A former teacher, Matt now specializes in R&D for ecommerce business owners and helps guide merchants in understanding the importance of this digital-first world.
By now, you’ve probably heard that the Supreme Court ruled last week (June 21, 2018) to allow individual states to require that ecommerce retailers begin collecting sales tax on sales made within state lines.
(If that’s a bit confusing, it’s because there’s a lot to unpack, here. Don’t worry, we’ll clarify everything throughout this article.)
But first, let’s go over exactly what happened within the Supreme Court’s walls, as well as what all led up to the decision in the first place.
South Dakota v. Wayfair, Inc.: The Ruling and the Background
The official ruling of South Dakota v. Wayfair, Inc., was rather close, with the state eking out a 5 to 4 victory - again enabling states to enact their sales tax mandate on ecommerce companies just as they do brick-and-mortar retailers.
(This decision essentially overturned the ruling of 1992’s Quill Corporation v. North Dakota, which prohibited states from collecting sales tax from ecommerce companies that don’t operate primarily within a single state. More on this in a bit.)
South Dakota’s argument boiled down to two main points.
Firstly, the state argued that local retailers for years have been operating at a disadvantage to ecommerce companies, since consumers would (of course) much rather purchase items from online stores sans sales tax than to visit their small neighborhood retailer and be forced to pay extra.
The irony, here, is that the aforementioned Quill v. North Dakota case affirmed that ecommerce companies were the ones at a disadvantage back in ‘92 - a time in which online shopping was not yet the norm. In other words, the Quill ruling aimed at helping small ecommerce companies gain momentum - and also provided incentive for larger brick-and-mortar retailers to make the jump into the world of ecommerce.
Needless to say, Quill certainly succeeded in spurring the ecommerce boom.
That said, there’s little denying that brick-and-mortar stores have suffered as of late due to the rise of ecommerce. If we’re being objective, here, as Quill did serve its purpose at the time, it is only fair that the playing field be returned to level ground.
At any rate, the second main point South Dakota argued was that state and local governments have also been losing out on billions of dollars in tax revenue since the ecommerce industry became the powerhouse it currently is. Again, this certainly isn’t wrong; if anything, ecommerce retailers have provided consumers with an obvious means to avoiding paying sales tax.
Needless to say, there’s a lot more to the actual ruling than these two main arguments. If you’d like to dig into the nitty-gritty of the decision, you can check out the official court document on the Supreme Court’s website.
Now that the law of the land has officially changed, the burning question is:
How, exactly, will this change affect your ecommerce company?
Vice President of Tax at Kruze Consulting, Stephen Yarbrough, has this to say:
“(The ruling) does create more complexity for smaller businesses, as there are over 15,000 taxing jurisdictions in the US…(but the ruling) will ultimately clear up the business uncertainty that had been hanging over companies, and now there's a greater chance that Congress may step in with some clarifying legislation.”
At any rate, to answer this main overarching question, we’ll need to answer a few more specific ones.
Let’s dive right in.
Question One: Do I Need to Start Collecting Sales Tax?
Back at the very beginning of this article, we admitted that the way in which we explained the ruling sounded a bit convoluted, and we promised we’d make things a bit more clear later on.
So, here we go:
Technically, as of this moment, ecommerce companies are not required to collect sales tax.
To explain further, the ruling says nothing about mandating that online retailers collect sales tax. Rather, the ruling simply allows individual states to decide whether or not to put this mandate in place. As we said, it undoes Quill v. North Dakota - essentially untying the hands of state-level government bodies in this regard.
That said, you can certainly expect states to begin rolling out legislation that obligates ecommerce companies to collect sales tax on sales made within state lines. Needless to say, South Dakota’s government - which spearheaded the recent court case - will likely get the ball rolling as soon as possible. From a logical standpoint, it’s likely that states that rely on a rather high sales tax rate (such as Louisiana Tennessee, and Arkansas) to generate revenues will soon hop on board, as well.
(Of course, this isn’t to say that states with lower sales tax rates won’t do the same, as well. As long as there’s more money to be made, we can be pretty certain that any state that collects sales tax will likely see this ruling as a boon.)
