Supreme Court online tax decision also impacts charities
Nonprofits of all types sell a wide spectrum of products and materials online, from associations that sell downloadable educational materials to museums that market art reproductions to wildlife organizations that offer edible birdhouses. Organizations for decades only had to collect sales tax on online sales in states in which there was a physical presence.
That all changed in June 2018 when the U.S. Supreme Court issued its decision in South Dakota v. Wayfair and approved the imposition of sales tax collection obligations on an out-of-state seller based on the seller’s volume of sales activity in the state. Such activity is referred to as “economic nexus.”
States can now require online sellers to collect sales taxes even if the organization has no physical presence in the state. However, not all states have enacted an economic nexus standard, and in those that have, the laws do not always fall squarely within Wayfair, making compliance extremely challenging for online sellers, nonprofit and otherwise.
Prior to the Wayfair Decision
Since the advent of Internet sales, the question of sales tax collectability has dogged the states and the courts, and Wayfair is not the U.S. Supreme Court’s first ruling on the subject. In 1992, the U. S. Supreme Court issued its opinion in Quill Corporation v. North Dakota, which limited a state’s ability to impose its sales tax collection obligations on an out-of-state retailer.
In Quill, the Court held that only a retailer that had a physical presence in a state by means of employees, stores, warehouses, or the like was required to collect such state’s sales tax. The Quill decision was one of the main reasons why many online retailers, including nonprofits, did not have to collect sales tax on sales to out-of-state residents.
Revenue-hungry states in recent years have tried all sorts of means to circumvent the Quill standard. For example, Colorado required out-of-state retailers to report information about sales to Colorado residents, and Massachusetts asserted that a retailer’s cookies on a customer’s computer created a physical presence in the state.
Other states enacted “economic nexus” laws that intentionally flouted the Quill physical presence requirement by asserting nexus (or a “sufficient connection” with the state) based on the number and/or dollar amount of sales into the state. One such state that enacted an economic nexus law was South Dakota, and South Dakota’s economic nexus law was at the heart of the Wayfair case.
To understand the state of play with regard to the myriad current sales tax statutes, it is important to understand the details of the statute at issue in Wayfair and the specific ruling. Wayfair involved three major internet retailers (Wayfair, Overstock, and Newegg), which challenged South Dakota’s economic nexus law. South Dakota’s law requires an out-of-state retailer to collect South Dakota’s sales tax if the retailer makes more than $100,000 of taxable sales of property or services into the state or makes taxable sales into South Dakota in 200 or more transactions in the previous or current calendar year.
In a 5-4 vote, the U.S. Supreme Court ruled that South Dakota’s economic nexus standard was constitutional and not an undue burden on interstate commerce. The opinion lists three aspects of South Dakota’s tax system as features that “appear designed to prevent discrimination against or undue burdens upon interstate commerce:”
The South Dakota law, by means of the dollar amount and volume of transaction thresholds, applies a safe harbor to protect those retailers that transact only limited business in South Dakota from having to comply with the law.
The South Dakota law by its own terms ensures that no obligation to remit the sales tax may be applied retroactively. Whether such collection obligations could and would be imposed retroactively by states for prior years on out-of-state retailers has been a much-debated topic. The Court’s limited comment on retroactivity seems to dictate that such collection obligations should not be imposed retroactively.
South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement. This agreement serves to standardize taxes and reduce administrative and compliance costs by requiring a single, state-level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules.
The agreement also provides sellers access to sales tax administration software paid for by the state. Sellers that choose to use such software are immune from audit liability. The court’s comment on South Dakota’s participation in the agreement can be read as suggesting a requirement that a state be a member of the agreement for its out-of-state seller collection law to be valid under the Court’s decision.
These three features can be expected to guide other courts in evaluating whether sales tax statutes of other states meet the Commerce Clause provision of the U.S. Constitution requirements so as to be upheld like South Dakota’s law.
Not surprisingly, following the Supreme court’s decision, states rushed to alter their existing standards to take advantage of the court’s liberalization of the nexus rules. More than half the states currently have some form of such economic nexus laws or regulations that require out-of-state retailers that satisfy that state’s particular economic nexus threshold to collect and remit sales tax to the state, regardless of the seller’s degree of physical presence in the state.
Not all states with an economic nexus standard meet all three of the criteria noted in the Wayfair decision. Accordingly, many years of further proceedings can be expected across the 45 states that impose sales tax, as unique situations in the states’ economic nexus laws are tested against the standards of the Wayfair case.
Like other online sellers, nonprofit managers should evaluate whether the Wayfair decision will now require your organization to begin collecting sales and use taxes in states where you have not previously done so. Your organization should move cautiously in evaluating compliance with the expanded collection obligations. At this time, the situation is highly changeable. Approximately 35 states have some kind of economic nexus rules, with similar laws or rules pending in at least three more states. However, some of these laws and rules differ in significant ways from the South Dakota law upheld by the Supreme Court.
As you approach your sales tax compliance obligations, if your organization is making taxable sales, you should collect sales tax in states where you have a physical presence. Plus you should collect sales tax in South Dakota, if you meet the economic nexus thresholds of more than $100,000 of taxable sales of property or services into the state taxable sales into South Dakota in 200 or more transactions in the previous or current calendar year, as that statute has specifically been upheld by the Supreme Court.
Next, you should consider whether you meet the economic nexus thresholds for other states that have enacted such thresholds. If you do, during this uncertain time, you will have to consider your own risk appetite in determining whether to collect sales tax. A number of these statutes are likely to be subject to litigation if such statute does not embody the three principles of the Wayfair case discussed above that might guide other courts in evaluating whether sales tax statutes meet the Commerce Clause’s requirements.
Enforcement has already been stayed for a time in a few states due to ongoing litigation and is currently suspended in Tennessee. As you make this decision, you should consider whether there are particular risk factors, such as a large volume or dollar amount of sales, that may be relevant.
Once you have begun collecting sales tax, you will likely find it difficult to stop as you will be registered with a state that expects continued, periodic filing of sales tax forms and remittance of tax absent an affirmative showing that you are no longer obligated to collect and remit tax.
Finally, much more guidance will be forthcoming in this very active and important area in our increasingly Internet- based economy. If your organization is an active online seller, you will need to proactively monitor these developments so that you can adjust and budget accordingly.
Walter R. Calvert and Cynthia M. Lewin are partners at Venable LLP. Calvert focuses on public and project finance and federal, state, and local taxation. His email is firstname.lastname@example.org. Lewin is chair of the Nonprofit Organizations practice. Her email is email@example.com. This column should not be considered legal advice.