on the amount of tax due, this kind of marketplace is unlikely to have any mechanism by which to collect the tax. Unless the marketplace participates in the payment, it will have no way to actually collect the tax due from the customer.
Similar to advertising marketplaces, payment processors have been suggested as state sales tax collection agents, usually by the states themselves, and they face many of the same issues as marketplaces. However, while payment processors know when a transaction is complete, as well as the amount of the transaction—meaning they don’t face the same risk of over-collection—they still face other significant risks.
For example, payment processors don’t know whether there are nontaxable elements included in a transaction, such as separately stated shipping, installation, or maintenance. These services, when part of a purchase of a taxable good, are taxable in some states but exempt in others. A payment processor may not even know what the underlying product or service is, much less whether it’s taxable or not.
Nexus Laws Before Wayfair
Before the Wayfair decision, several states attempted to circumvent the physical presence nexus standard articulated in Quill v. North Dakota with laws such as the Amazon affiliate nexus law. States have expanded the approach by adopting statutes presuming nexus for virtually any activity either affiliated with or paid for by the seller. This could include repair, installation, non-common carrier delivery, or any other activity associated with the seller’s ability to make the sale.
Remote Seller Reporting Requirements
In 2010, Colorado came up with an approach that avoided the collection requirement entirely, instead requiring remote sellers to report their sales rather than collect tax. The retail landscape has been further challenged by the adoption of this approach in multiple states after Colorado won a ruling on the constitutionality of this approach. This reporting must be done to both to the remote seller’s customer to aid them in paying the tax directly, and the revenue department of the state in which the customer lives, in order to ensure the tax is paid by the consumer.
Another strategy used by Massachusetts and Ohio to circumvent the previous physical standard nexus is known as a cookie nexus. This novel approach attempted to expand the notion of physical presence by asserting that the presence of apps on customers’ phones or cookies on their computers constituted a physical presence for vendors.
In both states, this approach was paired with a $500,000 sales threshold, so these rules are combinations of an expanded physical presence with an economic presence minimum. These have largely been rendered obsolete by the court’s decision in Wayfair. However, they still represent compliance burdens vendors must account for.
Streamlined Sales and Use Tax Agreement
A major factor in the Wayfair case was South Dakota’s membership in the Streamlined Sales and Use Tax Agreement (SSUTA). This pre-Wayfair agreement was an attempt to simplify the sales tax collection systems for vendors and consumers. This creates potential complications, as many of the states that have formally announced a remote seller collection requirement under Wayfair aren’t full members of the SSUTA, and one—Colorado—is completely nonparticipating.
This flurry of activity puts national retailers in a difficult position. It’s not clear if the collection requirements adopted by non-SSUTA states meet the requirements of Wayfair. But, as the risk of non-collection in those states is likely to be prohibitively high, remote vendors may have to incur the costs of compliance with these more complex state tax regimes.
The presence of reporting requirements or cookie nexus statutes in other states may motivate a remote vendor to simply turn on collection of all states’ sales taxes, even when not obligated to do so. While it may seem like a good strategy—as the vendor is only collecting tax that’s already acknowledged to be due—the costs of compliance are high, and the benefits for retailers below the threshold may be low.
We’re Here to Help
To learn more about the implications of Wayfair for vendors that do business across state lines, contact your Moss Adams professional.