You may have read by now that the Supreme Court issued a 5-4 decision that will end tax-free e-commerce shopping. While the 40-page opinion’s ink may still be drying, let’s talk about what this might mean for your business.
How Did We Get Here?
To understand the impact, we have to examine the Supreme Court's South Dakota v. Wayfair decision. To do that, we need to briefly discuss a 1992 Supreme Court case called Quill Corp. v. North Dakota. That case established the rule that in order for states to collect sales tax from a business, the business had to have a physical "nexus" or connection with the state. Without a physical presence in the state, the former opinion held the state had no ability to collect sales taxes from the business. Instead, the customer was responsible for reporting and paying the sales taxes on goods bought from out of state. As we know, no one does that. So, for many, e-commerce meant buying something tax-free. This disgruntled both state tax collectors and brick and mortar retailers who claimed they were losing business because they had to charge sales tax while online retailers did not.
The State of South Dakota decided that times have changed and they wanted to challenge the old rule. South Dakota claimed that they lost between $48 million to $58 million annually. The U.S. Government Accountability Office published a report indicating that collectively all states were losing between $8.5 billion to $13 billion. To challenge the rule, the state passed a law that called for the collection and payment of taxes regardless of physical nexus in direct contravention of the Supreme Court ruling. South Dakota knew the legislation would be challenged and several large retailers did just that.
What Exactly Did The Court Say?
The majority opinion said the old rule was "unsound and incorrect." The old rule had long been criticized as giving out-of-state sellers an advantage. Each year, the Court reasoned, the old rule became further removed from economic reality and resulted in significant revenue losses to the states. The Court found that the old rule created a "tax shelter" for businesses that limit their physical presence in a state but sell their goods and services to the state’s consumers. The Court also noted that companies were purposefully avoiding building a physical nexus in certain states and gaming the system to avoid taxes. Instead, the Court reasoned that modern e-commerce does not align analytically with a test that relies solely on a physical presence. As a result, the Court overturned its prior decision and no longer required a physical presence before a state could impose sales taxes.
So, What Are the New Rules?
Right now, there are still a lot of unknowns about how exactly this will impact every business engaged in interstate commerce. Technically speaking, the Supreme Court only looked at the specific South law at issue in the case. The specific statute only requires businesses that, on an annual basis, deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions for the delivery of goods or services into the state. Obviously, given the amount of revenues a state could collect, we expect almost all of the other states to pass similar laws. While it will take time to spread across all 50 states, you can expect swift and immediate change in some states.
For example, at least seven states anticipated the Supreme Court's decision and already passed laws very similar to South Dakota’s. Connecticut passed their law less than two weeks ago. Illinois passed its law earlier in June requiring remote retailers with cumulative gross receipts of at least $100,000 in sales into the state or 200 or more separate transactions in a year to collect and remit sales tax. Minnesota, Oklahoma, Pennsylvania, and Washington have also passed similar laws. Ohio, Rhode Island, and Massachusetts were trying to do creative workarounds the physical nexus requirement that will no longer be needed.
Many of the critics of the South Dakota law were concerned that navigating sales taxes for all 50 states for a small mom and pop shop or a start-up will stunt growth and innovation. The Court, however, noted that South Dakota's law affords small merchants a reasonable degree of protection because it does not apply unless you have sold more than $100,000 of goods into the state or engaged in more than 200 separate transactions.
So while we don't know the specific rules, we do know this will complicate things. Online retailers, or even service providers, will now have to analyze what are likely to be 50 state laws dealing with sales tax for out of state businesses. There is already tremendous variety with varying rates, some states not charging sales tax for services, some only charing on certain services and there could be a variety of different thresholds tested by various states to determine the limits.
While the shop that may occasionally mail a knick-knack out of state is not likely to be impacted, anyone that provides goods or services across state lines will have to start paying attention and may want to start looking at software providers or consider obtaining your sales permit in other states or consider becoming foreign qualified in states where you do a substantial amount of business.