Wayfair Turns Five | Sales and Use Tax Nexus

Source: RSM US LLP.

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Executive summary: Wayfair turns five, but may need some self-reflection

Five years ago, the U.S. Supreme Court issued the most important state tax nexus decision in three decades. The South Dakota v. Wayfair decision overturned the long-standing ‘physical presence’ nexus standard for sales and use taxes established under Quill v. North Dakota in 1992, allowing states to impose sales and use tax collection and remittance obligations on remote sellers based solely upon their economic activity in a state. The shift in focus from physical to economic presence represents a seismic shift for nexus analysis, giving states broad authority to tax remote sellers.

After five years, Wayfair has emerged from its teenage years to adulthood, but some might argue the decision and its impacts are still in their infancy. Too many questions remain, especially for growing businesses increasing multistate sales through ecommerce and fulfillment platforms.

Where Wayfair has taken tax policy and the state of the states

From a policy perspective, Wayfair may have been the most significant development in the history of state taxation. The Quill decision presented a myriad of issues that were fiercely debated for a quarter century. Most notably, the question of state taxing authority versus constitutional restraints on interstate taxation occupied policy makers and practitioners. There were numerous attempts by the states to interpret the Quill limitations narrowly and even overturn the decision through federal legislation.

As significantly, Quill was arguably unworkable in a technology driven service economy. The age of electronic commerce began within a handful of years after the decision and continues today. With the proliferation of internet consumerism and cloud services blurring state borders, total lost sales tax estimates reached over $20 billion per year before 2018. In theory, the complementary use tax should have accounted for that lost revenue, but individual consumer use tax compliance was rare and individual audits by the states were costly and ineffective.

Ultimately, Quill was inconsistent with ideal sales tax policy which dictates that sales tax should fall on all final consumption. However, the sales tax only works if the vendor collects the tax; and as noted, personal use tax compliance was virtually non-existent. Quill had created an impenetrable constitutional barrier preventing the imposition of sales tax on remote sales, leaving states to push physical presence boundaries without any significant progress in circumventing the decision.

Wayfair addressed many of these problems. In doing so, it shifted the balance between state taxing authority and constitutional restraints on interstate taxation decidedly toward the states. The decision placed the effective burden of remote seller sales tax collection on the vendor with a market-activity approach, allowing states to collect the lost sales and use tax revenue without creating any new taxes in the process.

The post-Wayfair landscape contributed to healthy state budgets and increased state revenues. State adoption occurred quickly, from mid-2018 through 2023. The average quarter-over-quarter growth rate for state sales and use taxes between 2005 through the second quarter of 2018 was approximately 3.4%. The growth rate since the third quarter of 2018 through the end of 2022 was over 8%, approximately 5.25% through the quarter preceding the pandemic. However, there are other dynamics to consider including high inflation with robust consumer spending fueled by a post-pandemic spending spree at least partially attributed to individual relief payments. But maybe more telling, between the Great Recession and the end of 2022, only a single quarter saw negative growth and that was the second quarter of 2020 during the first few months of the pandemic. Sales and use tax collections have been robust, rarely faltering even during periods of economic distress, and supported by many more sales and use taxpayers thanks to Wayfair.

With the knowledge that Wayfair is firmly rooted in the U.S. state and local tax regime after five years, RSM state and local tax specialists describe the current landscape below and offer solutions to the complexity that is economic sales and use tax nexus.

The sales tax nexus landscape is well-established, but questions remain

Economic sales tax nexus today

Wayfair economic sales tax nexus and marketplace seller nexus was adopted and enforced by every state within a few years of the decision. Florida and Missouri held out the longest, but both states enacted economic nexus legislation in 2021, effective July 1, 2021, and Jan. 1, 2023, respectively. Small-seller safe harbors have generally been based on sales amounts, transaction quantities or a requirement that thresholds are met or exceeded for both sales and transactions. However, safe harbor provisions vary greatly. States with sales-only thresholds are no lower than $100,000, but thresholds can be as high as $500,000 in states like California and Texas. No state has solely adopted a transaction threshold. A number of states originally adopted both a sales and transaction threshold, but have since removed the transaction requirement, including Louisiana and South Dakota itself in 2023.

Marketplace facilitator nexus

Marketplace nexus provisions vary greatly among the states, including who is subject to the law. Many states have adopted broad statutory definitions of marketplaces, in some cases resulting in more than one party to a transaction qualifying as a marketplace. Recently, more states have amended their marketplace provisions to provide clarity on whether the tax applies to vehicle rentals, restaurant and food aggregation platforms, lodging and accommodation rentals, and local taxes. In some cases, facilitators may be required to collect certain state and local excise taxes or fees that would normally apply in addition to any sales taxes.