With all of this in mind, your best bet here is to stay extra vigilant in terms of reading up on changes to state and local laws that pertain to your company. We’ll be sure to provide updates to you here on Sales and Orders’ blog as time goes on.
Question Two: Which States Collect Sales Tax?
As we’ve said, you’ll only be required to collect sales tax on orders placed within a state that mandates sales tax be collected.
(For example, if New Jersey mandates that ecommerce companies begin collecting state tax, you’ll be responsible for charging an extra 6.625% to customers within New Jersey borders.)
As you may or may not know, the vast majority of states do, in fact, collect sales tax on brick-and-mortar sales at the current moment. The only states that don’t are Delaware, Oregon, Montana, New Hampshire, and Alaska.
(Quick note: Alaska has no statewide mandate, but allows local municipalities to enact a sales tax of anywhere between 1% and 7%. Essentially, this is what South Dakota v. Wayfair has enabled each state to do.)
Now, a number of states (actually, about half of the fifty United States) have in effect - or are working on putting into effect - what is called economic nexus. In these states, companies are only required to collect sales tax if they reach a certain threshold (either monetary or relating to sales numbers).
For example, some states require that companies that make over $10,000 worth of sales in a year to collect sales tax, while in other states this number is more like $100,000, even $200,000. Other states require companies that make more than 100 or 200 transactions in a year to collect sales tax. Some states combine these stipulations, enacting a “whichever comes first” rule.
It’s worth noting that economic nexus laws have been in effect for some time now, essentially as a way for states to skirt the Quill ruling back in 1992. Actually, the recent South Dakota ruling was the culmination of years of legal battles revolving around the legality of economic nexus policies - with states’ rights eventually winning out.
At any rate, now that the dust has settled, states have been given the legal right to decide whether to implement economic nexus policies - or to simply mandate that all ecommerce companies, regardless of sales numbers, abide by state tax laws.
Obviously, the best case scenario for smaller ecommerce companies is that states don’t enforce sales tax laws at all. More realistically, though, these smaller companies should keep their fingers crossed that the states they operate in provide some leeway via economic nexus policies.
Question Three: What are the Penalties for Non-Compliance?
To reiterate once more, as of right now, ecommerce companies are not required to collect state sales tax. Ergo, there currently are no penalties for non-compliance on legal record.
However, for companies that have always operated solely online, who may not be familiar with brick-and-mortar sales tax laws in the first place, let’s quickly explain how retailers with physical locations can be penalized for not collecting sales tax.
Perhaps most obviously, non-compliant retailers are typically required to pay out the collective sum of money that should have been collected from their customers via sales tax. Obviously, since they hadn’t been collecting this money from their customers, non-compliant companies will need to pay this amount out of pocket. Obviously, the more revenue a company collects, the higher this amount will end up being.
But it only gets worse from there.
Non-compliant companies are also required to pay interest on unpaid sales tax - to the tune of an average 6.4%. Even worse, many states also enforce a lateness penalty of an average 17.85%. Needless to say, these extra penalties can eat up a pretty large chunk of a company’s profits - especially if the company has been non-compliant for an elongated period of time.
Again, we’re yet to see just how individual states will decide to penalize non-compliant ecommerce companies; chances are, though, it won’t just be a slap on the wrist - especially for continued non-compliance. Again, your best bet is to remain diligent in keeping up with changes to sales tax laws in the states your company operates within.
A Quick Note on Retroactivity
South Dakota v. Wayfair, Inc. specifically addresses retroactivity, clearly stating “the law is not retroactive,” and “...the Act ensures that no obligation to remit the sales tax may be applied retroactively.”
However, further along in the document, the following is written:
“Congress can also provide a nuanced answer to the troubling question whether any change will have retroactive effect.”
While this doesn’t necessarily contradict the two statements mentioned above, it does seem to hint that the ruling does warrant further discussion on the topic of retroactivity - presumably to be revisited as states begin rolling out their own ecommerce sales tax laws.
All this being said, you almost certainly won’t need to worry about being held responsible for remitting tax on sales your company makes until the point at which the state in question enacts its own ruling on the matter.
Question Four: So, What Should I Do?
Up until now, you’ve likely been able to operate your ecommerce company without worrying about anything at all having to do with sales tax.
