
In 2018, a landmark Supreme Court ruling forever changed the way companies that sell online manage their sales tax obligations. The case, South Dakota v. Wayfair, overturned the long-standing “physical presence” rule for sales tax collection, marking a new era for e-commerce businesses. Before the Wayfair decision, companies were only required to collect sales tax in states where they had a physical presence, such as a store, warehouse, or employees. This system allowed many online businesses to avoid collecting sales tax in states where they didn’t have a physical presence, giving them a competitive advantage over brick-and-mortar retailers.
However, as online transacting became more prevalent and state governments realized they were losing billions in potential revenue, a push to modernize sales tax laws gained momentum. The Wayfair decision introduced the concept of “economic nexus,” which requires online sellers to collect sales tax based on the volume of sales made in a particular state, regardless of whether the business has a physical presence there.
In this article, we will explore how the Wayfair decision reshaped sales tax compliance for companies that sell online and what businesses need to do to stay compliant with state regulations.
The Pre-Wayfair Sales Tax Landscape: Physical Nexus
Before 2018, sales tax compliance was relatively straightforward for most e-commerce businesses. Businesses were only required to collect and remit sales tax if they had a “physical nexus” in a state. Physical nexus typically meant having a physical location, employees, or inventory stored within the state. For example, if an online business based in Missouri sold products to customers in Illinois but had no physical presence in Illinois, it wasn’t required to collect Illinois sales tax.
This system allowed many online businesses, especially small ones, to avoid the complexities of multistate tax compliance, but it also created significant revenue losses for state governments. As online shopping grew into a dominant retail channel, states began pushing for reforms to level the playing field between local brick-and-mortar retailers and online sellers.
The Wayfair Case: A Turning Point
In South Dakota v. Wayfair, South Dakota challenged the physical presence rule by arguing that it was outdated and unfair in the digital age. The state passed a law requiring any retailer with more than $100,000 in sales or 200 separate transactions in South Dakota to collect and remit sales tax, regardless of physical presence. Wayfair, a major online retailer, was one of several companies that contested the law, but in a 5-4 decision, the U.S. Supreme Court ruled in favor of South Dakota.
The Court’s decision overturned the 1992 Quill Corp. v. North Dakota ruling, which had upheld the physical presence standard for sales tax collection. The Wayfair ruling introduced the concept of “economic nexus,” which allows states to require businesses to collect sales tax based on their economic activity within the state, even if they have no physical presence there.
Justice Anthony Kennedy, who wrote the majority opinion, noted that the previous rule was outdated in the age of e-commerce: “The Internet’s prevalence and power have changed the dynamics of the national economy… rejecting the physical presence rule is necessary to ensure that states receive tax revenues that are fairly owed.”
Economic Nexus: What It Means if You Transact Online
The introduction of economic nexus was a game-changer for companies transacting online. Under this new standard, a business must collect and remit sales tax if its sales or transactions in a state exceed certain thresholds. These thresholds vary by state but are typically based on either total sales revenue (such as $100,000 in sales) or the number of transactions (such as 200 individual sales).
For example, if an online retailer based in Texas sells $150,000 worth of goods to customers in California, that retailer now has an economic nexus in California and is required to collect and remit California sales tax, even though the retailer has no physical presence in the state.
Post-Wayfair Compliance Challenges
The Wayfair decision greatly expanded the number of states where online businesses are required to collect and remit sales tax, creating new compliance challenges. Suddenly, online retailers had to navigate the complexities of different tax rates, rules, and filing requirements in multiple states. With 45 states (plus Washington D.C.) imposing sales tax, compliance became a daunting task for many businesses, particularly small and midsize enterprises (SMEs) that had never dealt with multistate tax obligations before.
Here are some of the key challenges that businesses face in the post-*Wayfair* era:
1. Varying State Thresholds
Each state has its own economic nexus thresholds, and these can vary widely. Some states set the sales threshold at $100,000, while others may set it higher or lower. In addition, some states consider the number of transactions, which means that even if a business doesn’t meet the sales threshold, it may still be required to collect sales tax if it exceeds the transaction limit.
2. Different Tax Rates:
Sales tax rates differ not only by state but sometimes by locality within a state. This can make it challenging to determine the correct amount of tax to charge for each sale, especially for businesses that ship to multiple locations.
3. Complex Filing Requirements:
Once a business establishes nexus in a state, it must register with the state tax authority, collect the appropriate sales tax, and file periodic sales tax returns. Each state has its own filing deadlines, forms, and rules, making it difficult to keep track of all the requirements.
4. Penalties for Non-Compliance:
States are increasingly aggressive in pursuing businesses that fail to comply with their sales tax laws. Non-compliance can result in audits, penalties, and interest, further adding to the financial burden on businesses.
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What Companies Need to Do to Stay Compliant
To navigate the complexities of sales tax compliance in the post-Wayfair landscape, online retailers need to take several proactive steps:
1. Conduct a Nexus Study:
The first step is to determine where your business has economic nexus. This involves reviewing your sales data to identify the states where you exceed sales or transaction thresholds. Many businesses choose to work with tax professionals to conduct a comprehensive nexus study.
2. Register with State Tax Authorities:
Once you’ve determined where you have nexus, you must register with the relevant state tax authorities. This can involve applying for a sales tax permit and providing detailed information about your business.
3. Automate Tax Collection:
Given the complexity of sales tax rates and rules, many businesses find it helpful to use sales tax automation software. Tools like Avalara and TaxJar can calculate the correct sales tax for each transaction, ensuring that you charge the right amount and remit it to the appropriate state.
4. Track Sales and Transactions:
It’s important to continuously monitor your sales activity in each state to ensure that you remain compliant with changing thresholds. Some businesses may exceed a state’s nexus threshold mid-year, which would trigger the need to begin collecting sales tax in that state.
5. Seek Professional Help:
Sales tax compliance can be overwhelming, especially for businesses that sell in multiple states. Partnering with a tax professional or consulting firm can help ensure that you meet your obligations while minimizing the risk of audits and penalties.
Economic Nexus and Your Business: How The Brennan Group Can Help
The Wayfair decision has reshaped the sales tax compliance landscape for companies that sell online, introducing new complexities and responsibilities. While the concept of economic nexus has leveled the playing field between online and brick-and-mortar businesses, it has also created significant challenges for retailers that sell across state lines.
By understanding the implications of the Wayfair ruling and taking steps to stay compliant, you can avoid costly penalties and continue to thrive in today’s digital economy. If your business is facing challenges with sales tax compliance, it may be time to consult with experts like The Brennan Group to ensure you are meeting all state requirements and minimizing your tax liabilities.