States have been treading softly since the U.S. Supreme Court’s Wayfair ruling a year ago this week paved the way for taxing out-of-state online sales.
But the days of Mr. Nice Guy may be numbered.
Darcy Kooiker, transaction tax principal at Ryan LLC in Seattle, said she was in a meeting last fall with officials from the Washington Department of Revenue who wondered aloud, “When should we stop being nice?”
“All states are having the same musings,” she said. “I haven’t heard of any companies getting hit just yet, but adjustments will start coming this summer and fall. They’re scrubbing the internet for sellers to determine who should get letters.”
“My advice is to get into compliance as soon as you can,” said Timothy P. Noonan of Hodgson Russ LLP in New York. “The best thing you can do is flip the switch. It’s the guy who doesn’t do anything who’s going to have problems when California or New York comes knocking at the door.”
In the last 12 months, remote vendors have started collecting and remitting sales tax if they have economic nexus—a measure based on the volume of sales a remote vendor has in a state, instead of the now-dead physical presence standard used before the South Dakota v. Wayfair ruling. A majority of the 45 sales tax states, plus Washington, D.C., are working to enforce new rules.
So far, most states have campaigns to encourage remote sellers into compliance, but are also considering when they will stop dangling carrots and instead reach for the stick of audit letters—followed by assessments, penalties, and interest.
David Campbell, CEO of TaxCloud, a provider of tax compliance software, predicted enforcement will begin 30 days after the first filing is due for a group of merchants. “States operate under large machines,” Campbell said. “When one of these machines doesn’t see returns, it starts sending out letters, then another letter, then another. At some point, one of them is a notice of seizure.”
Up to now, Wayfair enforcement has been a low priority. “Nobody is talking about enforcement mechanisms, or even thinking about that,” said Verenda Smith, deputy director with the Federation of Tax Administrators. “Everybody is still in the stage of having elected officials work out what they want as a tax policy, generally getting their laws and guidance in place.”
That means some states—like Colorado, Louisiana, and others with strong home-rule cities and counties—will have to make their systems simpler before they can gin up enforcement. Colorado’s new remote sales tax law (H.B. 1240), which went into effect June 1, doesn’t set aside any money for enforcement or new audit staff.
“Colorado will hold off on penalties until they get things sorted out as far as collection is concerned,” said Joseph Bishop-Henchman, executive vice president of the Tax Foundation. “States are still working on their rules, they’re not using their sticks just yet. Wayfair doesn’t mean they can do whatever they want.”
‘Don’t Ruin It’
No state wants to be the state that invites congressional intervention or an unfavorable court decision, Bishop-Henchman said. After Wayfair was decided, Hawaii initially said it would impose collect-and-remit requirements retroactively to Jan. 1, 2018, which prompted other states to call up the Aloha State to complain: “You’re not going to be the state that ruins this for the rest of us,” Bishop-Henchman said. Hawaii backed off.
Many states have enacted their remote sales tax authority law with a “go-live” enforcement date months in the future. Others, like Colorado and Texas, put grace periods in place. Texas’ requirements took effect Jan. 1, but the Lone Star State said it wouldn’t start enforcing until Oct. 1.
Several states are joining with certified service providers (CSPs) that perform tax compliance functions for out-of-state retailers at no or reduced cost to vendors to encourage compliance. Pioneered under the Streamlined Sales and Use Tax Agreement, software companies such as TaxCloud, Avalara Inc., AccurateTax and Sovos Compliance LLC are now providing services to sellers in non-Streamlined states such as Pennsylvania and Illinois. Working with a certified service provider can relieve a seller of certain liabilities under audit.
The Marketplace Shift
In concert with marketplace facilitator statutes that many states are passing—laws that put the onus on large online marketplaces such as Amazon Marketplace, Etsy Inc. and eBay Inc. to collect and remit taxes on third-party sales on their platforms. States say marketplace faciltators and CSP programs result in very little revenue leakage and require minimum enforcement resources.
Illinois took the plunge earlier this month with a marketplace facilitator law (S.B. 689)effective Jan. 1, 2020, and a bill approved by lawmakers that would oversee certified service providers (S.B. 690). The CSPs would be permitted to retain 1.75% of their tax collections. The measure also requires remote sellers to collect taxes payable to cities and counties.
The Illinois Retail Merchants Association (IRMA) estimates this model, which puts most of the compliance burden on marketplaces and CSPs, will collect $460 million annually.
Ultimately, the only remote sellers left will be those “just trying to dodge this—folks taking the catch-me-if-you-can approach,” said Rob Karr, president and CEO of IRMA. “But I really believe CSPs will wind up working with the departments, or there will be amendments to these laws requiring CSPs to notify the authorities when someone doesn’t sign up. Then the departments will have a hot list of people to monitor.”
The approach will be attractive to other states, Karr said. “This simplifies auditing, because now they are going after maybe eight CSPs and however many marketplaces, rather than each individual seller,” he said.
“That is a significant simplification for everyone involved—for us, but also the sellers,” said Pennsylvania Revenue Secretary C. Daniel Hassell. “And this is part of what needs to be done to meet the undue burden test under Wayfair.”
Carrot, For Now
Such efforts reflect that states still see incentives programs as the best way to get vendor compliance as the one-year anniversary of Wayfair approaches, said Phil Horwitz, a director at Moss Adams LLP in Denver. “I think that’s the right way to do it,” he said. “We should still be in the carrot phase, and I do think the stick phase should be farther out.”
“We’re in a whole new world, and it’s important to remember the original rules of the road gave protection to vendors for collecting,” he said. “It’s also important to recognize that not everyone who’s not collecting is a bad actor. A lot of people still haven’t gotten the word about Wayfair. A lot of people we talk to are still surprised about what Wayfair means.”