Headaches from Fallout from the Wayfair Decision and Other Economic Nexus Enforcement

In 2018, the U.S. Supreme Court handed down the South Dakota v. Wayfair decision, which allowed states to require out-of-state sellers to comply with sales tax even if they lack a physical presence in the state. Over the past three years, nearly every state has enacted economic nexus laws in response to the Wayfair decision requiring sellers to register and collect tax if sales exceed a certain threshold (e.g. $100,000 or 200 transactions). Most business and practitioners agree that the Wayfair decision made light of the overwhelming compliance burden placed on businesses operating in multiple states.

Traditionally, many sales made by manufacturers are exempt from sales tax as the tax typically only imposed on retail sales, and not wholesale transactions. However, certain transactions, such as sales to construction contractors and other scenarios where the customer is (or is deemed to be) the end-user, will result in tax collection obligations. Many manufacturers are also exploring direct to consumer sales channels beyond their historical wholesale customer base, which require the collection of sales tax. State economic nexus thresholds are most often based on gross sales volumes (i.e. including wholesale activity). For example, a manufacturer whose sales in a state are primarily exempt can still be required to register in the state as a sales tax vendor, file sales tax returns in the state and maintain documentation from customers to substantiate exempt sales.

Likewise, if a manufacturer purchases equipment or materials from out-of-state sellers that are subject to the law, those sellers may now be required to collect sales tax. If these purchases qualify for a manufacturing or resale exemption, the manufacturer will need to furnish the sellers with an exemption certificate to avoid the tax. As vendors learn to comply with varying state exemptions, many manufacturers will have sales tax overpayments to vendors that should be evaluated and recovered from the state.

Many states have viewed the South Dakota v. Wayfair decision to reach further than sales/use taxes. While franchise and gross receipts taxes (Ohio CAT and Washington B&O) have long had “bright-line” or “factor-presence” economic thresholds, many states have begun to also impose these nexus standards for corporate and other state income tax obligations. These nexus developments are especially important in light of recent challenges to P.L. 86-272.

Since 1959, P.L. 86-272 has provided businesses with protection from state income taxes when their connections within a state are limited to solicitation of sales of tangible personal property. Many manufacturers still heavily rely on this law to limit their income tax filing footprint only to those states where they have substantial operations (i.e. offices/payroll). On August 4, 2021, the Multistate Tax Commission (“MTC”) adopted a revised interpretation of P.L. 86-272. Likely the most concerning items in this interpretation are the “Activities Conducted Via the Internet,” which provide examples of unprotected activities. Activities interpreted to create income tax nexus when performed over the internet include: providing advice by electronic chat or e-mail on how to use products after they have been delivered (example 2); soliciting and receiving online applications for branded credit cards (example 3); remotely fixing or upgrading products by transmitting code or other electronic instructions (example 7); and selling extended warranty plans on a website (example 8). In addition to these recent interpretations of internet activity, manufacturers should be mindful whether services are performed by employees or third-party representatives that may create additional state income tax filing obligations (e.g. repairs, training, SaaS or other post-sale support).

Overall, the state tax landscape is constantly evolving and changing. While taking care of your customers and growing your business is a priority, keep in mind that evaluating state income, gross receipt and sales tax obligations is extremely challenging in light of economic nexus enforcement. It’s important to have a full picture of potential obligations and weigh compliance costs, potential liabilities and other factors when determining how to address these.

Our dedicated national manufacturing practice is equipped with state and local tax specialists to assist your company in navigating complex state nexus rules. We combine a shop floor approach with 360-degree coverage to position your business for success now and into the future.