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Taxation without Physical Location: What the Wayfair Decision Means for e-Commerce and Other Online Businesses

10.29.18

This article originally appeared in the November 1, 2018 issue of the San Francisco Business Times and Silicon Valley Business Journal.

Americans are used to hearing the refrain “we pay the sales tax” from mattress sellers and car dealerships during big sales weekends. The phrase “you pay the sales tax,” however, is something we’re all going to become a lot more familiar with in the wake of the Supreme Court’s ruling in South Dakota v. Wayfair.

That’s because the Wayfair decision reverses precedent set by 1967’s National Bellas Hess v. Illinois and upheld in 1992’s Quill v. North Dakota, in which the court ruled that states can only require companies to collect sales tax if they have “sufficient physical presence” in the state. In South Dakota v. Wayfair however, the court ruled that making physical presence the minimum standard is “unsound and incorrect.” The result is that states can now require businesses to collect sales taxes if they meet the lower standard of “economic nexus” in the state – a condition which state legislatures get to define on their own.

This is a big win for state governments, whose desire to overturn Quill has been intensified in recent years by the rise of e-commerce and the billions of dollars in taxes that go uncollected every year. (Residents in states with sales tax are supposed to file a use tax return with items purchased outside the state, but most do not). By requiring remote sellers to collect sales tax, states are expecting to see a huge increase in the sales tax revenue, especially as this upcoming holiday season approaches.

Unfortunately, the battle to recover this tax base will also likely result in significant collateral damage in the form of the burden it places on e-commerce businesses. Many small and medium-sized e-commerce companies run on thin margins and have little resources to devote to ensuring they are collecting the appropriate amount of sales tax on each order. Indeed, the reason the Court decided in the past not to require businesses to collect sales taxes on orders sent across state lines was that they acknowledged the serious administrative burden associated with this task.

While economists can debate the macro effects of the decision (will this lead to residents of states with complex sales tax structures being underserved? Will it lead to lower competition because of the additional administrative costs needed to start or operate an e-commerce business?), what businesses owners want to know is how this will affect their operations and profitability.

The first thing companies should know is that you don’t need to conduct a lot of business in a state to trigger economic nexus there. In South Dakota, the physical presence condition remains, but is compounded with an economic nexus rules that says if you have $100,000 worth of sales, or more than 200 transactions involving customers in the state during the current or previous calendar year, then you must collect sales tax on all transactions with customers in that state.

This type of safe harbor threshold is quickly becoming the norm, given that South Dakota’s definition is serving as a model for the dozens of other states that have passed or are in the process of passing similar laws.

Worse, companies have been given extremely short timetables to comply. The decision came in July but many economic nexus laws are already in effect and more will go into effect later this fall and early next year. Many businesses, having other, more immediate worries, still aren’t sure even where to start. And while there are technology solutions out there, they take time and expertise to implement, which many small and medium-sized businesses just don’t have.

While the impact of Wayfair has largely been on e-commerce, that doesn’t mean e-commerce businesses are not the only ones who need to evaluate the effect of the new economic nexus laws. Some states require companies that sell intangible goods, such as Software as a Service (SaaS), over the internet to collect sales tax if they have an economic nexus there.

Now that states are making it easier for taxpayers to trigger sales tax nexus in their state, SaaS, cloud computing and other service-based businesses who have never had to worry about sales tax (because the state in which they’re physically located doesn’t tax their products) may already be in non-compliance without even knowing it.

The Wayfair decision has major ramifications for all types of businesses – not just e-commerce operations. From nonprofits to private start-ups to public companies, BPM’s Corporate Tax Services group provides comprehensive tax strategies to businesses of all sizes and kinds. We have the expertise and experience to help you navigate the Wayfair decision and many other operational and financial challenges that impact your business. 

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