The Supreme Court has overturned a 1992 precedent that allowed online businesses to only collect sales taxes in states where they had a “physical presence”. Today’s South Dakota v. Wayfair, Inc. ruling grants states broad authority to collect taxes from companies that have an “extensive virtual presence” even if they have no “physical presence” in that state.
Two primary principles limit a State’s authority to regulate interstate commerce under the US Constitution: State regulations may not discriminate against interstate commerce; and States may not impose undue burdens on interstate commerce. Generally, a state tax would impose “undue burdens” if it tried to tax businesses that didn’t have “substantial nexus” to the state. For decades, courts have held that a company must have a “physical presence” (employees, property, warehouses, etc.) in a state in order to have this “substantial nexus”.
South Dakota recently enacted a law requiring out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the State” if, on an annual basis, a seller delivered more than $100,000 of goods or services into the State or engaged in 200 or more separate transactions for the delivery of goods or services into the State. Nine other states (AL, CT, GA, HI, IL, IA, KT, LA & OK) have enacted similar “economic nexus” legislation with various sales and transaction volume thresholds in anticipation of this ruling.
Today’s ruling not only found that South Dakota’s economic thresholds were sufficient in meeting the “substantial nexus” requirements of prior case law but went further to hint that even lower thresholds of ”virtual presence” may be sufficient because existing 3rd party sales tax software can remove the “undue burden” of multi-state sales taxes.
The ruling acknowledged that prior law allowed start-ups to use the Internet as a means to access a national market, without exposing them to the “daunting complexity and business-development obstacles of nationwide sales tax collection”.
“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 categories of goods that are taxed and, sometimes, the relevant date of purchase. Eventually, software that is available at a reasonable cost may make it easier for small businesses to cope with these problems. Indeed, as the physical presence rule no longer controls, those systems may well become available in a short period of time, either from private providers or from state taxing agencies themselves”.
Thus, not only will states with “economic nexus” rules similar to South Dakota be able to collect taxes, but the remaining states may begin to impose tax with even lower thresholds.
What the ruling does immediately:
Sales to South Dakota (and AL, CT, GA, HI, IL, IA, KT, LA & OK), become taxable once a company, exceeds the sales and/or transaction volume in that state. (Note: the law is not retroactive, and does not apply to sales before this ruling or before meeting the threshold).
What the ruling doesn’t do:
The ruling doesn’t eliminate the requirement for a company to have “significant nexus” to a state before they must collect sales tax. Start-ups making their first sales into a new state where they don’t have a physical presence do not need to immediately collect taxes.
The ruling doesn’t provide a blanket threshold for when a state can collect tax, but if a company has more than 200 transactions or $100,000 of sales into any state, they can expect that the state will want them to impose sales tax.
The ruling doesn’t change the nature of any state’s sales tax. Each state imposes tax differently, and at different rates. A product or service can be taxable in one state, exempt in another, and partially taxed in another.
Get ready to start collecting now!
Step 1: Get a Sales Tax Study to determine if and where your product or service is taxable. The CPAs at Kruze Consulting can review your products/software/services/SaaS, perform a multi-state Sales Tax Study to determine the taxability, make recommendations on how to invoice (for example, some states will exempt bundled services if the majority of the product is nontaxable, whereas other states will allow you to separately state the tangible and intangible items to break out taxes), and work with third-party sales tax providers to set you up for collection.
Step 2: Get set up with a 3rd party Sales Tax collection/remittance service. We help startups get linked up with Avalara or TaxJar Once we code your products into their systems (taxable vs. nontaxable), they automatically charge sales tax based on the jurisdiction and take care of all the sale tax filings on the company’s behalf.
Don’t wait…give us a call today!
Stephen Yarbrough, CPA, is VP of Tax at Kruze Consulting. Stephen is a CPA with 20 years of corporate tax experience. Before joining Kruze, Stephen was a former IRS Senior Revenue Agent and a Tax Manager at a Big 4 accounting firm.