Under new laws just enacted in South Dakota, companies who have more than $100,000 in South Dakota sales or at least 200 individual transactions in South Dakota are required to collect and remit South Dakota sales tax. This is true even for companies that have no physical presence in South Dakota. This change becomes effective May 1, 2016.
This is not an isolated example. Retailers who are physically present in one state and who are selling tangible personal property in another state without collecting that state’s sales tax, should expect increased audits, assessments, and compliance obligations. The Wall Street Journal reported recently that the Commissioner of the Alabama Department of Revenue, for example, wants to get sued by an out-of-state retailer relating to its sales tax collection practices, as soon as possible. Alabama, along with several other states including South Dakota and Utah, have increased efforts to collect sales tax on out-of-state retailers and are hoping for litigation that will potentially lead to a U.S. Supreme Court reconsideration of Quill v. North Dakota.
What Is The Quill Case?
Very simply, Quill is a 1992 case in which the U.S. Supreme Court held that a state may not require a retailer with no physical presence in the state to collect sales tax when the retailer makes an in state sale. Quill came during the era of mail and telephone solicitations, and well before the advent of internet commerce. Quill sold office equipment and supplies by soliciting business through catalogs, flyers, advertisements in national periodicals, and telephone calls. While its annual national sales exceeded $200 million, about 0.5% of its sales were made to about 3,000 customers in North Dakota. All of its merchandise was delivered to its North Dakota customers by mail or common carrier. The U.S. Supreme Court at the time was very concerned about out-of-state businesses having to comply with the laws of numerous local taxing jurisdictions. In fact, in the Quill opinion, the court pointed out the existence of 6,000 local taxing jurisdictions as a reason why imposing a collection obligation could be overly burdensome on an out-of-state business.
Contrary to a common belief, while Quill may prevent a retailer from having a collection obligation when it makes an out-of-state sale, it does not mean that the customer is not subject to a use tax obligation. However, while the amount of revenue from online shopping and ecommerce has grown substantially, studies show that consumers simply don’t pay use tax even when, as in Nebraska, the customer’s individual income tax return contains a use tax line. Thus, a perfect storm for aggressive action by state departments of revenue has brewed. While Quill may protect the seller from the sales tax collection obligation, the average customer does not likely understand the customer’s use tax obligation, and as a result, there is a significant tax collection gap. In the eyes of the state departments of revenue and many state legislatures, businesses are the only legitimate target for uncollected sales tax notwithstanding Quill. In addition, the concern raised in Quill about subjecting an out-of-state business to 6,000 (or more) local taxing jurisdictions is, in the eyes of many states, no longer a burden on commerce. With the evolution of technology, local sales and use tax rates are easily available online and most state departments of revenue provide user-friendly guides for out-of-state sellers to determine their collection obligation.
What Are States Doing To Collect Tax?
In addition to South Dakota’s recent change, another example of legislation aimed at increased enforcement is a new Alabama law that became effective on January 1, 2016. This law states that out-of-state sellers are required to register for a license with the Department and to collect and remit sales tax, even without a physical presence in the state, if they have a “substantial economic presence” in Alabama. Like South Dakota, Alabama is blatantly challenging the Quill holding by imposing a sales tax collection obligation absent a physical presence if there is an “economic” presence. In Alabama, this is defined as having retail sales of tangible personal property into the state exceeding $250,000 per year (based on sales from the previous calendar year) and conducting certain activities, including the solicitation of sales through advertising on cable television or substantial solicitation of sales in the state while benefitting from banking, financing, debt collection, telecommunication or marketing activities in the state, among others. Thus, an out-of-state retailer with no South Dakota or Alabama physical presence is now required to collect sales tax if they meet the economic nexus standard set forth in these new laws.
Colorado has also been in the spotlight recently in its increased enforcement attempts against out-of-state retailers. In 2010 it passed a law that requires any retailer who sells $100,000 or more of products to customers in Colorado, but does not collect and remit sales taxes on those products (presumably because of a lack of physical presence), to (1) notify the purchaser that the retailer does not collect Colorado sales tax and that the purchaser is therefore obligated to self-report and pay use tax; (2) provide each customer who purchases more than $500 per year from the retailer with an annual report of the prior calendar year’s purchases and inform the customer that the retailer is required to file an annual purchase summary reporting the customer’s name and total purchases to the Colorado Department of Revenue; and, (3) provide the Colorado Department of Revenue with annual customer information stating the name, billing and shipping address, and total purchases for each of its Colorado customers. This law was challenged as unconstitutional by the Direct Marketing Association and upheld in February of this year by the Tenth Circuit Court of Appeals.
Why Is This An Issue Now?
The increased focus on this issue has been spurred by the rapid growth of ecommerce and the fact that many online retailers, Amazon specifically, utilize (whether intentionally or unintentionally) the lack of a sales tax as a competitive advantage. It is not difficult for prospective buyers to visit their local brick-and-mortar store to shop and, once a decision is made about what to buy, make the purchase online and avoid sales tax on the purchase. In addition, because of the physical presence test in Quill, the purchase cannot be made from the brick-and-mortar store’s online site because the very presence of the store in the state causes nexus for all online sales. Therefore, a customer is incented to visit one store to shop in person and then make an online purchase from a seller who has no physical presence in the state and does not collect tax. While this issue has been a topic in Congress for quite some time, proposed federal legislation has simply not made its way into law. The most recent version of the proposed Marketplace Fairness Act allows states to require sellers who have more than $1,000,000 of annual remote sales (taking into account all states into which the seller makes sales, other than those states in which the seller already has nexus) to collect sales tax.
In addition to the sales tax collection obligations imposed on remote sellers, businesses who make purchases from out-of-state sellers are also facing use tax assessments when being audited by their home state departments of revenue. Nebraska, for example, requires use tax returns to be filed by large volume purchasers as frequently as monthly. Those returns must report any out-of-state purchases of taxable items where the Nebraska sales tax was not collected by the seller. While use tax liability is generally a much less significant issue for purchasers of products from out-of-state retailers than it is for the sellers (given the relative volume of sales versus purchases), these assessments can still catch businesses by surprise and result in a significant assessment.
What Should My Business Do Now?
As a result of the increased emphasis by various states on collections, as well as the continuing activity by state legislators to pass laws attempting to put more burdens on out-of-state retailers to collect tax, businesses need to carefully review their business practices to assess their potential exposure. While it is true that an out-of-state retailer with no physical presence in a state still enjoys legal protection under Quill, the fact that states may be ready to litigate this issue means that a business who finds itself in the sights of a litigation-ready department of revenue may have no choice but to pay the assessment or fight a lengthy and expensive court battle.
The first step businesses should take is to review the laws of every state from which the business earns significant revenue and determine if the particular state, like South Dakota, Colorado or Alabama, has any recent legislation that imposes a collection or reporting obligation. It should also be determined whether the particular state would, notwithstanding Quill, under its owns laws and regulations, require the business to collect sales tax. In addition, the business should ask whether it has any of the following contacts with a state into which it makes sales but does not collect tax: (1) has an office, distribution center, or warehouse; (2) has a representative, agent, or salesperson; (3) delivers items into a state by using business owned vehicles; (4) avails itself of banks, debt collection agencies, or advertising agencies in the state on a regular basis; or, (5) has agreements that compensate for sales referrals of customers in that state.