Many implementation questions remain with little guidance from the states to assist taxpayers years after the first marketplace enactments. For example, sellers using the marketplace may be unsure of how to report marketplace sales to states where they are already registered. Does the marketplace have the legal liability to collect the tax? Can a marketplace and a retailer selling on the platform agree to the liability of a transaction? How are marketplace sales treated for purposes of determining whether the seller has exceeded a Wayfair threshold for direct sales made outside of the marketplace? These questions will linger until the states can provide the appropriate guidance or legislative clarity. While many states have since provided FAQs and preliminary guidance, many of the posed questions remain unanswered or unclear across the states.

Middle-market remote seller considerations

Do exclude or exempt sales count towards the threshold?

One consideration for remote sellers who sell for resale or sell mostly exempt property and services is determining when and how to calculate the threshold for purposes of a state’s economic sales tax nexus law. Some states have provided guidance on whether an exempt or excluded sale should be included. Other states, by the nature of the statutory and regulatory structure, apply the threshold to all receipts from the state. In some cases, sales for resale may not be included in the threshold calculation, but other exempt sales such as generally exempt manufacturing equipment may still be used to determine whether the threshold is exceeded. Remote sellers of exempt property or services, and remote sellers who sell primarily for resale, should review each state’s threshold calculation closely.

Registration considerations

Another issue for remote sellers approaching or exceeding thresholds is determining when registration and collection is required. First, the time it takes to complete a registration with the taxing authority and add the new state to a seller’s sales and use tax compliance system can take upwards of a month. Some states have provided a short period of time for sellers first meeting the threshold to register and prepare before having to collect the sales tax. Remote sellers should closely monitor their sales and transaction activity in states where the threshold has not yet been exceeded. Second, sellers should be aware that most state registrations inquire when an economic nexus seller exceeded the threshold, or when the seller began doing business in the state. In some cases, a state may require additional sales evidence to substantiate that the threshold was not met in earlier periods. A number of states have initiated efforts to specifically audit the ‘doing business date’ on a registration. Taxpayers may need to consider voluntary disclosure or other mitigating remedies if they are registering in a state after having exceeded the threshold. Ultimately, economic sales tax nexus registrations cannot be considered a ‘one and done’ occurrence as taxpayers can continue to establish economic nexus in new jurisdictions with growing sales or through physical presence.

Local sales and use taxes

One issue of concern is the Wayfair decision’s effect on local option sales taxes. There are many local governments with the authority to impose sales taxes. This authority varies widely by state. Some localities in select states have authority to impose and administer their own sales and use taxes, often in ‘home rule’ jurisdictions. In these states, the local sales tax base can differ from the state tax. Fortunately, most states levy all taxes, both state and local, at the state level, administered by a single state tax agency and using the same tax base.

Alaska does not impose a state-wide sales and use tax, but over 100 local jurisdictions have the authority to impose a local sales and use tax at widely varying rates. Before Wayfair, this was mostly a concern for sellers physically located in those jurisdictions. Since Wayfair, a number of Alaskan localities have adopted economic sales tax nexus. Additionally, in 2019, the Alaska Remote Sellers Sales Tax Commission was established to simplify remote seller administration of local Alaskan sales and use taxes. Since that time, over 50 localities have adopted the uniform remote sales tax rules, providing some level of certainty to remote sellers.

Alabama, Louisiana and Texas have taken steps to ease remote seller collection administration for sellers without physical presence in the state. In Alabama, the state has created a simplified sellers use tax program with a flat rate and single point of collection. In Louisiana, which began remote seller enforcement on July 1, 2020, the state’s Sales and Use Tax Commission for Remote Sellers is a single collection point for sales tax due on sales to Louisiana customers. However, Louisiana remains administratively complex even though progress has been made to further ease those complexities. Texas also has enacted a single combined rate option for remote sellers.

In 2021, Chicago provided a nexus safe harbor for remote sellers with revenue under $100,000 derived from the city’s amusement tax as applied to electronically delivered amusements and the personal property lease transaction tax. For remote sellers with revenues higher than the safe harbor, the city may use a number of factors to determine if nexus has been established, including, but not limited to, whether the seller has physical presence in the city or advertising directed to city customers.

In Colorado, a number of home rule localities administer their own sales and use tax laws. Many of these localities have begun to adopt a uniform local Wayfair ordinance and are enforcing economic nexus on the local level. As of the date of this article, over four dozen local Colorado home-rule jurisdictions have adopted the model economic nexus ordinance.

