South Dakota vs. Wayfair, Inc., also known as the “Wayfair decision,” is a Supreme Court ruling ushering in a whole new tax era… potentially.
45 states and their local governments lose up to $33 billion annually, because they do not tax remote sellers. (Why just 45? Because Alaska, Delaware, Montana, New Hampshire and Oregon don't have sales taxes at all.)
With the Wayfair decision, states can begin taxing remote retailers and recouping that revenue.
But what about the retailers? The ruling has struck fear into the hearts of small business owners (and the industry commentary has helped with that). How can they manage complying to thousands of state and local tax policies across the US? How will they survive?!
We don’t want to add to any sensationalism. We just want to give you the facts, and the potential limitations, of what’s now possible in the world of American digital taxes.
If we’re honest, US sales tax code has always been a confusing mess. This development could potentially simplify tax laws for online retailers over time.
Quick brief on the Supreme Court ruling
In a 5-4 ruling, the Supreme Court overturned a previous decision and law that’s prevailed since 1992, known as Quill. Quill established that state governments can only tax businesses who have a “physical presence” in the state. That worked back in the day, when sales were done by mail order and all the products were shipped in a box. Fast forward 25 years, when goods and services, tangible and digital, are sold online and transferred across borders instantaneously. The economy has a completely different landscape. Quill no longer makes sense.
Here are the two main problems that the Supreme Court sought to solve in this Wayfair decision.
I. The states are missing out on a big chunk of change, because the laws are out of date:
“[E]ach year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States.”
II. Online sellers have an unfair advantage because they’re tax-free:
“The physical presence rule puts businesses with a physical presence in a state at a competitive disadvantage to remote sellers.”
So, the Court sided with South Dakota to uphold their tax law, S.B. 106. The tax law applies to the sales of “tangible personal property, products transferred electronically, or services for delivery into South Dakota.” And it’s based on the customer’s location and the amount of sales, not the location of the seller.
(In some respects, the reasons for the tax change are similar to the 2015 shift in EU VAT, from the location of the seller to the location of the customer. European countries wanted to recoup the taxes they were missing and to even the playing field for their local merchants.)
Basically, the hubbub boils down to one seismic shift in American sales tax:
Physical presence is no longer the standard. States can now tax remote, online sellers.
But state and local governments won’t tax just any remote merchant, willy nilly. There are specific conditions to the South Dakota tax that the Supreme Court expects other states to follow, some of which serve to protect small businesses.
Key details of the South Dakota tax law that helped it win
In the name of fairness to all businesses and encouraging healthy economic activity, the Supreme Court wanted to see that South Dakota’s law was not putting “undue burdens” on out-of-state retailers. (They aren’t called Justice for nothing!)
Four qualities of the law helped it get in the Supreme Court’s good graces.
1. The law applies only to sellers who run a substantial amount of business in the state.
Any state’s tax law needs to determine a “substantial nexus,” so they can’t just tax any seller. They can only tax sellers who do a certain amount of business there. This is what some states call a “minimum presence threshold," known elsewhere in the world as a tax registration threshold.
South Dakota put in place thresholds of total sales and/or total transactions. Retailers with annual sales exceeding $100,000 or with more than 200 separate transactions in the state must set up shop to collect and pay taxes in SD.
The minimum presence thresholds helped the Court deem the law constitutional. The Court liked that the South Dakota law “applies a safe harbor to those who transact only limited business in South Dakota.” I.e.- The tax law protects small merchants. Win for the little guy!
2. The state has a simplified and standardized tax code that’s easy to comply with.
South Dakota is part of the Streamlined Sales and Use Tax Agreement (SSUTA), along with sixteen other states. These states share a simpler, more uniform tax system, which includes everything from product definitions to tax policy. The simplicity and uniformity of it removes some of the “undue burdens” of doing business in a different state and complying to their tax laws.
