In June 2018, the Supreme Court handed down its decision in South Dakota v. Wayfair, the landmark case that effectively greenlit states’ efforts to assess sales tax collection and remittance obligations on businesses that lacked physical presence in their state. By July 2021, every state with a sales tax, plus Washington, D.C., and Puerto Rico, had passed these so-called economic nexus rules into law. But while Wayfair narrowly concerned sales taxes, states have increasingly sought to stretch the case to other types of taxes as well.
The growing issue of Wayfair creep not only represents a dubious stretching of the scope of the original decision; it also is sure to create substantial compliance challenges for e-retailers on top of the problems they already face. While state officials often like to think of economic nexus issues as settled now that they’re enjoying new sources of revenue, a lot needs to change even without adding new compliance burdens.
Just over a year after Wayfair was decided, Hawaii Senate Bill 495 was passed into law, applying economic nexus rules to business income taxation in the state. Sellers into the state with 200 or more transactions valued at over $100,000—the thresholds generally used in post-Wayfair economic nexus sales tax laws—became liable for income tax obligations.
Yet even here, the protections of the 1959 Interstate Income Act, or P.L. 86-272, still applied. P.L. 86-272 has long been chipped away at but still serves to protect businesses from income tax obligations in a state when their sole activity in the state is the solicitation of sales of tangible goods.
But just as states sought various methods to “kill Quill” in the leadup to Wayfair, states quickly began to explore ways to render P.L. 86-272 toothless. In July 2020, the Multistate Tax Commission released a report suggesting that the use of a number of common website functions would lose a business P.L. 86-272’s protection.
These website functions included: offering post-sale customer service via a chat button on the business’s website; offering remote repairs and automatic updates of digital products sold; offering extended warranty plans; posting job descriptions; and allowing applications to be submitted through the website, placing digital cookies on a customer’s device. Taken together, this laundry list meant that most e-retail businesses would lose the protection of P.L. 86-272.
Not long after the MTC released its report, California and New York began the process of implementing the recommendations. California did so peremptorily this February with a Technical Advice Memorandum, even announcing that the change would be retroactive to all open tax years. New York is at least following a more traditional process.
But while the MTC and California pointed to Wayfair for justification for further eroding P.L. 86-272, Wayfair provides no such thing. Not only does the Wayfair majority never so much as mention income taxes—except to mention South Dakota’s lack of one—the court’s justification for deciding as it did in Wayfair does not apply to income taxes.
The decision was based heavily on concerns that e-retail businesses were tax-advantaged compared with their brick-and-mortar counterparts. And while technically, consumers buying from out-of-state businesses that did not collect and remit sales taxes on their behalf were expected to do so themselves, most didn’t. E-retailers theoretically were able to effectively offer consumers tax-free sales, while their brick-and-mortar competitors could not. In practice, the largest e-retail sellers either had entered into voluntary collection agreements by this point (such as Amazon.com Inc.) or were hybrid operations that had nexus nationwide (such as Walmart Inc.).
No similar imbalance exists between e-retail and brick-and-mortar sellers in the income tax space. The existence of throwback or throw-out rules means that “nowhere income” that is earned in states lacking jurisdiction to tax it can instead be taxed in states that do. In other words, the tools to ensure tax parity between brick-and-mortar and e-retail businesses already exist even with P.L. 86-272 in place.
As things stand, millions of small businesses likely are out of compliance with their sales tax obligations, out of either ignorance or inability due to a lack of time and resources to comply with different states’ definitions, exemptions, and rates across the country. This problem has flown under the radar as out-of-compliance businesses either are keeping their heads down or remain unaware of their accumulating obligations, but this represents a ticking time bomb that will go off once states start enforcing compliance more assertively.
The National Taxpayers Union Foundation has put together a list of solutions for Congress to consider to alleviate the problem before this happens, while states can pursue greater uniformity and simplicity in the meantime. But the problem remains that economic nexus rules remain an albatross over many small- and medium-sized businesses across the country as things stand. Should they continue to extend to other taxes as well, the problem will only be compounded.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Andrew Wilford is the director of the Interstate Commerce Initiative at the National Taxpayers Union Foundation, which seeks to rein in states reaching across their borders with excessive tax and regulatory burdens.
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