Finally, some localities in states with local sales taxes have tried to enforce tax collection based on the Wayfair decision without a threshold or specific economic sales tax nexus law under broad interpretations of pre-Wayfair local tax law. Most of these attempts have failed, but taxpayers may not understand the legal limitations imposed by the decision and overpay to an aggressive locality. Ultimately, it should be clear that the complex and fragmented local nexus landscape will remain of significant concern to multistate remote sellers for the foreseeable future.

Physical presence nexus: Alive and well

In the decades before the Wayfair decision, many states expanded physical presence nexus through affiliate nexus, click-through nexus, cookie nexus and use tax notice and reporting requirements. Many of these laws continue to remain active methods to establish nexus for remote businesses.

Importantly, physical presence nexus itself was not replaced with economic nexus – meaning that the presence of offices, employees, sales forces, inventory or other presence in a state will continue to establish sales and use tax nexus for an out-of-state business. States will continue to apply these and other nexus expansion provisions to remote sellers who may not meet the gross sales or transaction threshold standards of economic sales tax nexus. Remote sellers should be prepared to examine nexus-creating activities from every perspective, and not just whether sales or transactions into a state exceed an economic nexus threshold. All taxpayers should understand that while Wayfair replaced the constitutional physical presence nexus standard with economic nexus, physical presence remains a viable method to establish nexus and a sales and use tax liability in a state or locality.

ASC 450 concerns

Understanding the proper treatment of contingencies from a financial accounting perspective, whether it be from a gain or a loss, continues to be a challenge – and remote sellers are not excluded from this analysis. Remote sellers should consider contingencies required to be booked related to potential gains from a refund claim or offset of an audit adjustment, or potential liabilities from exceeding economic nexus thresholds. Noncompliance with economic sales tax nexus could have substantial financial statement audit impacts. Due to the various effective dates of state economic sales tax nexus following the Wayfair decision, many businesses may not have timely registered. Some businesses chose to register prospectively in groups of states once it was easier to handle the onslaught of new compliance obligations. Timing differences between when the threshold was met and when collection began may result in material amounts of tax, interest and penalties.

The key is to know whether a liability is known or whether there exists a level of uncertainty. There is more likely to be a contingency when there is uncertainty that a gain or loss will ultimately be resolved. It is also important to understand when the contingencies are eliminated. Was there a change in the tax law? Was a tax audit finalized? Was a voluntary disclosure agreement executed? Knowing how and when to properly account for a liability or contingency either through booking an adjustment, making a disclosure, or relieving a contingency is of critical importance.

International sellers and state enforcement

Before the Wayfair decision, foreign-inbound sellers essentially had a sales tax nexus safe harbor because physical presence was the constitutionally-required nexus standard. Therefore, sales tax nexus was only a concern if the business established physical presence in the United States through, for example, offices, warehouses, inventory, salespeople or employees. After the Wayfair decision, foreign-based remote sellers are no longer protected by the physical presence safe harbor. While state sales tax audits of economic sales tax nexus compliance will likely focus on domestic businesses in the near term, inbound businesses may also begin to be audited for economic nexus compliance. There are a number of mechanisms states may use in enforcement against foreign sellers. Some considerations for foreign sellers include whether the foreign business has any presence in the United States, including real estate, bank accounts, or property owned by officers and owners of the business, and whether the foreign business is owned by a U.S. company. There are too many considerations to note here, but consider reading RSM’s article, 5 misconceptions for inbound businesses in a post-Wayfair world, for more information.

Foreign-inbound sellers are just one consideration for cross-border sales. United States taxpayers selling to Canadian customers should be aware of new ‘Wayfair-styled’ remote seller provisions imposed at both the federal and provincial (local) levels. While traditional state nexus concepts do not exist internationally, many VAT countries, including Canada, impose various tax and compliance requirements on remote sellers.

Tax automation solutions

Designing and deploying a manual sales and use tax process has become nearly impossible since the tidal wave of economic nexus legislation. With each new nexus jurisdiction that a business faces comes an array of requirements that include maintaining state and local tax rates, product and service taxability rules, and customer exemption certificate maintenance, just to name a few. One pain point that has become increasingly burdensome is exemption certificate management. Each state administers their own unique rules around what types of customer exemptions are permissible and what specific documents can be provided to sellers to substantiate such exemptions. As a business’ nexus footprint grows, it may discover their operations teams become engulfed in the certificate collection process with more states now in their purview. As if the process was not tedious enough, complex circumstances such as drop-shipments further exacerbate the situation. In some instances, sellers facilitating sales for resale may be asked to drop ship products to end users on behalf of their customers. In these cases, customers may not be properly registered with the tax authorities in which the end-users are located, sometimes inhibiting their ability to provide the proper exemption documentation and slowing down order processing.

