By Gail Cole.
June 21, 2024, marked the sixth anniversary of South Dakota v. Wayfair, Inc., the pivotal United States Supreme Court decision that enabled states to tax remote sales. Some states and businesses are still grappling with the outcome of the ruling, even six years on.
Keep reading for a recap of the Wayfair decision, how Wayfair affected sales tax, and a summary of some of the most contentious ramifications stemming from remote sales tax requirements.
What was the Wayfair decision?
South Dakota v. Wayfair, Inc. overturned a long-standing physical rule for sales tax. The case stemmed from a 2016 South Dakota economic nexus law requiring certain out-of-state sellers to collect and remit South Dakota sales tax as if they had a physical presence in the state. The state law based nexus, the connection establishing a sales tax obligation, on a remote seller’s economic presence in the state.
To many, the Supreme Court decision came as a surprise. The high court had upheld the physical presence rule at least twice previously, in National Bellas Hess v. Department of Revenue (1967) and Quill Corp. v. North Dakota (1992). Many pundits doubted the Supreme Court would take up the case. Then they doubted the court would overturn precedent.
It did. Per the Wayfair ruling, “Because the physical presence rule of Quill is unsound and incorrect, Quill Corp. v. North Dakota, 504 U.S. 298, and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753, are overruled.” (More details are available here.)
The Supreme Court didn’t establish any parameters around taxing remote sales; its job was to determine the validity of the physical presence rule in the current environment. As the South Dakota attorney general explained in 2017, “The purpose of South Dakota’s current litigation is to give the United States Supreme Court an opportunity to reconsider Quill in light of the extraordinary growth of the internet and the exponential technological advances that have been made in the last quarter century.”
Yet the court was concerned with whether removing the physical presence requirement would discriminate against interstate commerce or create undue burdens for businesses. The majority determined South Dakota’s economic nexus law did neither.
In fact, the opinion praises and highlights three aspects of South Dakota’s tax system that “appear designed to prevent discrimination against or undue burdens upon interstate commerce.” These are:
- South Dakota provides safe harbor for small sellers with less than $100,000 in sales or 200 transactions in the state in the current or previous calendar year
- South Dakota cannot apply economic nexus retroactively
- South Dakota is a member of the Streamlined Sales and Use Tax Agreement (SST) so has taken steps to reduce the administrative and compliance costs related to sales tax for sellers
Other states took note.
How did the Wayfair decision affect U.S. sales tax?
Every state with a sales tax enacted an economic nexus law following the Wayfair decision, most within a matter of months.
To reduce the likelihood of a legal challenge, the states followed South Dakota’s lead. Their economic nexus sales tax laws are similar — though not identical — to South Dakota’s:
- All states provide safe harbor for small sellers (although economic thresholds vary)
- No states apply economic nexus retroactively
Participation in SST isn’t part of any state’s economic nexus law, but 24 states, including South Dakota, are members of SST.
Every state with a sales tax has also enacted a law requiring marketplace facilitators to collect and remit sales tax on behalf of third-party sellers. These laws relieve some of the compliance burden for marketplace sellers, many of which are small businesses. However, it can complicate sales tax compliance for the marketplaces themselves.
Some of the most contentious sales tax disputes since the Wayfair decision have centered on marketplace sales.
Remote sales tax ramifications for marketplace sales
South Carolina is holding Amazon liable for back taxes on third-party sales
Amazon and South Carolina have been locked in a legal battle since before the Wayfair ruling.
Here’s the crux of the matter: Amazon started collecting and remitting South Carolina sales tax on January 1, 2016, because it had a physical presence in the state and was required to do so. But the online retailer only charged customers sales tax on its direct sales. Amazon didn’t automatically collect sales tax for all third-party sellers until April 29, 2019, when South Carolina’s marketplace facilitator law took effect.
Shortly after Amazon began collecting tax in South Carolina, the South Carolina Department of Revenue learned from Amazon’s South Carolina customers that the marketplace had “charged them sales tax on some purchases but not others.” After investigating the matter, the department handed Amazon a bill for roughly $12.5 million in unpaid sales tax, interest, and penalties for the first quarter of 2016.
Amazon contested the assessment, arguing that marketplace sellers — not Amazon — were the retailers liable for the tax.
One of Amazon’s arguments was that requiring it to tax third-party sales during the relevant period violates the United States and South Carolina constitutional guarantees of fair notice and equal protection. The company maintained the Department’s assessment was an attempt to retroactively apply the 2019 marketplace collection requirements to Amazon Services, and South Carolina had singled out Amazon for that retroactive enforcement.
