A whole new world: Three ways states are looking to collect more sales and use taxes from online retailers
Retailers that sell in multiple states will need to stay up to date on developments
This article has been reviewed for changes under The Tax Cuts and Jobs Act of 2017 (TCJA). The information provided in this article was not affected by the TCJA. However, note that the 2018 Wayfair decision does impact the information provided here. We will publish an update to this article soon.
Taxing the sale of goods has been a hotly debated topic since long before the Boston Tea Party in 1773. Now, a new battle is brewing around state sales taxes. This time, people aren’t dumping precious tea into the harbor under the cloak of darkness. Instead, the battle is playing out in courtrooms all over the United States.
The turmoil surrounding sales and use taxes stems from two facts:
- Sales and use taxes have a large impact on state and local budgets. Most states rely on sales and use tax to generate a significant portion of their annual revenue.
- The decision in Quill v. North Dakota prohibits states from collecting sales tax from online retailers with no physical presence in the state.
In 2015, states missed out on an estimated $26 billion in uncollected sales and use tax revenue. Thus, it’s no surprise that more states are directly or indirectly challenging the legal decision in Quill.
This article discusses the impact of Quill, and three ways states are devising challenges and alternatives to collect more sales and use taxes from online sales.
1. Making laws that may conflict with Quill
In 1992, the Supreme Court confirmed in the Quill case the long-standing rule that remote sellers must be physically connected to a state to have to collect and remit sales and use taxes to that state. That physical connection establishes nexus, which means the state can regulate the remote seller. Examples of a sufficient physical connection include a storefront, a warehouse, or employees or other agents located in the state.
At issue in Quill was a North Dakota regulation that presumed nexus if the seller advertised in the state three or more times within a 12-month period, even if the seller didn’t have a physical connection to the state.
After the Supreme Court ruled against North Dakota’s regulation in favor of the physical presence standard, states haven’t had much authority to require remote sellers to collect and remit sales taxes – even as consumers have increasingly migrated online to shop.
Some states are arguing “economic” nexus
Even if an out-of-state retailer doesn’t have physical presence, some states have enacted laws redefining nexus to include a significant economic connection. These states (including Alabama, Minnesota, Vermont, South Dakota, Tennessee, Oregon and Wyoming) define economic nexus as a certain amount of sales revenue or a certain number of sales in the state.
For example, South Dakota passed a law requiring retailers to collect and remit sales taxes if they had more than $100,000 in annual sales in the state during the prior year, or at least 200 separate transactions for delivery within the state.
When a state law could conflict with a Supreme Court ruling, the individuals or businesses affected by that law can file a lawsuit challenging the law’s constitutionality. The lower court then must decide whether the law is constitutional in light of prior Supreme Court decisions. That was the case with the recent South Dakota law, which attempted to extend sales tax obligations to retailers with a sufficient economic nexus. The South Dakota Sixth Judicial Circuit determined that the economic nexus law was unconstitutional in light of the Supreme Court’s earlier decision in Quill. That decision sets up appeals that could eventually make it to the U.S. Supreme Court unless Congress passes a bill addressing the matter.
2. Requiring retailers to report information on sales and purchasers
The Quill decision doesn’t affect a state’s right to require retailers to report sales figures and purchaser information to the state. Reporting this information can help states collect more use taxes.
While states impose sales and use taxes on buyers, states collect the two taxes differently:
- Sellers collect sales tax from buyers at the point of sale.
- States collect use tax from buyers annually on purchases that avoided sales tax.
States have a hard time enforcing the use tax because it’s hard to track purchases that avoided sales taxes. Retailers don’t have to report transactions to the state if the retailers don’t collect sales tax on the purchases. As one might expect, voluntary payment of use tax tends to be low, so states are increasingly missing out on use tax revenue each year.
In one example, Colorado’s solution is to require out-of-state retailers with more than $100,000 in annual sales in the state to report transactions and identify the purchaser. That way, the state can more easily collect use taxes from buyers. Retailers that fail to provide notice to the purchaser at the point of sale face a penalty of up to $5 per transaction. Retailers that fail to issue an annual purchase summary to purchasers may face a penalty of up to $10 per required summary. Finally, retailers who fail to file an annual customer information report with the state may face a penalty of up to $10 per required report.
Courts have held that this rule is constitutional, because remote sellers are required only to report taxable sales and purchasers to the state, rather than collect and remit sales taxes.
3. Using “marketplace laws” to collect taxes from large retail websites
Under the U.S. Supreme Court’s interpretation of Article 1, Section 8, Clause 3 of the U.S. Constitution, states can’t unduly burden interstate commerce. Small retailers, such as those that sell items on Etsy or eBay, often assert that having to collect and send sales taxes to multiple states would hinder their ability to run a small business.
Recently, Minnesota and Washington began requiring the larger corporations that run online marketplaces to collect and remit taxes, instead of the individual third-party sellers. Stay tuned on how this approach plays out in other states and the courts.
For online retailers and their tax professionals, it’s important to keep a close eye on developments in sales and use tax collection in each state – and be prepared to fulfill any new obligations or face potential penalties.