On June 21, 2018, in a five to four majority decision deciding the case of South Dakota v. Wayfair, the US Supreme Court overturned 50 years of precedent. Businesses now face a new landscape for sales and use tax with the decision significantly expanding the authority states have to impose transaction taxes upon out of state companies of all types.
To understand what happened on that day, one first has to understand what power a state has to tax out of state businesses to begin with. In its most basic form, nexus is the connection or link with a jurisdiction that must exist for that jurisdiction to be able to impose tax on the activities of a business. There are different nexus standards for different types of taxes. For sales and use tax, physical presence had to exist within a jurisdiction for it to be able to require an out of state seller to collect and remit use tax on sales delivered to customers within the jurisdiction. Physical presence could take the form of property, an employee, or agent operating on behalf of the seller. Without a physical presence, there was no requirement on the seller to collect tax on transactions delivered into a jurisdiction.
The Wayfair decision reversed the physical presence requirement and upheld a state law that said use tax nexus could be created based solely on the sales activity of a company, regardless of physical presence. Under Wayfair, the Court ruled that a test based on sales revenue or number of transactions (in the case of South Dakota it was $100,000 in sales or 200 separate transactions) could be sufficient to establish nexus for use tax. It should be noted that the Court only accepted the reasonableness of the South Dakota threshold and did not spell out what the threshold for economic nexus actually should be.
The states have reacted in a variety of ways after Wayfair with regard to how they are addressing the new nexus. Almost universally they are pushing forward to either adjust their current laws or put new laws and regulations in place that impose economic nexus on out of state taxpayers. As of February 15; thirty eight states have either adopted or are in the process of adopting economic nexus rules based on sales and/or number of transactions.
Does this matter to manufacturers?
The Wayfair decision came about due to states believing there were billions of dollars of online transactions occurring where use tax was not being collected and feeling frustrated that a federal solution had not been created to address their concern. However, this decision has a far broader reach than just online and e-commerce type businesses. Manufacturers and wholesalers, who have traditionally been exempt from the need to collect tax because they sell for resale or are otherwise exempt from sales and use tax, now have to consider if the decision impacts them. To make that determination, businesses will only need to answer two questions: Do they sell something and do they sell it to out of state customers? If the answer to both questions is “yes”, then Wayfair may likely have an impact.
The impact will be felt by manufacturers and wholesalers, and must be addressed by taxpayers lest they face increased risk of use tax exposure. Issues manufacturers need to consider in the new use tax environment include:
Summary of complicating issues sellers face
One of the premises behind the Wayfair case being the vehicle sought by the states for bringing economic nexus before the Court was that the tax didn’t impose an unreasonable burden on the taxpayer. Additionally, that simplicity was one of the bases for which the Court sided with the state of South Dakota. But, in this case, the law of unintended consequences has reared its head again, and the states have managed to make the issue overly complex for the small business given how each has implemented economic nexus in their own manner. Some of the areas of concern are:
Manufacturers may not consider Wayfair to be particularly important since what they sell is generally treated as an exempt transaction but since the vast majority of manufacturers ship out of state, it’s certainly something that needs to be considered. Manufacturers must figure out previous year sales on a state to state basis to see if they meet the economic thresholds in states imposing these regulations. The Wayfair decision holds a lot more weight for manufacturers than it would seem, and there is a certain degree of complexity with policies varying state to state and some states not imposing economic nexus. Discussing how the decision will impact your organization with a UHY Advisors state and local tax professional is critical as the decision is relatively recent, and it may help limit accrued tax exposure. As with most new tax regulations, it is better to address concerns sooner rather than later to avoid tax liabilities.