Round and round they went until January 2024 when the Court of Appeals of South Carolina affirmed that Amazon was liable for the more than $12.5 million assessment. Amazon will likely appeal to the Supreme Court of South Carolina, and it won’t be standing alone.
In May 2024, the Council on State Taxation (COST) submitted an amicus brief urging the South Carolina Supreme Court to take the case. “The Department is attempting to impose a sales tax liability against Amazon Services well after third-party sellers consummated their sales on the Amazon.com marketplace,” COST argues. “In the broader historical and comparative state context, the Court of Appeals’ conclusion that the pre-Wayfair sales and use tax statute, enacted decades before, was ‘unambiguous’ as applied to the collection responsibility of marketplace facilitators (a radically different business model) is both jarring and inexplicable.”
COST also points out that in Wayfair, the Supreme Court “expressed concern over the retroactive application of tax laws.” Holding Amazon liable for sales tax on third-party sales prior to the state’s 2019 marketplace facilitator law, it argues, is a failure to heed “the U.S. Supreme Court’s warning in Wayfair against retroactivity.”
If the case does go to the South Carolina Supreme Court and the court finds in favor of Amazon, would South Carolina petition to the U.S. Supreme Court? Would Amazon, if it loses again? Would South Carolina ever try to hold individual marketplace sellers liable for the unpaid sales tax from 2016? Only time will tell.
Meanwhile, some other states are holding marketplace sellers liable for back sales tax on the grounds that their marketplace inventory gave them a physical presence in the states.
California and Washington say marketplace inventory gives marketplace sellers physical nexus
In January 2024, the Washington State Court of Appeals affirmed that two out-of-state sellers were liable for Washington business and occupation (B&O) tax and sales tax on sales made through the Fulfillment by Amazon (FBA) program. The sales in question all took place prior to the enactment of Washington’s economic nexus and marketplace facilitator laws.
Washington isn’t the only state to reach this conclusion. Marketplace inventory can give a marketplace seller a sales tax obligation in more than 20 states, including California. And in 2023, the Supreme Court of the United States refused to hear a case challenging California’s right to collect back taxes from nonresident third-party sellers for periods predating the state’s marketplace facilitator law.
Yet Pennsylvania courts reached a different conclusion. In 2022, the Commonwealth Court of Pennsylvania ruled that FBA inventory is not sufficient to establish a sales tax collection for nonresident FBA sellers.
Nevertheless, “Under Pennsylvania law, a business with property or inventory in Pennsylvania is subject to Pennsylvania taxes. This requirement applies to online retailers with inventory stored at a distribution or fulfillment center located in Pennsylvania.” Marketplace sellers are required to collect Pennsylvania sales tax if they have inventory in the state and make direct sales, or if they sell through a marketplace facilitator that doesn’t collect or remit sales tax on their behalf.
So, marketplace sellers that made sales in South Carolina in 2016 through Amazon may have cause for concern.
Then again, would South Carolina really try to go after what could be hundreds of thousands of individual remote sellers if Amazon prevails? How would the state identify those sellers? What would it cost to audit them? And what about uncollected tax on sales made through Amazon after the first quarter of 2016 and before Amazon started collecting tax on marketplace sales in April 2019?
And would South Carolina stop with Amazon and Amazon sellers? What about other marketplaces and other marketplace sellers? Did any other marketplaces have fulfillment centers or another physical presence in South Carolina prior to April 2019, when the state’s marketplace facilitator law took effect?
It could take years for courts to resolve these sales tax issues.
Business sues CPA for malpractice over remote sales tax
Here’s another interesting case stemming from Wayfair. A company based in North Carolina sued its former CPA firm and the successor firm for allegedly failing to inform the business that it had new sales tax obligations as a result of the Wayfair decision and subsequent state laws.
“The states’ (and occasionally local governments’) aggressive post-Wayfair ‘economic nexus’ rules potentially expose CPA firms to surprise malpractice claims,” according to an article in The Tax Adviser, a monthly publication of the American Institute of CPAs. “The North Carolina lawsuit is a cautionary tale for every CPA firm with clients that sell goods or services outside their home-state boundaries, whether online, via common carrier, or otherwise.”
What next?
These are just some of the legal disputes that have arisen since states won the right to tax remote sales. There will likely be others. But as the Wayfair decision enters its seventh year, remote sales tax obligations for businesses show no sign of easing.
Reprinted from the Avalara blog.
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