Sales tax nexus occurs when a business has some kind of connection to a state. All states have a different definition of nexus, but most consider a “physical presence” or “economic connection” creates nexus. Physical presence can mean a number of things, including having an office, employee, warehouse, or storing inventory. Economic nexus comes into play when a company has a certain dollar amount in sales or a certain number of transactions in a state.
Since the US Supreme Court issued its decision in the South Dakota v. Wayfair, Inc. case, physical presence not only creates nexus, but economic presence creates sales tax nexus. Currently, more than 40 states have economic nexus provisions.
Prior to the Wayfair case, states could only enforce a tax collection on businesses that had a physical presence such as a brick-and-mortar location. While the physical presence standard still exists, nexus laws have expanded to include a sales tax obligation based on a certain level of economic activity within the state, including sales revenue, transaction volume, or a combination of both. Like many sales tax laws, economic nexus criteria vary by state and by the type of tax.
What does this mean to online sellers?
Before the Wayfair case, marketplace sellers were not required to collect sales and use tax in states where they had no physical presence. Wayfair opened the way for various states to impose a duty to collect sales and use tax on out of state vendors with economic nexus. This includes venders that have direct sales and those that are marketplace facilitators.
A large fraction of sales is made by Amazon and eBay which are considered marketplace facilitators. Marketplace facilitators argue that they are not obligated to collect tax on sales made on behalf a third party because it is not their sales.
To date, all but four of the 43 sales tax states that assert economic nexus and the District of Columbia have enacted Marketplace Facilitator Legislation (MFL) or interpreted their economic nexus regimes to apply to marketplace facilitators. All but two states that have MFL make clear that market facilitators, that have economic nexus in the state, have an obligation to collect tax on sales made for marketplace sellers. Without clear guidance regarding MFL, facilitators will probably not collect tax on remote sales made over the internet into states that have enacted economic nexus laws, but not MFL.
Because of the court’s Wayfair decision, states are able to collect sales tax from online transactions and during the pandemic. This has added much needed revenue to various states that have remote seller law. Some state like Florida and Missouri are still trying to figure out the administrative and legal complexities of on-line sales taxation.
Impact of COVID-19 on sales tax
Stay at home orders brought a significant decline in sales tax revenue in many states. A state like Florida, that relies on the hospitality industry, saw a significant decline in sales tax revenue. The re-opening of businesses will lead to some growth in sales tax revenue, but that will depend on the future path of the pandemic.
The complex path of the pandemic and the respective responses from each state suggest that there will be significant movement in sales tax revenues over the next several months. Many states are likely to propose new tax legislation or broaden an existing tax to increase revenues.
States that impose an economic nexus threshold as a result of the Wayfair case may pass legislation that would lower the sales amounts. Tennessee passed legislation that lowered its economic threshold from $500,000 to $100,000. Other states may follow.
Michigan and Vermont have passed legislation that would legalize recreational marijuana. Both states imposed an excise tax in addition to an existing sales tax. Other states like Pennsylvania are trying to pass legislation that would legalize and tax recreational marijuana. Legislators are hoping this would give states a “desperately needed economic boost in the middle of the pandemic.”
Due to COVID-19, states are likely to increase audits, change tax rates or bases, or enact entirely new taxes to increase revenues. Businesses need to monitor the sales tax arena and make sure they follow the new regulations when enacted.