Sarah Horn (M.Acc., J.D.; Editor, Checkpoint Catalyst)
Practitioners and state officials from across the country recently gathered at the 25th Annual Paul J. Hartman State and Local Tax Forum in Nashville, Tennessee where the U.S. Supreme Court’s landmark South Dakota v. Wayfair 1 decision was a hotly debated topic. Wayfair overturned decades of precedent by holding that a remote seller can establish “substantial nexus” with a taxing state through sufficient economic and virtual contacts. 2
State Responses to Wayfair “Reasonable and Restrained”
Panelist Susan Haffield of PwC broke down the Wayfair majority opinion into three major components: (1) the physical presence standard in Quill was flawed, and it instead should be a “substantial virtual connection” test; (2) the legal principle of stare decisis was not appropriate in the case; and (3) the application of the standard to South Dakota’s economic nexus law at issue in the case. The Supreme Court found South Dakota’s law to have several important features that kept it from violating the Commerce Clause, including safe harbors (de minimis thresholds) for transacting limited amounts of business in the state, prospective (not retroactive) application, and South Dakota’s membership in the Streamlined Sales and Use Tax Agreement (SSUTA), which simplified administration and compliance. While Wayfair was a 5-4 decision, panelists noted that all nine justices agreed that Quill‘s physical presence standard was flawed, they just did not agree on how to remedy the issue.
Since the Wayfair decision, many states have issued guidance on economic nexus standards. 3 Panelist Joe W. Garrett, Jr., Deputy Commissioner of the Alabama Department of Revenue, said that he has overall been very pleased by how states have reacted to the Wayfair decision. He noted that state economic nexus standards have been very reasonable and restrained, as he has not seen states pursue retroactive application of economic nexus provisions. Garrett dismissed taxpayer concerns over retroactivity as “fear mongering.”
Simplified Sales and Use Tax Agreement (SSUTA) Membership Not Essential
Haffield noted that perhaps the most controversial aspect of the Court’s consideration of South Dakota’s law was the focus on “simplification” of a state’s taxation system. Garrett cautioned that states are not reading the case to mean that SSUTA membership is necessary to be compliant with Wayfair. Instead, Garrett said that he believes a state is just required to take steps toward simplification. Panelist Marilyn A. Wethekam of Horwood Marcus & Berk agreed that the Wayfair decision does not mandate that a state join SSUTA.
In a separate panel at the Hartman Forum, Brian Kirkell of RSM US LLP and Christopher T. Lutz of Horwood Marcus & Berk also predicted that states will not join SSUTA post-Wayfair. However, they noted that if states do decide to join, it will be interesting see how or whether increased membership reshapes SSUTA.
Emphasis on “Undue Burdens” of Post-Wayfair State Tax Systems
Panelists posited that post-Wayfair, the analysis of a state’s tax system should focus on the burdens it imposes and whether those burdens rise to the level of being “undue.” Wethekam asserted that under an undue burden analysis, the complex filing and compliance requirements of local jurisdictions are where states may have teed themselves up for a constitutional challenge. Garrett pointed to Alabama, Colorado, and Louisiana, which have locally administered sales taxes in addition to the state sales tax. He noted that Alabama has made a simplified system for remote sellers that differs from the more complex system that remains for in-state brick-and-mortar retailers. Garrett said that he thinks Louisiana and Colorado are also considering similar systems, and believes that dual or bifurcated systems may be more politically feasible than having localities give up their authority to administer local taxes.
Complying with rapidly approaching state enforcement dates may also add to the burdens imposed by post-Wayfair economic nexus provisions. Haffield said that it generally takes taxpayers 9-12 months to implement a new compliance system. Wethekam joked that compliance is a lot more complicated than people think, taxpayers cannot “just push a button and state returns come flying out.”
Garrett said that he thinks states will be generous in waiving penalties, adding that he has heard from sellers that cannot meet his own state’s October 1 economic nexus collection obligation enforcement date. Haffield noted that state enforcement dates are typically arbitrary dates, so many states will have authority to waive penalties associated with delayed or noncompliance with economic nexus provisions.
Panelists Predict Due Process Clause Challenges to Economic Nexus
Panelists at the Hartman Forum focused on the blurred line between nexus standards under the Due Process and Commerce Clauses of the Constitution, with many experts predicting increased relevance of Due Process Clause challenges to assertions of economic nexus.
