Understanding Sales Tax
Sales tax is inherent in almost all small businesses. No matter how remote or small your business, you are liable for collecting sales tax within your footprint. Until recently, it had long been the rule that states cannot collect sales tax from vendors that sell products in their state, unless the vendor had a physical presence in the state, known as a “nexus.” On June 21, 2018, in a 5-4 decision, the Supreme Court swept away the nexus rule in South Dakota v. Wayfair, Inc., saying states could collect sales tax even without a business’s physical presence in the state.
Is this good for business? It depends on who you ask. Before the ruling, many brick-and-mortar stores felt like online retailers had an unfair advantage in bypassing state sales taxes, and the ruling now levels the playing field. Of course, states are happy that they can collect more sales tax if they choose. For other businesses, it remains unsure how this will play out in the long run as there are several complexities involved. Let’s cover fundamental parts of sales tax collection, and then we’ll share with you the need-to-know basics of the Supreme Court’s ruling.
What is nexus?
This is also known as a “significant physical presence.” Basically, it is the rubric to determine whether sales tax is due on products sold between states. If a company has nexus, they will probably be required to pay sales tax in that jurisdiction.
…Significant physical presence?
When a company maintains either temporary or permanent presence in a state, nexus is created. This nexus can be comprised of people or property, including employees, independent agents, or service professionals, or property like inventory, offices, or warehouses.
…Temporary or permanent?
But what does “temporary or permanent” mean? It can be confusing when describing something as temporary. Generally, this refers to short-term presence, like a trade show or a sales meeting.
…Property or people?
As mentioned above, the business’s nexus is created by either having people or property in a state. That means when your Florida-based company sends a team of employees for a trade show in Michigan, you may be creating nexus that will affect sales tax. The requirements for nexus vary in each state, making the process very confusing to navigate.
Click through or affiliate nexus?
You may have also heard the terms “click-through nexus” or “affiliate nexus.” Businesses that conduct sales via the Internet can be required to collect sales tax on those sales depending on the state’s requirements. Many states have passed legislation on these types of nexus determinations, affecting countless online retailers.
Now how does the Supreme Court’s ruling affect online sales?
Before the Supreme Court’s ruling, online businesses without a significant physical presence and in areas unaffected by click-through/affiliate nexus were not required to collect and submit sales taxes in those areas. With the Supreme Court’s June decision, it’s now up to each state to decide how to address the new ruling.
Who is affected?
It’s important to note that the Supreme Court’s ruling does not require that states must collect sales tax or how to do so, only that they could. For the 45 states that impose a sales tax, it is up to them to decide how they will handle their requirements in the wake of this ruling. For example, in South Dakota, which was the plaintiff in this case, the state requires collection for retailers with more than $100,000 in annual sales or 200 separate transactions. In other states, the requirements for online sales could be more impactful to “mom and pop” operations that may only do a few hundred dollars in sales in a given state.
The real problem that online retailers will have to struggle with in the future is not that their prices will effectively rise, but that the cost of compliance could be significant. With so many different restrictions and requirements from state to state, the complexities of complying with the ruling will be difficult to navigate. One expert noted that in New Jersey, marshmallows are candy and thus taxable, while marshmallow fluff is a food and not taxable. Multiply these subtle distinctions by 45 states and it becomes overwhelming. Outsourcing companies that can lift the compliance burden from small online retailers will likely find a healthy niche to serve in the wake of the ruling.
Large online retailers like Amazon, not a party to the lawsuit, will probably fare better in what lies ahead as they have greater resources. Before the ruling, Amazon was already collecting sales tax, so it was not deeply affected by the decision, but competitors such as Wayfair and Overstock may now struggle to update their systems to collect sales tax as effectively as Amazon has been doing. While Amazon itself may not have any issues, its site also hosts third-party retailers, which may now have to figure out how to collect sales tax. Some states may require Amazon, as the platform host, to shoulder some of the responsibility in such a situation, but only time will tell.
As if it wasn’t before, this ruling makes sales tax all the more complicated. One of the main issues is the lack of uniformity or a national standard to comply with, meaning there are potential opportunities for Congress to step in eventually and impose a national system for managing sales tax.
This situation is even further complicated by the surrounding politics of the issue, although sales tax does not seemingly split opinions along party lines. Many tax and finance issues are often boiled down to “conservative versus liberal,” but in the Supreme Court vote, it appears that was not the case in this decision. Ruth Bader Ginsburg, one of the court’s most liberal justices, sided with the majority along with the very conservative Clarence Thomas. Chief Justice John Roberts, also conservative, sided with the rest of the liberal justices in his dissent. It will be difficult to predict how state governments or Congress will act based on party affiliations alone. Like all of those affected, we will be watching state and federal developments in the wake of this decision, over the coming months.
If you find yourself with lingering questions about how your business could be affected by this Supreme Court decision, or you want to ensure your sales tax filings are handled properly, please contact us for more information.