The U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair revolutionized sales tax by removing the “physical presence” requirement for sales tax nexus. This provided state and local governments with greater taxation authority over remote transactions and changed the tax landscape for businesses that sell tangible personal property or provide services that are subject to sales and use tax.
While physical presence still establishes traditional nexus in a jurisdiction, many companies with multistate sales are only now learning about their tax obligations under these new laws. To avoid penalties and additional tax liability, companies with multistate sales must understand their exposure to economic nexus through remote sales and take steps now to comply with their reporting and tax obligations.
Changing what Constitutes Nexus
With the increasing digitalization of the economy, state governments have been missing out on sales tax revenue from the growth in e-commerce transactions since 2000. To correct this, in 2016, South Dakota passed an “economic nexus” statute that required businesses with more than $100,000 in gross sales or 200 or more separate sales into the state within a year to register with the state and collect sales tax on sales into the state. This requirement applied even if the business lacked a physical presence in South Dakota. Sellers soon challenged the law as a violation of the U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota, which prevented states from collecting sales tax on e-commerce unless the seller had a “physical presence” in the state.
The U.S. Supreme Court upheld the law in South Dakota v. Wayfair, Inc. and overturned the “physical presence” nexus standard. Citing the digitization of the economy, the Court stated that “[e]ach year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States.” The physical presence rule, the Court held, “is an incorrect interpretation of the Commerce Clause.”
Since the Wayfair decision in 2018, all states with a sales tax have passed legislation to adopt the new economic nexus standard. In 2021, Kansas, Florida, and Missouri were the last states to do so. The Kansas and Florida laws took effect July 1, 2021, while the Missouri law takes effect January 1, 2023. With the exception of Missouri, the grace period for the adoption of economic nexus has expired in all states.
Increasing Cost of Noncompliance
Given the number of changes over the past three years, complying with economic nexus laws is still a key concern for businesses with multistate sales, and many of these businesses are unaware of their tax exposure. Wholesalers, for example, are often unaware of their reporting and tax obligations due to differences between states with a nexus threshold that includes gross sales and states with a threshold that includes only retail sales.
The financial risks of non-compliance continues to build. States facing budget shortfalls due to the COVID-19 pandemic are increasing the frequency and volume of sales tax audit and collection efforts which can lead to increased tax liability as well as additional interest and penalties.
Additionally, executives who are the “responsible persons” of companies that have economic nexus in a state could be personally liable for the related reporting and tax liabilities. A responsible person is generally an officer, director or employee of a corporation who has a duty to perform an act around the collection, accounting or payment of tax, but it does not necessarily have to be the person who oversees the filing of tax returns. Actions that can create personal liability for sales or use tax include failing to collect sales tax, diverting tax receipts for other purposes, understating the tax due, mishandling records and failing to file a tax return or other required reports.
Next Steps: Focus on Compliance
Companies with multistate sales should not delay compliance with economic nexus laws any longer. Tax leaders can protect their businesses and themselves by evaluating internal sales tax processes several times a year in an effort to identify potential compliance issues. They can implement this focus on compliance through a three-part process.
- First, companies should perform a nexus study to determine if they have registered in all required state and local jurisdictions and have fulfilled the appropriate tax reporting requirements. This activity will reveal whether the amount of economic activity has met the thresholds for registration and reporting in each state. This also may require a review of products and services for taxability, as some states base their economic thresholds on taxable sales only.
- Second, companies should then register to file sales tax returns in states and localities in which they have a reporting obligation, and in some cases, submit a voluntary disclosure of taxes that are past due. Under a voluntary disclosure agreement, a company can report and pay its prior period tax obligations, while avoiding penalties. Companies should do this as soon as possible, as they will lose eligibility to file a disclosure agreement if the state contacts them first.
- Third, companies should assess their internal systems and processes to ensure they are accruing and invoicing tax accurately. This requires ensuring that the company’s enterprise resource planning (ERP) system calculates sales tax on customer invoices correctly. They should also determine if they are paying the correct sales tax on expense, inventory, or asset purchases and if they have all the exemption and resale certificates for exempt customers.
Weaver Can Help
Weaver can assist companies with multistate sales evaluate their compliance with economic nexus statutes and help them identify potential sales tax issues. We can perform nexus studies, evaluate tax risks and liability, and help companies fulfill their reporting and tax obligations, including voluntary disclosures of past-due tax. Addressing economic nexus issues now is critical, as companies that take a proactive approach can avoid increased costs from interest and penalties. For information about how we can assist your company with nexus issues, contact us.
Economic Nexus Since the Wayfair Decision: Frequently Asked Questions About Sales and Use Taxes (Part 1)
The South Dakota v. Wayfair, Inc., decision and economic nexus laws have changed the landscape for taxpayers who sell…