sales tax nexus

Wayfair II: Congress strikes back

 
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Posted by Evan Piccirillo, CPA

In June of 2018, the Supreme Court rendered their Wayfair Decision, apparently giving states license to much more aggressively legislate sales tax laws for out-of-state vendors. With the longstanding and archaic physical presence standard seemingly abolished, states and their local jurisdictions were granted a method of increasing tax revenues without going through the unpopular process of raising tax rates, but instead increasing their tax base. What a concept!

Obviously, businesses dealing primarily in interstate retail sales were most upset to hear this news. Cost of compliance with respect to registering to do business and perpetually filing various tax returns in many jurisdictions can be burdensome. In addition, states might seek to retroactively impose tax on prior-period sales, opening an unanticipated floodgate of tax, penalties, and interest. Smaller businesses that lack the infrastructure to deal with these compliance matters are particularly vulnerable. Since sales and use taxes are “trust-fund” taxes and business owners can be held liable, the exposure for businesses in these areas could be crippling.

Arguably, the primary concern over the Wayfair decision is the uncertainty left in its wake. Some states have acted quickly to pass laws aiming to scoop up as much cash as possible as quickly as possible. Business aren’t sure if they should scramble to register now and begin filing returns and collecting sales tax or if they should take a wait-and-see approach.

Luckily for businesses, Congress has stepped in to save the day (you don’t hear that very often). A bipartisan bill with a good chance of passing was introduced in the house (you don’t hear that very often either) called the “Online Sales Simplicity and Small Business Relief Act.” What the bill lacks in naming creativity, it makes up for in substance. The bill seeks to clear up problems and provide structure and order left in the pandemonium created by the Court’s decision.

The bill sets a cut-off date for sales prior to June 21, 2018; no sale tax collection on transactions prior (which is the date the decision was rendered). It calls for a phase-in of compliance beginning in January of 2019. It also establishes a small business exemption for sellers with gross annual receipts of less than $10 million per year. Lastly, the bill seeks to compel states to work together to develop a “compact” that defines what gives rise to nexus and decreases the burden of compliance on taxpayers.

Hopefully this shred of sanity in such a chaotic time will survive our legislative process and become law. Either way, businesses that have out-of-state retail sales should take steps to identify potential exposure in applicable jurisdictions, paying special attention to those states that have already passed legislation that ignores the physical presence standard and act accordingly.

The taxes, they are a-changin'

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Posted by Courtney Kopec, CPA

A recent Supreme Court decision upheld a South Dakota sales tax law requiring sales tax to be collected by large internet retailers, such as Wayfair and Overstock, who are not physically present in South Dakota, but “maintain an extensive virtual presence.” The law applied only to out-of-state sellers who deliver more than $100,000 of goods or services into the state or engage in 200 or more separate transactions. For South Dakota, a state with no income tax, the effect of the losses from online sales tax revenue to state and local services was critical. While the Supreme Court decision seems reasonable, it effectively gutted the bright-line physical presence standard established by the Quill decision. Prior to the Supreme Court decision, businesses relied on the Quill decision to avoid nexus (a connection to a state upon which the obligation to pay or collect sales tax is based).

The physical presence standard limited the burden of businesses required to collect sales tax to those with a physical presence, such as an office, employee, or inventory. In this new decision, the Court reasoned: “Each year, the physical presence rule becomes further removed from economic reality and results in significant losses to the States. These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.”

The Court opinion further explained that the physical presence test espoused in Quill was “flawed on its own terms” and could no longer uphold, because a business need not have a physical presence in a State to satisfy the demands of due process. This resulted in market distortions caused by the desire of business to avoid tax collection and a “judicially created tax shelter for businesses that limit their physical presence. … [the] rule produces an incentive to avoid physical presence in multiple states. And this Court should not prevent States from collecting lawful tax through a physical presence rule.”

What’s next for nexus?

