Experts say recent court rulings create more questions than answers for online sellers
As internet access and adoption are rapidly increasing worldwide, the number of digital buyers has grown proportionately. In 2020, more than 2 billion people purchased goods or services online, and during the same year, e-retail sales surpassed $4.2 trillion U.S. dollars worldwide, according to Statista, a German company specializing in market and consumer data.
These figures, while impressive, don’t tell the whole story. One recent development has had more weight than others perhaps. It pertains to the collection of in-state sales tax on out-of-state purchases in an online retail setting.
On June 21, 2018, the U.S. Supreme Court ruled 5-4 in the landmark case South Dakota v. Wayfair. It allows states to mandate entities without a physical presence in a state with more than 200 transactions or $100,000 in-state sales to collect and remit sales taxes on transactions in the state. This decision overturned the Court’s 1992 previous decision in Quill v. North Dakota and 1967 decision in National Bellas Hess v. Illinois. After this most recent decision, states, retailers and other stakeholders have been asking “What’s next?”
J.T. Eagan, a clinical assistant professor of accounting at Purdue University Northwest and accounting professional, spent the first decade of his career working for a big, nationally known accounting firm and gained a great deal of experience with respect to state and local taxes.
“(Among the areas) I would specialize at the state level included income taxes, direct and indirect taxes — indirect meaning the sales taxes,” he said. “During that time, I saw the administrative costs that it takes to facilitate a proper sales tax collection.”
He said the administration is just mind boggling.
“I think it’s burdensome, plain and simple,” Eagan said.
Fast-forward to the South Dakota v. Wayfair case in 2018, and it gets even more interesting. Before June 2018, Eagan said Wayfair was following the laws on the books when it didn’t collect sales tax. At the time, the law had specified that a retailer had to have a physical presence in the state — also known as “nexus” — in which it was collecting sales tax.
The Supreme Court case challenged this notion, citing the concept of “economic nexus.” Economic nexus requires an out-of-state seller to collect and remit sales tax once the seller meets a predetermined level (a threshold) of sales transactions or gross receipts activity within the state. No physical presence is required.
This represents a line in the sand, if you ask Eagan.
“The Supreme Court found in favor of the state,” he said. “They basically said we are going to go ahead and allow economic nexus.”
Eagan said the world has just changed too much.
“But at no point did the court ever opine as to the text to determine this qualification,” he said. “What is the threshold for the number of transactions or total amount of sales?”
According to Eagan, the court never spelled this out. Instead, it’s up to the individual state to make the call. While South Dakota defined it as $100,000 or more in sales and/or 200 transactions, the court never made this determination.
“States are actually able to do whatever they want (with respect to sales tax),” he said.
“So, you see there are some states that have higher bright-line tests, lower bright-line tests, and some haven’t (made a determination).”
Further complicating matters is the fact that what’s considered taxable also varies state to state. Certain states tax food, and how food is defined is another wild card.
“If you have certain ingredients in your food, it can be taxable (or not),” Eagan said. “For instance, in the state of Indiana, a Twix bar is considered food because it has flour.”
Any candy that has flour is considered food — not candy — and therefore is not subject to the 7% tax, he said.
Eagan offers a local example of a retailer that’s impacted by this seemingly arbitrary determination. The Northwest Indiana retailer ChicagoLand Popcorn is a purveyor of gourmet popcorn. According to Eagan, CEO Dwayne Walker had to put in the time to determine if his product is considered “food” and tax exempt in a state that doesn’t charge sales tax.
If you ask Walker, his product is in fact food, but that distinction hasn’t really entered the equation at this juncture. In business since 2014, Walker said he has worked with a consultant to stay in compliance with tax code.
“The way we work (now) is that if you buy in Indiana, you get charged sales tax,” he said. “If you’re outside of Indiana, you don’t get charged sales tax. The reason that we did it that way … is we haven’t exceeded the (volume) threshold for any single state.”
However, if the rules change in any given state, Walker said he feels confident that he and his team are well positioned to pivot as necessary.
Staying in compliance
ChicagoLand Popcorn is a real-life example of the concept of nexus in execution. This term refers to the threshold for the number of transactions or the volume of sales in these different states, and how they can differ. In other words, it can be an accounting nightmare.
“So now this small Northwest Indiana business has to go through and think about and do the research on their product,” Eagan said. “To me, it’s also inhibiting interstate commerce to some extent.”
He said, at some point, a business may decide the rules are too complicated in a given state.
“And what a shame that is, because that totally defeats the entire purpose of the internet and having that amazing ability to effectively get what you want when you want from where you want,” Eagan said.
These legislative hurdles put the onus on the business owner to ensure they’re in compliance.
Eagan said businesses need to examine their books to determine if they’re close to the thresholds for transactions or sales. Eagan’s advice: Start small and start mitigating your exposures by looking at what amounts to the most activity on a state-by-state basis.
Mike Ralston, special policy counsel at the Indiana Department of Revenue, said business owners must be mindful of where they’re making sales and keep records to streamline future reporting.
“You need to look at total transactions in each state, to give you an idea whether you’re approaching the (threshold that means) you need to register in that state,” he said.
Although, this can quickly amount to a lot of paperwork and be resource intensive. In some ways the sales tax landscape is even more complicated than before.
Ralston said, while the Wayfair case addressed a very specific issue, it didn’t set a single rule. There has been a movement in recent years to more toward more uniformity.
In the meantime, Ralston said there are resources to help small business owners cut through the clutter. For instance, he recommends consulting the website, Federation of Tax Administrators and state tax commissions.
Being proactive is always the best approach, but if a business owner falls behind on sales tax remittance, Ralston is clear about the consequences.
“Just keeping your head down is not a good strategy,” he said. “You need to be aware of what your responsibilities are.”
He said if a business discovers they have outstanding obligations, they should move expeditiously to meet those requirements, because the liability is going to be cumulative.
“The longer you wait, the worse it’s going to get,” Ralston said.
Seeking out the help of a certified public accountant also can help on the front end.
Megan Applegate, a CPA with Michigan City-based Applegate & Co. PC, is well versed in matters pertaining to sales tax collection and remission. She helps clients register with the appropriate state and anticipate the transaction figures.
Applegate also helps clients file with the state, whether monthly, quarterly or annually.
She makes it a point to monitor real-world trends that might shape tax policy. For example, Applegate said the pandemic has brought with it the onset of remote work setups as the norm.
“Things have changed as far as how people work, and you had a lot more employees (who) possibly worked remotely,” she said. “The question then becomes: ‘do you have a physical presence there if you have employees (who) are working remotely?’”
Like all tax advisers, Applegate said she and her team are on the lookout for forthcoming guidance on this matter, as it would likely affect tax policy.