Should Small Business Retailers Be Required To Collect and Remit Sales Tax For Online Sales?

Patrick Tuley, CPA

Tax Partner

June 6, 2018

South Dakota vs. Wayfair – U.S. Supreme Court to Weigh In.

While the current law of the land is that a company needs to have a physical presence in a state to be subject to the responsibility to collect and remit state sales taxes, you wouldn’t know it from the recent intrusion by states into online sales.

The current legal precedent is Quill vs. U.S. (“Quill”), a 1992 U.S. Supreme Court Decision that affirmed a previous decision which ruled in favor of the taxpayer (National Bellas Hess v. Dept. of Revenue of Illinois). These Supreme Court cases prevented North Dakota (and other states) from imposing a sales tax collection and remittance obligation on out-of-state companies unless they had physical presence in the state. Physical presence has typically meant some type of presence in the taxing state, either in the form of employees or tangible property (real or personal).  Even though the Supreme Court affirmed the National Bellas Hess decision in 1992, states are once again asserting the argument that the economy and the way business is transacted (via the internet) has changed significantly – thereby rendering the Quill decision moot.  Interestingly, the recent argument by South Dakota in Wayfair is very similar to the argument that was promoted in the Quill case. In Quill, the advent of mail order business changed the business environment since the last Supreme Court decision.

Leading up to the Wayfair case, which was heard by the U.S. Supreme Court on April 17, 2018, is a litany of legislation, regulation and other declarations from state and local taxing authorities imposing a new “economic” nexus standard in lieu of the Quill “physical presence” nexus standard.  It should be noted that many national online retailers have yielded to the states and now collect and remit sales tax on most online orders, including Amazon, Barnes and Noble, etc.  While there are widely varying assessments of the current tax collections states are receiving and the amount of tax that the states are missing out on, many believe the windfall to state and local jurisdictions from a taxpayer-adverse ruling in Wayfair would be significant. But at what cost to small businesses?

What’s the Big Deal? 

Data from Vertex, a sales tax software company, estimates that there are at least 10,814 sales tax jurisdictions in the United States, with Texas and Missouri accounting for over 1,300 jurisdictions each!1 So you can imagine, just keeping track of the rates of tax in all of these state, county and municipal jurisdictions would be a cumbersome task.  And while large companies can leverage this cost across multi-million / billion dollar sales, small online retailers must absorb these costs, sharply increasing their costs of doing business. This hinders their ability to generate profits, adding yet another headwind against a small business’ ability to survive or thrive.

Even if an online retailer could determine the correct rate of tax, the incidence of tax also varies by jurisdiction. For example, a number of states don’t impose sales tax on clothing, as noted below:

  • Iowa, Maryland and Texas – clothing costing less than $100 is exempt during sales tax holidays. Dates of sales tax holidays differ by jurisdiction also, so you need to investigate the dates of these holidays in order to properly collect sales tax.
  • Massachusetts – Clothing costing less than $175 is exempt.
  • Minnesota – Clothing is exempt.
  • New Jersey – “Most” clothing is exempt, but you would have to determine what clothing is not based upon your particular facts.
  • New York – Clothing and footwear costing less than $110 per item (or pair of shoes) is exempt.
  • Pennsylvania – Clothing is exempt; however, items “not-for-every-day” wear and luxury items are taxable.
  • Rhode Island – Clothing is exempt up to $250 per item; amount over $250 is subject to tax.
  • South Carolina – Clothing is taxable in South Carolina. However, sales of clothing during tax holidays are exempt. Effective January 1, 2016, sales of children’s clothing, sold to an organization exempt from federal and state income tax, except for private schools, for the sole purpose of distribution by that organization to needy children also are exempt. – Editorial comment – while a noble purpose behind this exemption, a very complicated compliance precedent for businesses.
  • Vermont – Clothing is exempt in Vermont. However, clothing accessories or equipment, protective equipment, or sport and recreational equipment is taxable.2

Are you starting to see the picture?

This is just one subset of potentially taxable sales. Similar exemptions apply in some jurisdictions for food, beverages, alcoholic beverages, etc. If you take this decision tree to a small online retailer, you can quickly appreciate the predicament of a company’s ability to properly administer a collection duty on behalf of the state and local governments.

What is a Government to do? 

A taxpayer-friendly decision in Wayfair would require a significant amount of restructuring by the sales tax authorities. While the states’ argument that taxes for the sale of property or use tax for the use or consumption of property should be levied is sound in some respects, the current systems which span over 10,000 jurisdictions are an unfair burden on interstate commerce, especially for small businesses. This is exactly why the U.S. Congress has authority under the Commerce Clause of the U.S. Constitution to regulate commerce among and between the states.

Congress has utilized this authority in the past to limit the states’ ability to tax across state lines. Unfortunately, many legislative proposals have not been enacted, facing resistance at some point in the legislative process.  This inability to address the physical presence standard (and the states blatant dismissal) has been going on for decades.  While the Supreme Court must address the Wayfair case based upon existing law and legal interpretations of the law, it ultimately rests with the U.S. Congress to pass legislation to streamline the sales tax collection process and make it workable for the multitude of small businesses.  To continue to place inordinate burdens on companies that wish to transact business over the internet, will only decrease our competitive and entrepreneurial landscape. This is the lens through which this decision, and Congress’s response must be viewed. To ignore the practical application of an adverse Wayfair decision is just another move in favor of large, national and multinational companies (and more money for the government) at the expense of small and emerging businesses. And, let’s face it, an impediment to the American Dream.

Small businesses are a significant engine in the ongoing growth and viability of the U.S. economy. Against regulation, taxes and other headwinds, they continue to exert themselves and fuel not only employment, but also innovation. The government should get behind small business and create solutions that empowers entrepreneurship, not hinder it further.

References:

1 (Katherine Loughead on the Tax Foundation’s website – Growing Number of State Sales Tax Jurisdictions Makes South Dakota v. Wayfair That Much More Imperative). 

2 Thomson Reuters Checkpoint State Tax Chart service

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