Supreme Court Opens the Door for States to Collect Online Sales Tax
South Dakota v. Wayfair and Its Profound Effects
The U.S. Supreme Court made sweeping changes to how sales tax laws can be enforced by overturning a 26-year-old precedent. In South Dakota v. Wayfair, the Court held that physical presence is no longer necessary for a state to enforce sales tax laws against out-of-state sellers. Countless online retailers have relied upon the “physical presence” requirement over the last three decades to avoid paying sales tax where they had no offices, employees, inventory, or other physical contacts. The Court held that the “physical presence” rule was no longer sound and that states can tax any activity that has a “substantial nexus,” in this case through “extensive virtual presence” within the taxing state. In the Wayfair case, the Court found that selling more than $100,000 in goods or engaging in more than 200 transactions annually created a substantial nexus with the state.
The consequences of this decision are profound. Under prior precedent, online retailers only needed to be concerned about the sales tax laws in states where they had a physical presence. Presumably, for many retailers, this was only a few states. Retailers could control where they were liable for sales tax by structuring their operations accordingly. The ruling in Wayfair means that online retailers could be liable for sales tax in every state. The activities of consumers now dictate where online retailers must register, not management decisions about how to structure operations.
The Wayfair ruling does not mean that retailers are automatically liable for sales tax in each state where they have consumers. Most states will need to pass legislation that requires online retailers to collect and remit sales tax. The legislation will most likely not apply to small retailers that make only a few sales per year to residents of the state. This is because under the now existing law, states may only tax retailers with a “substantial nexus” within the state. Other states will likely adopt a standard similar to South Dakota’s ($100,000 in sales/200 transactions) since the Court held that this qualifies as a “substantial nexus.”
With the Court’s holding in the Wayfair case, online retailers should monitor their activities in each state where they have consumers to determine where they are liable to collect sales tax.