In this article, we have included some legal cases that set the precedent for current multi-state sales tax laws. Included among them is the historic Wayfair case that broke ground in the area of e-Commerce.
Hopefully, this background will put some of the present law into context. But as always, as the business climate continues to shift and change, so will the laws associated with multi-state taxation.
If you have any questions about your business and its sales tax compliance in the states where you do business, do not hesitate to reach out to me. We are experts in interpreting these laws and showing you how to apply them to your specific situation.
The first case that introduced the concept of nexus was the 1977 case of Complete Auto Transit v. Brady. In this federal case, a unanimous Court established the first legal precedent in terms of what the federal government considers interstate commerce, and what it considers matters for the states to decide.
In Complete Auto, the Court held that states have the power to regulate commerce that occurs in their state or impacts their state so long as such activity does not interfere with interstate commerce. The Court's decision established four criteria for a state tax to be valid and not an unreasonable burden on interstate commerce. The tax must be:
At its core, the case stands for the proposition that so long as in-state commerce does not interfere with the dormant commerce clause, then the states have free rein to set whatever standards for the treatment of commerce that they see fit. Due to this extensive, multi-test holding, Complete Auto created a large playing field for the states to interpret their own laws.
This has created much conflict between how the various ways that states interpret the law. Through their differing interpretations of the law, one state may come up with regulations that are more stringent than those of other states. For this reason, it becomes all the more difficult for a multi-state business to manage compliance across the various jurisdictions in which it is deemed to have nexus.
Following Complete Auto, in the early 1990s, the Supreme Court decided the case of Quill v. North Dakota. In Quill, the Court held that in order to have economic nexus with a state, there must be physical presence within that state. Quill set this bright line rule that serves as a limitation on states' abilities to tax.
Eventually, with the advent of the internet, the authority of the precedent that was set by the Court in Quill began to diminish. States began finding new ways to tax activities and items through contacts with the state that did not involve actual physical presence.
States have pushed back and created a series of laws that have allowed them to extend their tax base to include people that have substantial contacts with their state, physical and otherwise. For example, various states have instituted affiliate nexus laws. Under affiliate nexus laws, an out-of-state business establishes a physical nexus through in-state employees or representatives.
Some have also instituted laws that limit sales tax liability for entities or individuals operating through an agent or conducting significant marketing activities. As demonstrated by such laws, the criteria for levying taxes is far from limited to physical presence.
Despite how extensive these laws regarding nexus may appear, there always must be some level of contact in some form in order for a state to levy taxes against you. States cannot impose unnecessary burdens onto out of state retailers where no contacts with the state can be demonstrated.
However, the laws across states have been trending towards an increasingly more liberal definition of what constitutes contacts and, by extension, nexus. This trend is embodied in the most recent Supreme Court decision of Wayfair v. South Dakota.
In Wayfair, the Court eliminated Quill’s physical presence standard and made way for looser interpretations of what constitutes economic nexus. While the Court overturned Quill in the Wayfair case, it did not adopt a stringent standard for determining what constitutes economic nexus.
In Wayfair, part of what was at issue was a state statute stating that economic activity generating over $100,000 constitutes a significant nexus creating activities. In this case, the state statute had a clear dollar amount threshold that had to be met for the state to find that there was an economic nexus.
In Wayfair, the Court found that there was economic nexus using the standard set by South Dakota. The Court did not remark on what the outcome would have been had another state’s standards for economic nexus been applied, nor did it comment on the validity of other states’ standards. Nonetheless, the court affirmed the validity of South Dakota’s law.
A majority of states that have statutes using the same $100,000 economic threshold that, by extension of the holding in Wayfair, we know are legally sound. However, there are a variety of other states that have different thresholds or different standards altogether.
They may have clicked through nexus laws or they may not have a $100,000 threshold for economic nexus. Due to the limitations of the Wayfair ruling, we do not know whether the laws that differ from that of South Dakota are constitutionally valid.
With the holding in Quill being overturned, the holding in Complete Auto now governs and the inquiry that matters for purposes of determining nexus is whether taxation interferes with the dormant commerce clause. As of now, there is no federal law that would preempt any of the state nexus laws. Apart from the loose guideline set out in Complete Auto stating that taxation cannot interfere with the dormant commerce clause, states have free reign to create their own nexus laws.
Without federal judicial restraint, states will wield near total control over taxing out-of-state entities which they can prove have contact with the state.
It may be that California's current laws are unconstitutional. However, there are no current judicial challenges or judicial restrictions in place. Furthermore, there is no legislative restriction that limits California’s taxation power under the concept of economic nexus. At least for now, California's law as it applies to economic nexus within the state is the supreme law of the land.
Another issue that was not addressed in Wayfair is whether an economic nexus provision can be applied retroactively. It is fairly certain that going forward, economic nexus laws will continue to be upheld at least if they mirror the general guideline of South Dakota’s law.
What was left unclear is whether states can retroactively enforce economic nexus provisions to levy state sales and income tax against out of state sellers for activities that occurred before Wayfair was decided in 2018.
Absent any legislative or judicial comment on the matter, states actually can retroactively seek taxes for activities constituting economic nexus. In fact, a number of states have already seized this opportunity to increase their enforcement efforts. California is evidently at the forefront of these efforts.
We see a lot of instances in which California seeks to levy taxes on out of state businesses. California has one of the most well-funded departments of revenue, which enables it to be active in enforcing its tax laws. We have also seen that the state of Washington is increasingly pursuing tax enforcement for out of state businesses.
Increased enforcement on the basis of economic nexus — rather than physical nexus — is thus, a direct consequence of the Court’s ruling in Wayfair. The case is a win for the states because the expanded definition of nexus provided a further pathway for states to raise tax revenue.
As time progresses, states will become increasingly more aggressive in their enforcement efforts. This will have various implications for businesses and individuals performing out-of-state transactions.
First, going forward, you can assume that to the extent you or your organization perform activities in a certain state you will be considered to have nexus in that state. The nexus in that state will have consequences from a sales tax perspective. It can also potentially have consequences from a state income tax perspective.
If you are considered to have nexus within a state, even if you are located outside of that state, having nexus is equivalent to having a branch office within that state.
The tax department looks at your operations in that state for state income tax and state sales tax purposes.
By using Amazon, for example, or by performing some other nexus creating activity, you are effectively setting up branch offices in multiple states. Amazon currently has warehouses in 33 states. Thus, if you are using the Amazon FBA platform to sell goods through Amazon, you are creating nexus in 33 different states. In such an instance, no matter how small or large the business is, the business’ reach across many states may create a large compliance issue.
Some states like Washington, Minnesota, and Oklahoma have created marketplace tax rolls. Increasingly, places like Amazon and eBay will be required to collect and remit tax and thus, the compliance burden will be shifted away from businesses. However, these laws have only been adopted by the minority of jurisdictions. Therefore, going forward, multi-state businesses must assume that it is their burden to collect and remit tax.
If you are a remote seller of any type of product or service, just assume that you are going to be considered to have nexus in every single state where you have conducted a business transaction.
This nexus can be established through a direct sale or through more intangible means such as Saas. It is better to err on the side of caution, than to be taken by surprise down the road with a sales tax audit.
To devise an air-tight strategy for your interstate commerce activities, give me a call. We can assess your multi-state commerce activities and take it from there.
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