Other states, including New York, that passed similar sales tax legislation based on “click-through nexus” as far back as 2008 may now rely on the South Dakota law as a constitutionally upheld example. The Supreme Court noted the effects of the South Dakota law as minimizing the burden on interstate commerce by including a safe harbor provision on certain transactions “so small and scattered that no taxes should be collected,” forgoing retroactive application, and through the Streamlined Sales and Use Tax Agreement providing state-funded sales tax administration software intended to reduce compliance costs. While the South Dakota law has been constitutionally upheld, the Court did not address economic nexus laws in other states, nor the possibility of imposing sales tax retroactively.

Because no international treaty provisions apply to sales tax, foreign sellers are subject to the same rules as domestic sellers.

Will states seek back taxes?

In its case, South Dakota noted that advances in computer technology have made it easier to determine appropriate sales tax based on the purchaser's location and that requiring such "poses a minimal obstacle."

In the summer of 2017, the Multi-State Tax Commission Online Marketplace Seller Voluntary Disclosure Initiative offered sales tax amnesty. Twenty-five states offered to waive all past tax, interest, and penalties for companies that agree to register for and collect sales tax for online sales going forward.

Therefore, it stands to reason that states will engage in litigation to verify how much sales tax revenue they can attempt to collect and the constitutionality of the sales tax statutes already in place. However, the guidelines written in the decision stressed: “The Court has consistently explained that the Commerce Clause was designed to prevent States from engaging in economic discrimination so they would not divide into isolated separable units.”

Federal legislation from Congress has proposed a destination-based collection system based on the location of the buyer and the local sales tax rate where the buyer receives the product.

What about my company’s exposure?

The evolving concept of nexus also applies to income and franchise tax, so a good understanding of the regulations is critical. The analysis and interpretation of these laws is challenging, in part because the Court’s most recent decision upended prevailing state statutes. Now, a modern “economic nexus” standard is required, but not yet written nor agreed upon by the fifty United States. We can expect revised statutes based on a new form of nexus to potentially broaden the states’ claim on income and franchise tax.

While the Court favors prospective legislation, companies that have received notice from state taxing authorities regarding past sales transactions should not consider the Court’s recent decision as constitutional protection.

Our recommendation

When a sales transaction is complete, it is difficult to impossible to retroactively collect sales tax for which the taxpayer may be responsible upon audit. What should have been a tax collection process becomes an expense to the seller.

In states that already have sales tax requirements for online sales and have enacted legislation similar to South Dakota, such as Georgia, we recommend registering to do business in that state and complying with sales tax collection. The odds are they will offer some type of amnesty.

If a state has not yet enacted legislation, we recommend a “wait-and-see” approach that may offer prospective amnesty. This decision gives some certainty that companies with sales in other states will have to register and collect sales taxes according to each state’s laws.

If your business has transactions out-of-state and you would like to review whether your business has nexus in another state, contact your CPA to review the latest guidelines.

Taxability of software can wear you down

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Guest post by Mark L. Stone, CPA, MST

This week, the REM Cycle is pleased to welcome Mark L. Stone of Sales Tax Defense LLC as  guest blogger. Mark is an expert on Sales and Use Tax, and has served as an expert witness, testifying in tax court on behalf of his clients. Mark can be contacted here.

Software is prominent in today’s world.  Just to read this blog post, you’re using software.  It’s everywhere.  But it wasn’t prominent when most sales tax law was written and that’s an issue.  Trying to fit the definition of software into a pre-internet world tax code is like trying to fit a square peg into something even worse than a round hole.  The states are catching up though and issuing a lot of guidance about what software is, the taxability of different types of software and whether certain services are actually the sale of software.

The definition of software in many states is usually something along the lines of a set of coded instructions designed to cause a computer or automatic data processing equipment to perform a task.  That’s Georgia’s definition.  But some states, like Maryland, don’t even have a formal definition of software in their tax code.

