By Terry Barrett, Tax Senior Manager | Keiter State and Local Tax Team
Businesses are required to collect sales/use tax on taxable sales in states where they have “nexus.” Nexus is a sufficient connection with a state that gives the state the authority to require a business to collect and report sales/use tax on taxable sales to customers in the state. This connection traditionally has been through a physical presence in the state, whether through store locations, the storage of inventory, the location of fixed assets, employees living or traveling in the state – some real, visible, physical connection. The physical presence standard was set by the U.S. Supreme Court in the Quill Corp. v. North Dakota decision in 1992.[i]
Even before the Quill decision states were looking for ways to require out-of-state sellers to collect and remit sales/use tax on sales to residents in their states. While state laws require residents to self-assess and report use tax directly to the state on their nontaxed purchases (e.g., on line 35 of the 2015 Virginia Individual Income Tax Return, Form 760), most states do not aggressively enforce the use tax requirements for individuals. More recently, given the ever-increasing popularity of shopping over the Internet and eroding sales tax bases some states have started to bend the physical presence rules by passing “click through nexus” laws to go after Amazon and online sellers. These laws establish nexus for out-of-state retailers that have an affiliate in the state that directs customers to the out-of-state retailer’s website. With the click through rules, there still is a physical presence in the state, not by the out-of-state seller but through its affiliate in the state. Approximately 21 states currently have “click through nexus” laws or rules.
The newest nexus rules, however, challenge the physical presence requirement of Quill. The states have been waiting for Congress to pass legislation to require the collection of sales/use tax by remote sellers but with the prospects of that happening any time soon uncertain, some have taken the matter into their own hands. Alabama Revenue Commissioner Julie Magee was quoted as saying “[t]he effects of Quill have been detrimental to the states’ revenues, have forced in-state retailers to operate at an unfair competitive disadvantage for decades, and have allowed online retailers who are clearly doing business in our state to evade collection responsibility. Until Congress acts, we will continue to lead the charge to overturn Quill.”[ii] With that Alabama enacted a regulation effective January 1, 2016, that established “economic nexus” for out-of-state sellers that did not have physical presence with the state if they made retail sales of tangible personal property into the state that exceeded $250,000 per year and conducted certain other activities in the state. Some of the other activities in the state included some with a physical requirement but others such as distributing catalogs or other advertising matter and by reason thereof receives and accepts orders from residents within the state did not.[iii] In June, a large online retailer filed an appeal with the Alabama Tax Tribunal challenging the regulation.[iv] The state, however, continues to maintain its regulation is valid.
South Dakota was the next state to take economic nexus action. It passed legislation that, effective May 1, 2016, instituted an economic nexus standard that required sales tax collection and remittance by any business with sales in the state that exceeded $100,000 or 200 separate transactions in a year. The bill also included language that would ‘fast track’ the question of the constitutionality of the legislation to the state’s Supreme Court. Prior to the effective date of the legislation, the state filed a declaratory judgement action against four remote sellers with no physical presence in the state seeking a determination that it may require the remote sellers to collect and remit the tax. The next day, a separate complaint for declaratory judgment was filed by organizations on behalf of remote sellers to challenge the constitutionality of the economic nexus standard. What this means is that because the actions were filed before the effective date of the new tax collection/reporting requirements the new requirements never were in effect. If the state prevails in the proceedings, after all the appeals which likely will occur, compliance with the requirements will be prospective only.[v]
Vermont has enacted legislation similar to South Dakota – requiring remote sellers with sales into the state exceeding $100,000 or 200 or more individual transactions – to collect and remit its sales tax. However, these provisions are not yet effective. Rather, they become effective on the later of July 1, 2017 or beginning on the first day of the first quarter after a controlling court decision or federal legislation nullifies the physical requirement of Quill.[vi]
Other states have considered legislation challenging Quill this year. However, with the legal challenges in both South Dakota and Alabama it appears we may be on our way to the resolution of the physical presence issue. Our advice is that remote sellers should take note – sales tax changes may be on the horizon.
Additional Sales and Use Tax Resources:
[i] Quill Corp. v. North Dakota, 504 US 298 (1992)
[ii] “Newegg Inc. Files Appeal Challenging ADOR’s Regulation Requiring Remote Sellers to Collect Alabama Tax,” State of Alabama Department of Revenue News Release, June 15, 2016.
[iii] Rule 810-6-2-.90.03, Alabama Department of Revenue, effective 10/22/2015 and applicable on or after 01/01/2016.
[iv] “Newegg Inc. Files Appeal Challenging ADOR’s Regulation Requiring Remote Sellers to Collect Alabama Tax,” State of Alabama Department of Revenue News Release, June 15, 2016.
[v] Multiple actions filed on South Dakota sales tax nexus expansion,” Tax Insights – PwC – May 6, 2016
[vi] “Vermont enacts sales tax economic nexus & vendor notification requirements,” Tax Insights – PwC, June 2, 2016.