In a panel entitled “Treasures in the Attic: Forgotten Favorites for Attacking Economic Nexus,” William M. Backstrom, Jr., of Jones Walker LLP and June Summers Haas of Honigman Miller Schwartz and Cohn LLP examined the importance of the Due Process Clause in a post-Wayfair world. Backstrom noted that states have been emboldened to expand nexus, so this is a critical time to look at old, typically non-tax Due Process cases and put them in a tax context. Backstrom added that the Wayfair decision itself points toward this type of constitutional analysis, as the Court stated that protections other than the Commerce Clause can “better and more accurately address any potential burdens on interstate commerce.” Backstrom and Summers Haas both observed that in a Due Process analysis, the goal is to have fundamental fairness, which happens when a seller purposefully avails itself of the benefits of a state. Summers Haas said that if a law or nexus provision is fundamentally fair, it should not be a surprise that a taxpayer has tax obligations in a state.
Backstrom and Summers Haas analyzed a series of due process cases that may now be relevant in an economic nexus context. Summers Haas questioned whether cookie and app nexus provisions are fundamentally fair in a Due Process context. She noted that sellers typically do not know where their cookies and apps are being downloaded. She also questioned the fairness of marketplace facilitator policies, when marketplace facilitators do not know where inventory is located or sold.
Backstrom noted that there should also be a focus on Due Process protections in the context of dollar and transaction economic nexus thresholds. Whether you have a lot of very small sales or a few larger sales, thinking about whether those transactions meet a Due Process standard is important. He also said taxpayers should question whether a passive sale is enough to meet a threshold, and whether marketplace facilitator marketing in a state is enough to get over the Due Process hurdle.
In the Wayfair panel, Garrett pointed out that sellers may have better Due Process arguments post-Wayfair, and said that he thinks Due Process and the concept of purposeful availment will be more relevant now. He cautioned, however, that it is hard to tell in the ever-changing economy. In that panel, Wethekam said that ultimately the devil will be in the details as taxpayers and state governments sort through questions over which sales should be counted for purposes of dollar and transaction-based thresholds.
Areas to Watch
Beyond the constitutional issues discussed above, various panelists at the Hartman Forum noted that taxpayers must also pay close attention to other evolving areas and potential traps.
Kirkell and Lutz observed that changes in technology and the evolving economy will have a big impact on state tax. They noted that the mentality of “same as last year” no longer works, and we may even be in a world were “same as last month” is not enough.
In the context of sales and use tax audits, John F. Fletcher of Jones Walker LLP said that expanded nexus post-Wayfair may create Due Process issues with enforcing subpoenas. He said that he expects states will become more aggressive in audits.
Fredrick J. Nicely of the Council on State Taxation (COST) cautioned that taxpayers should pay close attention to the post-Wayfair distinction between sales tax and use tax. Whether the tax collected by a remote seller under an economic nexus provision is characterized as sales tax or use tax may impact credits that states often provide in their use tax laws for taxes paid to other states.
The topic of sales by foreign sellers into the United States was also discussed as an area to watch. Wethekam noted that while Wayfair was not limited to domestic businesses, questions remain as to how economic nexus will be enforced against foreign sellers. Garrett added that the issue becomes even more important in the context of online marketplaces, which are often used by small to mid-sized foreign sellers.
Application of the Wayfair decision to state income taxes is another evolving area that taxpayers should follow closely. Garrett noted that while state income taxes have had economic nexus provisions for a while, he anticipates that more states will adopt a factor-presence standard going forward. He also said that he thinks that there is more to come in the context of Due Process issues with respect to income taxes.
The impacts of the Wayfair decision are far reaching and may arise in many aspects of state tax compliance and controversy. Many states are still in the process of analyzing the decision and issuing guidance. In some states, the legislature may be introducing economic nexus legislation in the coming months. Closing out the Wayfair panel, Wethekam cautioned that nexus will become more important in areas where we had not previously thought about it.
For additional coverage of the Wayfair case and economic nexus laws impacting remote sellers, see our Create-a-Chart and Checkpoint Catalyst products (e.g. , Topic #1050, Sales and Use Tax: Nexus ), and our State & Local Tax Reporters. A special report, client letter, and other resources are available in our South Dakota v. Wayfair Resource Center: https://tax.thomsonreuters.com/wayfair/ .
3 For prior coverage on state responses to Wayfair, see Horn and Newton-Clarke, One by One, States Respond to South Dakota v. Wayfair, Checkpoint State & Local Update (08/29/2018) .
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