Governments rely on tax revenues to fuel the vital services they provide to residents and businesses – from firefighting and public education to water system repair and road maintenance. Retail sales taxes have long been key sources of state governments’ budgets and have been their greatest single stream of revenue since the mid-1900s.
This tax base has shrunk by about 20 percent since 1970, however. Charging sales tax on online purchases made at out-of-state businesses has therefore become a tempting target for states seeking to maintain strong financial bases and to level the playing field between in-state sellers and remote online retailers. Such a levy was not legal until last year’s South Dakota v. Wayfair case went to the Supreme Court.
The Wayfair case set major policy shifts into motion across the U.S., the effects of which are still unfolding. The Supreme Court’s decision granted states the option of demanding sales tax collection from online, out-of-state vendors, though the states are not in complete agreement over policy details, implementation deadlines and other factors. Domestic and foreign businesses alike are experiencing new frictions as they seek to stay compliant in a rapidly changing landscape.
This Deep Dive examines the case’s legacy, including its history, the implications for sellers and marketplaces, and the efforts being made to reduce the frictions generated by this free-for-all state policy landscape.
Inside South Dakota v. Wayfair
The Supreme Court ruled during 1992’s Quill Corp. v. North Dakota case that businesses must have physical, in-state presences to be subject to state sales tax requirements. The court overturned that ruling last year, citing that eCommerce enables retailers to have substantial economic activities in areas in which they do not have brick-and-mortar locations or employees. Requiring compliance with levy obligations is unlikely to impose undue economic burdens on businesses thanks to modern technology, the court said, adding that the Quill Corp. case’s prohibition of out-of-state taxes had essentially – and wrongfully – “created a tax shelter.” This gave sellers without physical presences in certain markets a competitive advantage. The court noted that increasing eCommerce growth aggravated the misguided Quill ruling’s damaging impact.
Wayfair, an eCommerce company that sells home goods and furnishings, took South Dakota to court over a remote seller policy the state created in defiance of the Quill Corp. decision. The Supreme Court said South Dakota’s law had prevented undue burden from being placed on SMBs that had only minor economic participation. The policy created exemptions for vendors that generated less than a certain amount of sales in terms of monetary value and transaction counts.
The court overturned the Quill Corp. ruling and returned the Wayfair decision to the South Dakota Supreme Court. This handed a victory to states wishing to tax out-of-state online sales without making Congress responsible for creating an official resolution. Individual states can now determine their own versions of so-called “economic nexus” policies, including deciding whether to exempt SMBs from the taxes and determining how small an enterprise must be to meet those exemptions. States and businesses alike have expressed confusion over legal requirements, and some governments are questioning whether the Supreme Court implied that an SMB exemption is necessary for such levies to be constitutional. As a result, businesses are left unsure about how to maintain compliance.
Compliance Questions and Business Opportunities
Businesses that are noncompliant risk facing audits and expensive fees. They must keep up with changing policies, determine how much they owe in each locale and understand any reporting requirements that may exist – even in states in which they fall below the threshold for tax collection. Retailers may make choices about where to sell based on whether they can remain below that level and earn enough from sales to make incurring tax obligations worthwhile.
Several states also have marketplace facilitator laws that make online platforms responsible for handling sales taxes for sellers. Some observers suggest that such marketplaces may struggle to precisely determine products’ tax categories and classifications, as they would be less knowledgeable about the items than the vendors. It is often left unclear whether marketplaces, sellers or both would face ramifications for compliance failures.
SMBs and marketplaces have difficult obligations to uphold. A 2019 survey of 600 American SMB owners found that 20 percent reported being “very concerned” about the Wayfair decision, 29 percent were unaware of it and nearly 53 percent thought that managing sales taxes for their businesses was either “somewhat” or “not at all” clear.
The complexities of staying current with sales tax requirements generate ample business opportunities for solution providers, such as those offering accounting and tax management software. Those are not the only opportunities emerging. Some suggest that foreign businesses may find it daunting to enter the U.S. market due to difficulty navigating disparate economic nexus regulations. This may cause them to seek local partners that could help them better understand their obligations.
Continued Changes and Questions
Staying informed on compliance is an ongoing task for businesses and marketplaces as these policies continue to shift. More states are passing marketplace facilitator laws, partly because they may be able to reduce the administrative burdens of handling remote online sales tax if they can target a handful of platforms rather than individual sellers.
Many state governments are also revising their exemption policies by eliminating transaction volume-based thresholds in favor of those linked solely to sales revenue. Oklahoma has been trialing different benchmark levels, for example, sheltering more SMBs from its taxes by raising the revenue exemption level from $10,000 to $100,000.
These exemptions, combined with the popularity of the buy online, pickup in-store (BOPIS) retail model, which blends digital purchases with in-store presences, have limited the tax bases to which economic nexuses apply. A smaller tax base restricts the revenue boost states might gain from these policies. One study suggests that only 11 percent of retail sales in 2018 occurred outside physical stores, 80 percent of which would have been taxable even before the Wayfair ruling.
Post-Wayfair economic nexus policies will ultimately produce some funding for state governments, although it remains to be seen how much, and whether revamped business conditions will be introduced. These laws are leveling the playing field for brick-and-mortar stores, affecting SMBs’ and marketplaces’ choices on where to sell and creating business opportunities for tax management software providers and foreign players’ U.S. partners.
States continue to tinker with and roll out these laws, and some players are advocating for a unified federal remote sales tax policy, meaning the dust has not settled on the Wayfair case and that the sales tax landscape remains very much in flux. Businesses, marketplaces and public officials will be watching closely as new legislation develops.