Significant changes have occurred in the laws governing which companies must pay sales tax in various states, impacting startup sales tax strategies. What was once straightforward has become more complex. Fast-growing eCommerce and SaaS companies now need to implement robust sales tax software solutions and work with experienced CPAs.
In 2018, the Supreme Court overturned a 1992 precedent in the landmark South Dakota v. Wayfair case, which significantly affected state tax legislation. This ruling granted states the authority to collect taxes from companies with an “extensive virtual presence,” even if they lack a “physical presence” in that state.
Historically, two primary principles limited a state’s authority to regulate interstate commerce under the US Constitution: state regulations could not discriminate against interstate commerce and could not impose undue burdens on it. A state tax imposed “undue burdens” if it taxed businesses without a “substantial nexus” to the state, traditionally requiring a “physical presence” (such as employees, property, or warehouses) to establish this nexus.
South Dakota 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 they delivered more than $100,000 of goods or services into the State or engaged in 200 or more separate transactions annually. This economic nexus legislation was a significant change, and nine other states (AL, CT, GA, HI, IL, IA, KY, LA, & OK) enacted similar laws with various sales and transaction volume thresholds following this ruling.
The 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 previous laws allowed startups to use the Internet to access a national market without facing the complexities and obstacles of nationwide sales tax collection. It recognized that these burdens were significant, especially for small businesses making low-volume sales across many states. However, reasonably priced software now eases these challenges, either from private providers or state taxing agencies themselves
Thus, states with “economic nexus” rules similar to South Dakota now collect taxes, and other states might impose taxes with even lower thresholds, marking a significant tax change.
Immediate Implications of the Ruling:
Sales to South Dakota (and AL, CT, GA, HI, IL, IA, KY, LA, & OK) became taxable once a company exceeded 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.
Since the ruling was put into place, nearly every state with a sales tax has adopted remote seller tax collection rules, which requires remote sellers to collect and remit sales tax on sales made to customers in that state, subject to specific thresholds. You’ll find a map of tax nexus rules across the US here.
What the Ruling Doesn’t Do:
The ruling does not eliminate the requirement for a company to have “significant nexus” to a state before collecting sales tax. Typically, startups making small initial sales into a new state without a physical presence do not need to immediately collect taxes until they meet or exceed that state’s tax nexus threshold..
The ruling does not provide a blanket threshold for when a state can collect tax and different states have different thresholds. In most states, a company with more than 200 transactions or $100,000 in sales can expect the state to require sales tax collection. In some states the sales amount threshold is $500,000, and $250,000 in others. Some states have no transaction number threshold. Again, consult our tax nexus map for specific information.
The ruling does not change the nature of any state’s sales tax. Each state taxes differently and at different rates. A product or service may be taxable in one state, exempt in another, and partially taxed in yet another.
Recommendations for Sales Tax Strategy for Startups:
Get Ready to Start Collecting Now!
Step 1: Conduct a Sales Tax Study: Determine if and where your product or service is taxable. Kruze Consulting’s CPAs can review your offerings, perform a multi-state sales tax study, make invoicing recommendations, and work with third-party sales tax providers to set you up for collection.
Step 2: Set Up with a Third-Party Sales Tax Service: We help startups connect with Avalara or TaxJar. Once your products are coded into their systems (taxable vs. nontaxable), they automatically charge sales tax based on jurisdiction and manage all sales tax filings on the company’s behalf.
Don’t wait…give us a call today!
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