The U.S. Supreme Court’s recent ruling that a state government can require retailers to collect sales tax even if they have no physical presence in the state overturns decades of precedent and exposes online merchants to a complex web of compliance decisions. 

The case, South Dakota vs. Wayfair, Inc., revisited an earlier decision, Quill Corp. vs. North Dakota, which held that requiring sales tax collection from out-of-state entities violated the Constitution’s commerce clause. In its June 21 5-4 ruling in Wayfair, however, the Supreme Court noted that the Quill decision came down in 1992, well before the e-commerce explosion; a report from the Federal Reserve Bank of St. Louis found that e-commerce has gone from representing 0.6 percent of U.S. retail sales in 1999 to 9.46 percent in 2018. Because the retail economy has changed so much, the court’s majority found that the Quill decision is no longer relevant. The Government Accountability Office estimated in a recent report that if states were able to tax all online sales from remote sellers, then they would collect $8 billion to $13 billion in additional revenues. 

“Compliance costs will go up” as a result of the decision, said Akshay T. Shrimanker, a member of the NYSSCPA’s Emerging Tech Entrepreneurial Committee. E-commerce retailers, he said, will need to familiarize themselves with the applicable rules in all 45 states that charge sales tax. (The exceptions are Alaska, Delaware, Montana, New Hampshire and Oregon.) “To know the tax rules of all the 45 states, you will probably need 45 people to give you advice.”

Another complicating factor: Counties and municipalities also impose sales tax, noted Alan Goggins, a member of the Society’s Chief Financial Officers Committee. “I would break it down to even the ZIP code, because the sales tax you pay in New York City is different [from] the one in you pay in Nassau County,” he said. Retailers will need to account for sales on a very granular level if they expect to remain in compliance.

Background of the case

At issue in Wayfair was a 2016 South Dakota law providing that an out-of-state seller has nexus with the state for sales tax purposes if the company, on an annual basis, sells more than $100,000 in goods or services into the state, or engages in 200 or more separate transactions in the state. The language of this legislation completely flouts the precedent set by Quill  because it was written specifically to prompt a court challenge.

South Dakota, in its brief, argued that the physical presence test established in Quill is no longer applicable to today’s economy, noting that the “tides of time have completely washed away whatever foundation Quill’s rule ever had.” However, Wayfair, along with co-respondents Newegg Inc. and Overstock.com, Inc., argued that overturning Quill would present an excessive compliance burden for online sellers, given the large number of jurisdictions—each with its own rules—they would need to account for. They argued that Congress would be a better place to address this issue. The Supreme Court sided with South Dakota, finding that the economy has changed so much that the physical presence rule has become unworkable, as the standard is no longer clear and easy to apply, given the structure of online retail.

Justice Anthony M. Kennedy, in his majority opinion, went so far as to find the physical presence rule to be an incorrect interpretation of the commerce clause. To illustrate how artificial the test is, he observed that “a company with a website accessible in South Dakota may be said to have a physical presence in the State via the customers’ computers. A website may leave cookies saved to the customers’ hard drives, or customers may download the company’s app onto their phones.”

In his dissent, Chief Justice John G. Roberts Jr. echoed Wayfair’s argument that changes to e-commerce taxation should be undertaken by Congress, rather than the courts. He also argued that the decision will put an undue burden on small businesses, which will have trouble untangling the large number of sales tax regimes in the country: “ New Jersey knitters pay sales tax on yarn purchased for art projects, but not on yarn earmarked for sweaters,” he wrote. “Texas taxes sales of plain deodorant at 6.25 percent but imposes no tax on deodorant with antiperspirant. … Illinois categorizes Twix and Snickers bars—chocolate-and-caramel confections usually displayed side-by-side in the candy aisle—as food and candy, respectively (Twix have flour; Snickers don’t), and taxes them differently.”

Compliance challenges

The ruling’s complexity doesn’t stop at determining how much tax is paid to each jurisdiction, explained Aaron Berson, chair of the Emerging Tech Entrepreneurial Committee. A company must go through numerous bureaucratic steps even to start paying those taxes to the relevant entities. He brought up the example of an online makeup company with $15 million in annual revenue that meets the nexus thresholds in the 45 states that charge sales tax.

“That company would have to file to do business in 45 states, [and would] have to collect and remit sales tax in 45 states,” he said.  And because “a lot of states require a registered agent or a physical address in the state, there’s the cost for 45 different registered agents, so this becomes not a trivial thing for companies, and very quickly they can be subject to big hits.”

Despite this added work, it’s likely that the Wayfair decision won’t dissuade companies from accepting business in other states, predicted Chaim V. Kofinas, chair of the Society’s New York, Multistate and Local Taxation Committee: “If your client, who might not be New York-based, says, ‘You know, I recommended you to my friend in Connecticut,’ are you going to say no because you don’t want to deal with Connecticut sales tax? If it might mean another $50,000 revenue contract?”

That will be one of many questions that companies need to consider going forward. The issue might extend even beyond sales tax, suggested Berson. The court’s decision dealt specifically with whether physical presence was required to establish tax nexus, so it could also potentially set precedent for income tax nexus, which would come with an entirely new set of compliance concerns.

And because the decision concerns only nexus, non-internet companies are affected too. “This doesn’t just apply to e-commerce sellers,” he said. “A manufacturer who sells couches in the three states around him may have to now pay sales tax to the three states.”

All this complexity means that e-commerce companies will likely turn to their CPAs for assistance even more than before, which Berson said will be good for firms—at least at first. He explained that he is troubled by how this decision might affect the way firms and clients think about tax compliance services in the future.

“Sales tax, historically, was not such a [major] compliance product for accountants, but it was more value-added to keep people out of trouble,” he said. “But if it gets to a point where you collect and pay tax in all states to be safe, it becomes a complete compliance product, and you’ll see CPAs specializing in this, competing in a commodity marketplace where prices go to the floor. So that’s my concern for the profession: How will we stay out of this massive commodity price war? ... How do we avoid that and keep it as a value-added product, not a compliance product?”

cgaetano@nysscpa.org