What Might Wayfair Mean for Me? The Changing Landscape of State and Local Sales Taxes and Retroactivity Concerns
The rise of the internet retailer has created significant loss of sales tax revenue for state revenue agencies due to the loss of revenue from sales and use tax collected in brick-and-mortar retail establishments. Historically, in-state retailers are required to collect sales tax on goods sold to customers in retail locations and remit the sales tax (or use tax, both of which are referred to as sales tax herein for simplicity) to state revenue authorities on the customer’s behalf. When a customer purchases an item in a state with no sales tax or a lower sales tax than his or her home state, the customer is responsible for paying the difference to his or her home state’s taxing authorities. However, few individuals are aware of this requirement and compliance is a significant issue.
Companies without a physical presence in a particular state have historically not been required to collect sales tax in such state even if they are selling to a customer in that state. This rule is based on the so-called “physical presence standard” for determining whether a company has what is referred to as “sufficient nexus” for the state to require the company to collect and remit sales tax to the state directly and was upheld in the long-standing Supreme Court decision of Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The practical effect of this rule, however, is that a Connecticut resident who purchases an item online from a company with no physical presence in Connecticut is responsible for reporting the purchase to Connecticut’s Department of Revenue Services and paying the sales tax directly. Of course, consumers rarely complete this step and Connecticut never receives its sales tax.
As more and more consumers turn to the internet to purchase goods, state taxing authorities are losing revenue due to the non-compliance of consumers. Thus, states have been enacting legislation which claims to subject out-of-state online retailers to the same rules as companies with a physical presence in the state, for example, based on the use of an in-state agent such as a local delivery service, or so-called “click-through laws” where out-of-state companies use in-state companies to advertise their products online. The myriad of different tests and standards has created a headache for online retailers comparable to that felt by state taxing authorities watching their sales revenue decline.
Various states have enacted voluntarily registration systems to allow companies to collect and remit sales tax even though they have no physical presence in that state and arguably have no nexus which requires them to collect and remit sales tax in that state. In December of 2017, Connecticut announced a program called CT Fresh Start to allow taxpayers, including remote retailers, to resolve outstanding sales and use tax liabilities as part of a voluntary compliance initiative. Many online retailers welcome voluntary programs which are easy to comply with—thus reducing the risk of penalties and interest if a state later claims that the online retailer did have sufficient nexus in the state based on whichever local test that state has adopted.
The Quill case first illustrated the quagmire that had been created by each state’s varying rules for testing nexus. In Quill, the state of North Dakota imposed a sales tax on any retailer that had three or more advertisements in the state within a 12-month period, even if the retailer didn’t have any other physical presence in the state. In the days before the internet, this targeted mail-order business that solicited business through catalogs and flyers. The North Dakota Supreme Court upheld the test, and the retailer appealed to the United States Supreme Court. The United States Supreme Court found that the Commerce Clause of the Constitution prevented North Dakota from expanding the test for nexus beyond physical presence in the state.
Since Quill, states have been twisting and turning to redefine what counts as a “physical presence” in their statutes to include as many online retailers as possible. As a practical matter, companies are rarely willing to challenge such legislation because it is first tested in that state’s courts, which are typically friendly to such revenue-generating home-court legislation and the cost of pursuing the matter to resolution at the Supreme Court is prohibitive.
One online retailer, Wayfair Inc., a popular interior decorating site, has brought one such challenge. South Dakota passed legislation that requires remote retailers to collect and remit sales tax if they had over $100,000 of gross revenue from sales in the state or more than 200 separate transactions in the state in a single year. The South Dakota Supreme Court in State v. Wayfair, Inc., 2017 S.D. 56 (2017) acknowledged that this legislation was a direct affront to Quill and invitation to the United States Supreme Court to overturn the physical presence requirement. The Supreme Court accepted such invitation, granting certiorari on January 12th of this year.
A decision on Wayfair, scheduled to be argued in April, is expected before the Court’s summer recess. State taxing authorities are poised to react when the decision is issued.
If a decision in Wayfair allows states to require online retailers to collect sales tax without having a physical presence in the state, Connecticut will be well-positioned to do so. The system set up by the Department of Revenue Services for voluntary compliance may be expanded for mandatory use and Revenue Commissioner Kevin Sullivan claims that neither compliance nor implementation will be a major hurdle if Wayfair goes the states’ way.
One question on the minds of businesses and taxing authorities alike is whether the Court’s decision, if it does expand the definition of nexus, will allow states to retroactively collect taxes and, if so, how far back the states can collect. If states can demand retroactive sales tax—which remains uncollected and likely uncollectible from the customer—then businesses could find themselves with a hefty tax bill, not to mention interest and penalties. While Connecticut legislators may seek retroactive compliance in an effort to balance the state budget, Revenue Commissioner Kevin Sullivan has expressed that his primary concern is future compliance.
Regardless of the outcome in Quill, the lack of uniformity among states’ tests for nexus and how sales tax is collected requires constant vigilance by online retailers, big and small, to avoid inadvertent noncompliance.