Sales tax nexus is an area of the law that many businesses would prefer to believe does not affect them directly, though most are aware that the issue exists.
States have become increasingly aggressive in terms of audit techniques, enforcement of existing laws and the enactment of new laws to compel businesses to comply with sales tax collection and reporting requirements. And with the Supreme Court ruling in South Dakota v. Wayfair Inc., there is now a binding legal precedent emboldening states’ efforts.
Smart Business spoke with Thomas Frascella, director of Tax Strategies at Kreischer Miller, about sales tax nexus, how and when it applies, and what the Wayfair decision will mean for businesses.
How is sales tax applied to out-of-state sellers and what are the exceptions?
Most tangible personal property is subject to sales tax unless it is either excluded or exempt from sales tax. For decades, most states were fairly lenient about the collection of exemption certificates. Although state rules require that the exemption certificate be obtained at the time of the sale, most states had historically allowed taxpayers to collect exemption certificates long after the sale had already occurred. Presently, states are beginning to enforce the collection requirement on audit and assessing sales tax if the taxpayer cannot provide an exemption certificate coinciding with the date of the sale.
States are also beginning to more closely scrutinize transactions involving drop shipments. Drop shipments typically involve a scenario in which the seller has a manufacturer ship a product directly to the seller’s customer. Drop shipments can create a sales tax trap for the unwary. Generally, sales for resale are exempt transactions provided a valid exemption certificate has been granted to the appropriate party. In the case of a drop shipment, it is the sales tax nexus of the manufacturer making the delivery that will determine the appropriate state exemption certificate needed.
For example, Seller A is located in Pennsylvania and is not registered in any other state. The manufacturer is located in California and is making a delivery to Seller A’s customer in California. Seller A must provide the manufacturer with a California resale certificate. If Seller A cannot provide a valid California resale certificate, the manufacturer should collect sales tax because it delivered a product that it sold to a location in a state where it has nexus. Some states will allow sellers to use their home exemption certificate or a multistate certificate. Others will not, rendering an otherwise tax-exempt sale taxable.
What effect is the Wayfair decision expected to have on states’ sales tax collection?
The most significant development in the area of sales tax nexus is the U.S. Supreme Court’s decision in South Dakota v. Wayfair Inc. The Wayfair case involved legislation enacted by South Dakota to impose sales tax nexus on remote sellers. The legislation required out-of-state retailers with either 200 or more transactions or $100,000 in sales to residents of South Dakota to register for and collect South Dakota sales tax. Wayfair challenged the constitutionality of the law based on the court’s prior decision in Quill Corp. v. North Dakota, requiring a physical presence in a state to establish sales tax nexus. In a surprising decision, the Supreme Court sided with South Dakota and overturned the long-standing physical presence standard.
As a result of the Wayfair decision, a significant number of states have enacted similar legislation as the law enacted by South Dakota aimed at compelling remote businesses — businesses located outside state borders — to either begin to collect and remit sales tax or report purchases made by residents of states enacting such laws. To date, approximately 22 states have enacted legislation that adopts an economic nexus standard for sales tax purposes.
Today, remote sellers of all sizes that meet these economic thresholds could become subject to multistate sales tax reporting and collecting, and will need to deal with the impact on their businesses. The hope now is that Congress finally takes action to enact a national nexus standard for sales tax purposes that will provide consistency for businesses. Until that happens, businesses will be forced to understand the various state standards and assess the impact on their business.
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