Sales & Use Tax – Economic Nexus & Reporting Requirements
Author: Ken Taylor
The continued growth and popularity of e-commerce in recent years has undoubtedly caused states to lose out on a significant amount of sales tax revenue. As a result, there’s been much discussion regarding how states can combat this revenue loss. Four pieces of related legislation are currently under consideration in Congress. At the same time, states are pushing the constitutional boundaries of traditional sales and use tax nexus concepts. However, the fact remains that the current “law of the land” is still derived from the physical presence nexus standard laid out in the 1992 U.S. Supreme Court (the Court) case, Quill Corp. v. North Dakota (Quill v. ND).
The primary issue on appeal to the Court in Quill v. ND was whether North Dakota could require an out-of-state mail-order retailer with no physical presence in the state to collect use tax on goods purchased by North Dakota customers. The Court ruled that under the U.S. Constitution’s Commerce Clause, an out-of-state seller cannot be required to collect and remit sales tax on remote sales made to an in-state purchaser unless the seller has established a physical presence in the purchaser’s state. Significantly, the Court also indicated Congress has the authority to overrule the Court’s decision in regard to the Commerce Clause—an action Congress has yet to exercise.
Economic Nexus – Is It Constitutional?
Due to the ever-changing digital economy, states are attempting to expand sales and use tax collections by directly challenging the physical presence nexus standard established in Quill v. ND. In Quill v. ND the Court held that the threshold for physical presence nexus wasn’t crossed. This was even as Quill distributed floppy disks and licensed computer software programs that enabled some of its North Dakota customers to check Quill’s current inventories and prices and even allowed customers to directly place orders.
To circumvent the Court’s decision in Quill v. ND, states have created and applied alternative nexus standards over the last decade, e.g., “click-through,” “cookie” and “affiliate” nexus. Beyond creating new nexus concepts, states also are attempting to apply an “economic” nexus standard to sales tax, a concept previously employed by states with regard to income taxes. As applied within the context of sales tax, economic nexus can be defined as the idea that a specified amount of sales or a certain number of transactions within a state—regardless of physical presence—is enough to impose a collection and remittance responsibility on an out-of-state seller. It should be noted the Court in Quill v. ND had the opportunity to create an economic nexus standard but didn’t, even though Quill made almost $1 million in sales per year to approximately 3,000 customers in North Dakota. The economic nexus thresholds states are currently establishing vary in the amount of sales and number of transactions, but all are significantly less than Quill’s activity in North Dakota.
Today, economic nexus standards have been adopted by legislatures in numerous states, including Alabama, Connecticut, Indiana, Maine, Massachusetts, North Dakota, Pennsylvania, Rhode Island, South Dakota, Tennessee, Vermont, Washington and Wyoming. Alabama and South Dakota were two of the first states to adopt an economic nexus standard for sales tax purposes and have been two of the first states to face legal challenges related to adopting such a standard. Litigation in Alabama and South Dakota has quickly moved through each state’s court system, although South Dakota v. Wayfair, Inc. was the first to reach the Court, as a petition for a writ of certiorari was filed on October 2, 2017.
In lieu of requiring an out-of-state seller to collect and remit sales tax, some states have decided to focus on requiring remote, or online, sellers to notify their customers of their responsibility to remit use tax. Certain states also may require an out-of-state seller to submit information related to such sales directly to the state. States imposing these types of reporting requirements are doing so with the belief that any challenges to such reporting requirements will withstand judicial scrutiny, as the limitations to require an out-of-state seller to collect and remit sales tax wouldn’t apply to a use tax reporting requirement. Colorado was the first state to enact a reporting requirement. At least 11 states enacted similar requirements once Colorado’s reporting requirements were upheld in Direct Marketing Association v. Brohl.
As states continue to enact new nexus concepts and impose sales tax collection or reporting requirements, it’s imperative businesses continually review their operations. This should include not only how sales are generated, i.e., sales representatives, web portal or online marketplace, but also where those sales are shipped. Failing to adhere to a state’s reporting requirement obligation may result in significant penalties. New registration, collection and remittance obligations also require a business’s tax function to be acutely aware of the states with new economic nexus laws, effective dates of the laws, various sales and transaction triggering thresholds and whether the law is potentially on hold due to pending legal challenges.
Businesses making sales into states where they don’t have a physical presence or sales tax compliance obligation may suddenly need to decide on one of the following potential outcomes:
- Collect that state’s sales tax under new and possibly unconstitutional economic nexus laws
- Wait for possible litigation in the state to enjoin the law
- Wait for the Court to take up a case, e.g., South Dakota v. Wayfair, Inc., and issue a decision that reaffirms or reverses the physical presence nexus standard originally established in Quill v. ND
- Wait for Congress to enact legislation to overturn Quill v. ND should the Court deny certiorari in the South Dakota v. Wayfair, Inc. case
The changing tax laws increase the seller’s burden to be compliant with the tax laws. One thing is for certain—the definition of nexus and doing business in a state is changing.
Contact your trusted BKD advisor with questions or for more information.