Sales tax law changed forever in June 2018 when the Supreme Court of the United States issued a ruling in the South Dakota vs Wayfair case. Prior to the Wayfair case, the law of the land was that businesses collected and remitted sales tax in the states in which they were physically located. However, with the rise of online sales, states began losing substantial revenue to online retailers. Businesses located in one state could make substantial sales across the country and do so without collecting a penny of tax outside their home state.
Eventually, states became desperate to recapture that revenue, and began disregarding the rule that they could only force businesses located within their state to collect and remit tax. States did this in a variety of ways: they enacted rules, issued Department guidances, and even passed laws. Yes, states passed laws that were against the law. South Dakota was one such state.
South Dakota was in real trouble with no personal income tax and a heavy reliance upon sales and use tax. Only being able to tax businesses located in their state wasn’t working out because…well…what business wants to be in South Dakota?! It didn’t make sense for large online retailers, like Wayfair, to have a physical location in a remote state with a low population.
For years, states had waited on the legislature to pass a federal law leveling the playing field for all states to get the tax they were entitled to. With nothing to show for it, South Dakota decided physical presence was out and economic nexus is in. The fallout of this decision, and subsequent US Supreme Court decision upholding it, has left taxpayers wondering: What is Economic Nexus?
Economic nexus is a threshold established by a state that can be a dollar and/or transaction amount. When a business crosses a state’s threshold, that business must then register, collect, and remit sales tax in that state. The most common economic nexus threshold is $100,000 or 200 transactions. If a business makes sales over $100,000 or makes 200 or more transactions within a one-year period, many states now take the position that the business is required to register with the state in the subsequent month.
Remember, physical presence is not gone altogether. States typically will require you to register to collect and remit sales tax if you have either a business location, employee, warehouse, or inventory within its borders. Economic nexus is simply a new nexus standard in addition to the longstanding physical presence nexus standard. Businesses should be registered in states in which they are physically located AND in states in which they have surpassed the economic nexus threshold.
Unfortunately, that’s only the beginning of the confusion. While the South Dakota v. Wayfair case allowed for economic nexus to continue, it didn’t fully define what exact economic nexus standard states can apply. As such, states are left to choose their own economic nexus standards. They can vary from $10,000 to $500,000 and may include additional requirements, such as “engaging in a particular, listed activity” or “engaging in regular and systematic solicitation of consumer in state.”
Now, how does economic nexus work in practice? Here’s an example:
Company A is located in Alabama.
In 2018, Company A made: $150,000 in sales to Georgia; $120,000 in sales to Illinois; and $11,000 in sales to Pennsylvania.
Where does Company A need to register for sales and use tax purposes?
First and foremost, Company A needs to be registered in Alabama, where it has an actual, physical presence.
Company A does NOT need to register in Georgia because Georgia’s economic nexus standard is $250,000 unless they made more than 200 or more retail sales within the state.
Company A DOES need to register in Illinois because Illinois’ economic nexus standard is $100,000 or 200 or more separate sales.
Company A DOES need to register in Pennsylvania because Pennsylvania’s economic nexus standard is $10,000, or Company A can opt to comply with notice and reporting requirements instead of registering.
This example does not even address the transaction number threshold that Georgia and Illinois have. As mentioned above, even though Company A does not satisfy the sales amount threshold, they may still need to register if they made more than 200 or more retail sales in the prior years.
Each state has it owns threshold and its own rules associated with them. Unfortunately, that’s not the only difference between states. States also have different effective dates of their economic nexus standards. Many such standards became effective in October, November, and December 2018. However, many more still have thresholds that become effective in early 2019. Some states also have effective dates with additional grace periods, allowing taxpayers a several month period to register and begin compliance.
Managing varying effective dates of varying economic nexus thresholds is not the end of the road for business owners. Some states want back taxes back to the effective date of their economic nexus standard. A few states are even taking the position that their economic nexus standard is effective back more than a year! In other words, their economic nexus law goes back father than the Wayfair case. If you are planning on making your business sales tax compliant in 2019, you may be expected to pay a hefty tax bill to each state upon registration.
Taxpayers unsure about the effects of Wayfair on their businesses world may want to consider a Sales Tax Nexus Study. What is a sales tax nexus study? A tax professional will evaluate your sales and first determine where you have nexus under both the physical presence and economic nexus standards in each state. Next, they will identify what potential liabilities are in those states. States typically offer a voluntary disclosure option or a registration option. But in the past year, several states have a third option available exclusively for remote sellers. Each option may have a different potential liability associated with it. Finally, a professional can help you navigate the complex registration process.
Remember, it is not just states that are requiring registration. Many counties and cities require registration too. For example, taxpayers that have nexus with Colorado may have to register in over 70 localities in addition to registering with the state!
Taxpayers should approach registration cautiously. First, it is not always as easy as it seems to determine if or when a threshold has been crossed. Businesses that register in error may find themselves losing their competitive edge for no reason. If done improperly, registrations may result in an audit or an assessment for back taxes.
Jeanette Moffa is an attorney who concentrates on state and local taxes at Moffa, Sutton, & Donnini, P.A. She is an executive council member of the American Bar Association Tax Section State and Local Tax Committee and the Florida Bar Tax Section. Ms. Moffa is an author of both the CCH’s Expert Treatise Library: Sales and Use Tax as well the ABA’s Sales and Use Tax Deskbook. In addition, her regular columns on state and local tax issues can be found in State Tax Notes and Actionline, a publication from the Florida Bar’s Real Property, Probate, and Trust Law Section. She also serves as assistant editor to the Sales and Use Tax Deskbook and Actionline. Ms. Moffa is a regular speaker at the American Bar Association Tax Section conferences, the Institute of Professionals in Taxation, the Florida Bar Tax Section, the Florida Bar Real Property, Probate, and Trust Law Section, and the FICPA. In her free time, she teaches as an adjunct professor at Broward College.