US Supreme Court and Sales Tax Nexus: Wayfair will argue What’s Fair?

Published on March 26, 2018 by Cheryl Ganim in State Local Tax, Tax Services

Wayfair, Inc. and other internet sellers will have their day before the Supreme Court of the United States to argue whether or not state taxation on interstate commerce is constitutional[1].  On April 17, 2018, state sales tax nexus standards will be argued, as well as how states can fairly subject out-of-state businesses to collect their share of taxes. The more difficult question taxpayers, states and the Supreme Court will face will be less about a physical presence standard, than how to measure nexus.

The US Supreme Court decided that a state has the power to exercise its taxing authority against an out-of-state vendor if the vendor has a “physical presence” within the state in National Bellas Hess in 1967 and reaffirmed its applicability twenty-five years later in Quill[2] in 1992. The US Constitution’s Commerce Clause[3] sought to restrict states from discriminating against or interfering in interstate commerce by granting authority to Congress to regulate commerce.

States obtain a significant portion of their revenue from sales taxes. The states currently do not have uniform measures for sales tax nexus and have begun adopting multiple varying standards for nexus in order to subject out-of-state businesses to their tax regimes. The abundance of varying state sales tax nexus standards has made it burdensome for multi-state businesses to maintain compliance.

According to a 2017 Bloomberg BNA survey[4], the states have numerous methods for determining nexus. The complexity can be an expensive trap for the unwary taxpayer.

• States may tax sales made by the mail-order division of a business where that business’ only physical presence in the state is unrelated to the mail-order division.[5]
• Hiring an unaffiliated printer.
• Making remote sales into a state and hiring a third party to refer a customer via internet click-through is also enough to create nexus in 15 states.
• Drop shipments to customers.
• Ships from unrelated distribution center.
• Investment in a partnership or LLC.
• Click-through nexus – Eighteen states indicated that using an internet link or entering into a linking arrangement with a third party in the state is sufficient to create nexus if the relationship results in sales under $10,000. The number of states imposing nexus increases to 27 when the relationship results in more than $10,000 in sales.
• Short-term accommodations facilitated by a third party such as Airbnb. Twenty-five states said the collection obligation is imposed on the owner, and only 15 states said they impose this obligation on the third-party facilitator.
• Temporary presence – the majority of states said that holding at least two, one-day seminars was sufficient to create nexus.
• States almost unanimously agreed that nexus is created when a representative visits the state in order to customize canned software.
• Nineteen states indicated that entering the state solely for the purposes of providing disaster relief was sufficient to create nexus.
• Other activities that may cause nexus for remote sellers:
  • Agent warranty services
  • Employee visits to customers
  • Agent selling property in state
  • In-state affiliate sells property
  • Web link to in-state third party
  • Sells digital magazine or newspaper subscriptions
  • Loyalty points program
  • Selling gift cards
  • Agent or employee installing or delivering property
  • Providing customer assistance
  • Delivering merchandise
  • Delivering in returnable containers
  • Utilizing a third-party distributor
  • In-state phones or kiosks

Before internet sales and common carrier shipping were commonplace, physical presence was a more accurate predictor of whether a seller might have a significant physical presence in a state. Given the (incomplete) list of sales tax nexus causing activities above, physical presence does not accurately track a seller’s volume of sales in a state.

Ohio, Washington, and West Virginia have enacted laws, upheld by state courts, which impose other types of business taxes on out of state businesses without regard to physical presence. Ohio enacted a “factor presence” law which imposes a Commercial Activity Tax[6] on any business with at least $500,000 of Ohio gross receipts. Washington imposes a business and occupancy (B&O) tax[7] on the privilege of “engaging in business activities,” measured by gross receipts. West Virginia taxes credit card companies with customers, but no employees or property, in the state.

Alabama, Mississippi, and Tennessee have adopted economic nexus sales tax provisions which ignore physical presence completely.

 Almost half the states have adopted click-through nexus sales tax laws, which expand physical presence.

Ten states have adopted statutes requiring non-collecting retailers to provide a “transactional notice” at the time of purchase to the customer that the purchase may be taxable.

The US Supreme Court’s decision will be the most significant guidance states have to help them adopt nexus laws that are fair and constitutional since National Bellas Hess and Quill.

[1] SOUTH DAKOTA., Petitioner, v. WAYFAIR, INC., ET AL, Respondent.

[2] National Bellas Hess v. Department of Revenue of Illinois, 386 U.S. 753 (1967) and Quill v. North Dakota, 504 U.S. 298 (1992).

[3] Article 1, Section 8, Clause 3 of the U.S. Constitution.

[4] 2017 Survey of State Tax Departments, Special Multistate Tax Report, Vol. 24, No. 4, Bureau of Nat’l Affairs, Inc.

[5] Nat’l Geographic Society v. California Bd. of Equalization, 430 U.S. 551 (1977).

[6] Ohio Rev. Code § 5751.01(I).

[7] Wash. Rev. Code § 82.04.220.

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