02 07 2018

Wolters Kluwer Tax Expert Weighs In On Landmark Wayfair Ruling

The decision by the US Supreme Court to drop the physical presence requirement for states to impose sales tax will have an "incredible impact" on states' tax regimes and revenues, according to Mark Friedlich, Senior Director of Tax and Accounting, North America, Wolters Kluwer.

In an interview with Accounting Today, Friedlich, who is a member of the Senate Finance Committee Chief Counsel's Tax Advisory Committee on Tax Reform, said the South Dakota v. Wayfair ruling could generate USD10-USD25bn per year in additional revenue for the states.

It is expected to enable states to levy sales tax on those online retailers selling to other states but who lack a physical presence to trigger taxation under the existing physical presence test. The ruling said South Dakota's law to tax those without a physical presence in the state but who are engaged in significant economic activity is lawful.

Of the ruling, Friedlich said: "It has an incredible impact, particularly on those states that don't impose state and local income taxes, because it's their primary source of tax revenue. Right now there are 45 states that have various forms of sales tax laws. 31 of those have laws which will allow them to expand their tax collection beyond the physical presence standard. 16 of those states have laws similar to South Dakota. It's a safe bet that if they follow the South Dakota model, they won't be challenged by retailers or anybody else."

"Those 16 states have very simple sales tax laws. They have single rates, they collect on only the state level, and they have a threshold that essentially protects the moms and pops from the imposition of sales tax obligation, which could effectively put them out of business. And of the states that don't have a sales and use tax, virtually all of them have bills in their legislature which will be impacted by the Wayfair decision. For example, legislative leaders in Texas have told me that they are going to act quickly in passing legislation that is similar to South Dakota's legislation."

One area of uncertainty arising from the Wayfair decision is the issue of retroactivity, says Friedlich: "A key feature of the South Dakota law was that there would be no retroactive imposition of sales tax on ecommerce sellers. Justice Kennedy in the majority opinion did not deal directly with the issue of retroactivity, but did mention that retroactive application could presumably be dealt with by using existing tools and legal recourse. Theoretically, states can impose sales tax retroactively as far back as 10 years, but most states would not go in that direction, because it would be challenged."

However, he rejected the notion that the ruling would give states "carte blanch:" "What they've done is eliminate the physical presence requirement and effectively authorized South Dakota's economic presence standard. States that have an economic nexus standards law in place that are more complex than South Dakota's, or that don't provide protection for small businesses, are likely to simplify their statutes by following the South Dakota model. Doing so would effectively give them a free pass."

Friedlich added that smaller states are also likely to benefit more from the ruling than larger ones. "It's a win for the states, particularly the smaller, less populous states with fewer brick-and-mortar retailers. But states like New York and California, which have very complex statutes on the books, will have to make some significant changes to their laws. For example, there's the requirement that sellers remit taxes to each and every locality as well as the state. That doesn't meet the Wayfair standard, and retailers are likely to take the issue to court. There's a lot more activity in this area which will have to take place in order to have the sales and use tax regimes in place that will meet the Wayfair standard and provide New York and California with that protection provided by the Wayfair holding to collect additional tax revenue in this area."

Friedlich also anticipates that Congress will legislate to introduce a more consistent sales tax framework. "The decision is a lightning rod," he said. "There will be a confusing hodgepodge of different state laws with which many retailers will need to comply. This will impose an undue burden on all sellers, large and small. Congress will have to act, even though they haven't done so for 26 years. It won't happen before the November midterms, but there will be a lot of pressure for them to step in and simplify the sales tax collection and compliance process by providing one set of rates and standards that apply to all states that impose the sales tax."

Friedlich also observed that the Wayfair decision could have ramifications beyond sales taxes, noting the effects of the ruling "will have incredible legs."

"Once you eliminate the physical presence requirement, it opens up so many other things – such as corporate income tax, to which the new standard may eventually be extended to."

In a landmark decision, delivered on June 21, the Supreme Court overturned existing case law by ruling that a state can collect sales tax on remote sales even when the vendor does not have a physical presence in the state. The highly anticipated decision reverses the Supreme Court's pre-internet decision in Quill, released in 1992, which held that states cannot force sales tax collection obligation on vendors who do not have personnel or property in the state (the "physical presence" standard). In so doing, it gave the green light to South Dakota's economic nexus law that requires collection of the state's sales tax by internet vendors with at least 200 transactions or USD100,000 in sales to South Dakota residents.