Fortunately, there are viable tax engines available on the market that can integrate with a multitude of billing platforms to automate a business’ tax requirements. It is critical for taxpayers to fully understand their tax profile and invest ample time in configuring the tax solutions to ensure accurate, real-time customer calculations. Automated solutions can also be leveraged to manage use tax requirements on purchases and even assist with collecting expired or missing exemption certificates. Such solutions provide significant value by ensuring a higher level of accuracy, easing the burden of updating tax rates and rules in the infrastructure, and giving time back to stakeholders to invest in value-added activities. The current economic environment is unpredictable. Rising costs and elevated inflation have directly increased the tax base, further emphasizing the importance of correctly calculating and charging sales and use tax. Given the joint and several nature of the tax, neglecting the indirect tax process may lead to unnecessary tax bills for sellers.

Non-sales and use taxes

Wayfair addressed whether a state can require an out-of-state seller to collect sales and use tax when the seller lacks a physical presence in that state. However, the Supreme Court’s analysis in determining whether a state tax nexus law is constitutional under the commerce clause applies to all state taxes. States have used the decision to consider economic activity tests for non-sales and use tax nexus, like existing income tax factor-presence standards previously adopted in several states. A flurry of activity around non-sales and use taxes occurred after the decision as states expanded economic nexus beyond sales taxes, although few actions have occurred recently.

A summary of some of that activity is below:

Hawaii enacted a $100,000 sales or 200 transaction standard for purposes of the corporate income tax effective for tax years beginning after Dec. 31, 2019
Maine enacted a $500,000 sales, $250,000 payroll or $250,000 property factor-presence standard effective Jan. 1, 2022
In October of 2019, Massachusetts promulgated a corporate income tax nexus regulation presuming nexus from economic and virtual contacts when the volume of sales is over $500,000
The Pennsylvania Department of Revenue established a rebuttable presumption that corporations with $500,000 of gross receipts establish nexus beginning on or after Jan. 1, 2020
Philadelphia adopted a $100,000 threshold for the city business income and receipts tax
Texas adopted a $500,000 receipts threshold for purposes of the franchise tax effective for reports due on or after Jan. 1, 2020
Washington reduced the business and occupation tax threshold to $100,000

Noteworthy, the Hawaii and Texas thresholds are identical to each state’s economic sales tax nexus standard. Many of these actions are because of, or supported by, the Wayfair decision. It is important that businesses consider how Wayfair may impact their non-sales and use tax obligations, such as income and franchise taxes and gross receipts taxes.

Takeaways five years later

Unless a business operates in all 50 states and the District of Columbia, economic nexus remains an issue for any business operating over state lines. Is the post-Wayfair environment more symbolic of the death of nexus? Businesses might consider asking “where do we not have nexus?” when planning to minimize nexus. Business and entity structuring, sourcing, apportionment, remote work and numerous other state and local tax dynamics are more relevant than ever as negotiating the nexus landscape becomes more about proactive strategizes to optimize tax footprints. Focusing on sales and use tax nexus, businesses should consider the following.

First, businesses should understand their current operations and nexus footprint. A nexus study can provide valuable insight for a moment in time but must be updated after relevant business events like expansion, new hiring, and increased sales, or simply after extended periods of time. A process review is another valuable resource to understand the current state of the sales and use tax function from the purchase order to remittance of the tax. Process reviews can identify critical weaknesses and provide actionable next-step solutions to help streamline and manage risk in the sales and use tax compliance process.

Second, businesses should be able to identify their economic presence by tracking nationwide sales and transaction data monthly. Many of the economic sales tax nexus statutes require collection in the year that the relevant sales or transaction threshold is exceeded. Accordingly, historical analysis should not occur months after transactions occur. When sales or transactions near thresholds, taxpayers should be prepared to register and begin collection. An automation solution tailored to the specific needs and size of the business can help manage business changes and new nexus registrations.

Finally, beyond the basic aspects of responding to economic nexus, taxpayers must also be prepared to address the dozens of different state and local sales and use tax regimes. Taxing jurisdictions may have critical differences on how to treat sales and use tax exemption certificates, taxability and basic administration, let alone the very requirements of economic nexus itself. Are the products and services sold subject to tax? Are there applicable exemptions? What evidence do you need to justify an exemption? Those are just some of the questions related to the nuanced differences in sales and use tax regimes.

This article was written by Brian Kirkell, David Brunori, Mo Bell-Jacobs and originally appeared on 2023-06-08.
2022 RSM US LLP. All rights reserved.
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Wayfair Turns Five: A Coming of Age Story