Knowing this information, here’s a few helpful hints to understand the taxability of software:

  1. Understand that what you believe you’re selling and what you are selling as defined by the tax law are often two different things. For example, “software as a service” is not defined under the tax law in many states.  If you operate in one of those states, what are you selling then?
  2. There is usually a difference between prewritten software (aka canned software) and custom software.  Sometimes combining two pieces of prewritten software does not quality as custom software.
  3. In certain states, there are situations where you can be selling taxable prewritten software but a separately stated charge for customizations to that software are not subject to tax.
  4. If you host software that customers access through the internet, there is often specific information or documentation that must be maintained to prove that customer is located in a different state.
  5. There are often very specific rules relating to software sold via the “load-and-leave” method – both for taxability purposes AND for nexus purposes.
  6. SHOCKER SPECIAL:  If your customers access software electronically and you pay a third party to host that software, it might create nexus with a state.  That means you might owe tax in a state that you didn’t realize you had any connection with.

Someone once said that a computer programmer is a machine that turns coffee into code.  If you sell software, let us be the machine that turns your tax problem into… well... not a tax problem!

This article originally appeared here.

The Multistate Tax Commission’s sales tax amnesty for internet sales has closed

Posted by Courtney Kopec, CPA

Recently, the states have signaled that their sales tax regulations for sellers of online goods will change yet again.

First, the window has closed on the Multistate Tax Commission Online Marketplace Seller Voluntary Disclosure Initiative’s offer for sales tax amnesty.  Twenty-five states offered to waive all past tax, interest, and penalties for companies that agree to register for and collect sales tax for online sales going forward. 

 
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Second, South Dakota has filed a petition to have the Supreme Court overturn the landmark Quill case because the proliferation of internet sales has too much appetizing tax revenue on the table left uncollected by the states.  And so going forward the states’ goal is to force out-of-state-sellers to collect sales tax by expanding the definition of nexus, data sharing, and enforcement which have been the factors that would allow states to compel taxpayers to comply.

When must I collect sales tax?

Taxing authorities require businesses to pay or collect tax based on nexus, which is their connection to the state.  The 1992 Supreme Court case Quill Corp v North Dakota limited the burden of businesses required to collect sales tax to those with a physical presence:  in general, an office, employee, salesperson, or inventory physically present in the state creates physical presence nexus.  However, physical presence is just the starting point and not the only determining factor.  The state’s narrow application of the physical presence test allowed for the creation of economic nexus that is generally triggered when a company has a purposeful direction of its business activities within a state rising to a substantial level.

New York State has been said to lead the way in proposed legislation defining economic nexus.  In 2008, New York State amended the definition of vendor and created “click through nexus” (sometimes referred to as the “Amazon laws”) with the intention that large internet retailers with no physical presence in the state be required to collect sales tax if they pay commissions to in-state residents and gross receipts exceeded $10,000 during the preceding 12 months.  Then in 2015 New York proposed that “marketplace providers” collect and pay New York State sales tax at the point of sale when the transaction takes place whether the actual seller is located within or outside the State.   In October 2017, the state of South Dakota filed a petition for certiorari in the U.S. Supreme Court urging it to "abrogate Quill's sales-tax-only, physical-presence requirement."  In its appeal South Dakota noted that advances in computer technology have made it easier to determine appropriate sales tax based on the purchaser's location and requiring such "poses a minimal obstacle."  For a foreign seller of goods:  “Tax treaties do not cover the taxing activities of the States” (1983 Supreme Court, Container Case).   Therefore, because no international treaty provisions apply to sales tax, foreign sellers are subject to the same rules as domestic sellers.

Cover your bases

If you engage in internet sales and this is confusing to you, join the club.  The statutes are evolving continually in reaction to the changing landscape of retail sales.  However, the evolving concept of nexus may also apply to income and franchise tax, so being aware of and understanding the regulations is critical.

Another important thing to keep in mind is that when a transaction is complete, it is impossible to go back later and collect sales tax for which the taxpayer may be responsible.  Under audit, what should have been a tax collection process becomes an expense to the seller.

The analysis and interpretation of these changing laws is challenging. If your business has transactions out-of-state and you would like to review whether your business has compliance requirements in another state, contact your CPA or trusted advisor to review the latest guidelines.