That said, cost of compliance remains a huge concern for some Court Justices and business owners everywhere. What about the other 28 states who aren’t part of SSUTA? Justice Roberts expressed worry in his final comments:
“Correctly calculating and remitting sales taxes on all e-commerce sales will likely prove baffling for many retailers. Over 10,000 jurisdictions levy sales taxes, each with ‘different tax rates, different rules governing tax-exempt goods and services, different product category definitions, and different standards for determining whether an out-of-state seller has a substantial presence’ in the jurisdiction.”
Hopefully, the gradual standardization of sales tax code across the states and the proliferation of software that automates sales tax compliance will converge to help business owners, so they never have to worry about these complex, tedious tax variations.
But in the meantime, yeah, it might be a bit messy.
3. The law will not tax out-of-state businesses for past sales.
This way, online retailers are protected from retroactive taxes. If the law allowed the state to go after remote retailers and charge back taxes, the Supreme Court might have seen that as unfair and an undue financial burden on those businesses. ‘Nuff said.
4. The state is providing a free tax software to remote retailers.
Again, cost of compliance to all the state and local taxes is a concern. Some Justices worried that sales tax compliance software “is still in its infancy,” while other Justices were confident that the market will quickly provide affordable solutions. (Quaderno to the rescue!)
Another caveat to this whole Court ruling: It’s not set in stone. Congress actually has authority over this issue, and politicians could write legislation that contradicts the Court’s ruling. It’s not likely Congress would write laws that intentionally limits economic growth… but, just saying, it’s possible.
Now other states will mimic South Dakota’s law
If there’s a new way to make money, you can bet states and local governments will jump on it. And they're jumping on it FAST.
Many states are following South Dakota’s lead. States mimic the four things from South Dakota’s tax law, listed above, effectively creating carbon copy tax code. (And here lies the possibility for simplification!)
So, which other states should you keep an eye on? Basically, all of them. Other states making moves include: Washington, Wyoming, Wisconsin, West Virginia, Vermont, Virginia, Tennessee, Texas, South Carolina, Rhode Island, Pennsylvania, Oklahoma, North Dakota, New York, New Mexico, New Jersey, Nebraska, Mississippi, Minnesota, Maine, Louisiana, Kentucky, Iowa, Indiana, Illinois, Idaho, Hawaii, Georgia, Connecticut, Colorado, California, DC, Arkansas, Arizona, and Alabama.
All in all, what’s the impact?
- States can tax remote sellers. But this will vary greatly depending on which products a state decides to tax. Perhaps just “tangible personal property” or maybe digital services, too. The hope (and expectation) is that states will increasingly standardize product definitions and which products are taxed. (States can also now hold marketplace facilitators responsible for sales tax.)
- Retailers must track sales levels and tax law changes in all states where they do business. (Watch benchmarks and the minimum presence thresholds.)
- Retailers must set up operations to collect tax wherever they sell, and then pay taxes on that state’s schedule. Tax compliance software should help with this!
- Competition is a more even playing field. If an online business must start charging tax, they lose the competitive advantage of being tax-free. This makes remote retailers more vulnerable to competitors, including local brick-and-mortar shops.
Huge providers likely won’t notice much of an impact because of the sheer scale of their business and volume of profits.
It’s feared that small merchants will really suffer as a result of this ruling, but if they don’t reach the benchmarks (“minimum presence thresholds”), then they might not be affected at all. Small businesses who sell through online marketplaces, such as Amazon or Etsy, might experience some minor changes due to new marketplace facilitator laws.
It’s the medium-sized businesses who might feel hit the most. They will take on the pressures of tracking tax law changes, tracking their own sales volumes in each jurisdiction, and then actually collecting and paying the sales tax when they need to.
That’s where software that automates tax compliance can swoop in and save the day. At Quaderno, we’re gearing up for the US jurisdictions that tax digital goods. We’ve already completely automated EU VAT compliance, and we’re ready for this new challenge. We'll keep you posted!
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.