And, as the original Quill ruling intended, this almost certainly means you’ve been able to keep your prices and expenses down - at least when compared to your brick-and-mortar counterparts.
On the other hand, if the states you operate in decide to mandate that you begin collecting sales tax, this will likely throw a monkey wrench into your overall plan of attack.
Obviously, your customers aren’t going to be too happy when their out-of-pocket cost for your products increases by 4-9% which means making a touch pricing decision for your business: Do you decrease your prices to accommodate, or do you simply deal with the potential drop in sales numbers you may experience? Either way, there's a strong possibility that your company is going take a hit.
Alexander Lowry, Professor of Finance at Gordon College, had the following to say:
"This will likely have a huge impact. The big companies like Amazon have been prepared for this, i.e. systems in place. Indeed, many big companies have been collecting tax in anticipation of this.
But small companies will need to put those systems in place. And then decide whether pass on the cost to customers or absorb it out of their own profits. They can ill afford this. And business, as a result, may end up flowing to the bigger companies who with greater economies of scale can better absorb this."
With that in mind, you might want to consider whether it’s even worth it to do business in a given state moving forward. In other words, think in terms of cost-benefit analysis, here. For example, if you only make X amount of money in annual revenue from, say, South Dakota, and the cost of registering, reporting, and filing state sales tax ends up eating up a large chunk of this revenue, you unfortunately might decide to cease catering to customers located within the state.
(In such a case, you may discover that you can make up for the lost sales in tax-enforcing states by increasing your marketing efforts in tax-free states, or states whose population is more representative of your target audience.)
Len Nitti, a CPA for Wilkin & Guttenplan, PC, dives deeper into this issue:
“While the cost of tax compliance should be considered, business owners will need to make a sound business decision based on the profitability of continuing to sell (within) a state. It’s not as simple as looking at a maximum dollar amount in any state, as most of these laws will be connected to a number-of-transactions threshold. Different states will likely establish differing thresholds in their laws, as well.”
Of course, rather than avoiding the issue, you could opt to face it head-on.
Again, the first step to take, here, is to stay up-to-date with individual states’ rulings as they begin to be rolled out. Of course, with 45 states to worry about (minus the five that don’t enforce sales tax at all), and thousands of municipalities within these 45 states, this might seem like a monumental task. With that said, you might want to consider investing in software that automatically charges sales tax as applicable based on a customer’s current location.
A quick note for marketplace sellers:
“It’s possible,” Nitti says, “that marketplaces could provide a solution for sales tax collection and reporting which could help simplify the process.”
In other words, while marketplace sellers will certainly need to prepare for any upcoming changes to sales tax laws in the states in which they operate, each marketplace will likely automate the process of actually charging tax as applicable.
For dropshippers, things might get a bit complicated, here, in terms of which party - if any - will be held responsible for remitting sales tax.
Attorney and CEO of the Institute for Social Internet Public Policy Anne P. Mitchell provides the following hypothetical scenario:
Joe T. Customer is located in South Dakota, and places an order from dropshipping company Widgets ‘R Us. WRU does not pass South Dakota’s economic nexus threshold, and does not collect sales tax on Joe’s order. WRU then passes the order along to its supplier, ACME - which does pass South Dakota’s nexus threshold, meaning the state may hold ACME responsible for remitting sales tax on the transaction.
Mitchell reiterates that it’s currently unclear how such a situation will play out in the near future, but posits that South Dakota could potentially require the fictitious company ACME to remit sales tax, here.
If this becomes the norm, the question then becomes whether or not ACME will require WRU to pay sales tax on the transaction at the point of sale. If the answer here is “yes,” then WRU would again be put to a decision: should the company eat the cost of sales tax when such a situation arises, or should it pass along the cost to its customers?
Whatever the case may be, Mitchell provides the following advice for dropshippers moving forward:
- Know which states collect Internet sales tax
- Always know whether the retailer for whom they are dropshipping to one of those states has collected sales tax on a given order
- If the retailer has not collected sales tax, determine if their own (the dropshipper's) business has an arguably sufficient nexus with that state in order to determine whether there is any risk of the state coming back to the dropshipper and assigning (attempting to assign) sales tax liability to them (the dropshipper).
We’ll also continue to update this post as states begin implementing changes to their sales tax laws - so be sure to check back often.