Leveling the Playing Field or Creating Confusion? Illinois’ New Sales & Use Tax Sourcing Rules
Prior to Illinois’ enactment of the Leveling the Playing Field for Illinois Retail Act (Act), sellers shipping into Illinois without having a physical presence were required to collect only Illinois state-level sales tax (6.25 percent). This was true only if a seller had cumulative gross receipts from sales of tangible personal property to purchasers in Illinois of $100,000 or more or the retailer entered 200 or more separate transactions. This was Illinois’ economic nexus response to Wayfair v. South Dakota (Wayfair). Recognizing its economic nexus statute created disparity between in-state and out-of-state sellers, Illinois passed the Act.
Beginning January 1, 2021, the Act deems a remote retailer with Illinois nexus to be liable for all applicable state and locally imposed Retailers’ Occupation Taxes (ROT) on all retail sales to Illinois purchasers. The Act also holds a marketplace facilitator with Illinois nexus to the responsibilities.
However, the sourcing regime for these new Illinois provisions has proven to be rather complex. New regulations promulgated by the Illinois Department of Revenue prescribe sourcing rules for the ROT that may be outlined as follows:
These complex sourcing rules appear to stem from two U.S. Supreme Court cases long before Wayfair. In McLeod v. J. E. Dilworth Co., 322 U.S. 327 (1944), the U.S. Supreme Court held that the imposition of a sales tax by Arkansas on goods shipped from out of state violated the U.S. Constitution even though the seller established a physical presence in the state. The actual sales were consummated out of state. That same year, in General Trading Co. v. State Tax Comm’n, 322 U.S. 335 (1944), a use tax imposed upon the use of such goods in Iowa, and the requirement that the seller with a physical presence in the state collect and remit the tax, didn’t violate the U.S. Constitution. Therefore, even though Wayfair lifted the physical presence requirement, the type of tax that may be imposed is still depending on where the sale is consummated.
Despite the apparent compliance with J.E. Dilworth Co. and General Trading Co., scenarios 1, 5, and 6 described above are still in conflict from a U.S. constitutional standpoint. First, the regulations may not be fairly apportioning the tax. In J.D. Adams Manufacturing Co. v. Storen, 304 U.S. 307 (1938), a manufacturer located in Indiana challenged imposition of the Indiana gross receipts tax on its outbound interstate sales. The tax applied to “gross income of every resident of the State and the gross income of every nonresident derived from sources within the State.” The taxpayer manufactured the goods in, accepted the orders in, shipped the goods from, and received payment in the taxing state. The Indiana gross receipts tax applied both to inbound interstate sales by nonresidents (destination-sourced) and outbound interstate sales by residents (origin-sourced). The U.S. Supreme Court viewed the tax as applying to gross receipts from interstate commerce without apportionment between the local activities, which were deemed taxable by the state, and the interstate activities, which were deemed not taxable by the state. Thus, the tax violated the U.S. Constitution. Essentially, the Illinois regulations change the sourcing methodology for retailers based on the mere fact of an in-state physical presence in scenarios 1 and 6 above. Second, the rate differential between the ROT and the use tax may be viewed as discriminatory as an in-state presence and can lower the use tax rate in scenarios 1 and 5. Third, Illinois may not even be able to levy a sales tax—the ROT—on remote retailers in scenario 1 even if such a retailer meets the $100,000 or 200-transaction threshold. It must be noted that Wayfair involved only South Dakota’s sales tax and the sales were consummated in the state. Illinois’ attempt to source a remote retailer’s sales purely based on destination conflicts with J.E. Dilworth Co.
For additional guidance on the new Illinois sourcing regulations, contact your BKD Trusted Advisor™ or submit the Contact Us form below.