Physical Presence No Longer the Key to Taxing by States
Business owners beware – You do not have to be in a state physically to be taxed by that state, so says the United States Supreme Court. Overturning a prior decision that required businesses to have a physical presence in a state before the state could tax that business, in South Dakota v. Wayfair (“Wayfair”) the Court ruled states could tax internet commerce where the seller has more than occasional sales to customers in the taxing jurisdiction, even though the seller has no physical presence in the state and has not qualified to do business in that state.
Prior to Wayfair it was generally accepted that states could not collect sales tax from sellers who lacked a physical presence in the state. This rule was known as the “physical presence test.” As recently as 1992, in Quill v. North Dakota, the Supreme Court affirmed the physical presence test by prohibiting states from requiring sellers to collect sales tax unless the seller had sufficient contacts in the state, such as physical store locations or sales representatives. If a business did not have a physical presence in a state, that state was powerless to tax a business. The dollar value and number of transactions was irrelevant.
After Wayfair, all that has gone by the wayside. More than thirty states have jumped on the Wayfair bandwagon. Most states followed South Dakota’s lead by enacting legislation requiring sellers who have more than $100,000 in sales annually or more than 200 transactions annually, to report, collect and pay sales tax. Some states, Pennsylvania and Washington to name two, have a $10,000 threshold, while states like Alabama, Connecticut, Georgia, and Mississippi have more generous $250,000 thresholds.
Although Wayfair arose in the context of internet sales, its application goes far beyond internet sales. Going forward any business that makes sales to customers in other states needs to monitor the number of transactions and the dollar value of those sales to avoid substantial under reporting or failure to report sales tax penalties. Not to be forgotten are local tax options. Nothing in Wayfair suggests that its rationale is limited to states. Where local taxing jurisdictions have a local option tax, it is only a matter of time before those local taxing jurisdictions demand their share of the pie from businesses under Wayfair.
To avoid being surprised by a nasty tax bite, businesses should review carefully where they sell their products and services, the number of sales outside their home state, and the dollar value of those sales. For example, the North Carolina Department of Revenue imposes: (1) a 5% penalty for failure to file for each month the return is not filed up to a maximum of 25%: (2) a 10% penalty for failure to pay a tax when due; (3) and a 25% penalty for a substantial understatement of tax liability (an understatement of more than 25% of the actual tax liability). Other states have similar penalties.
If a business does not know it is required to collect and remit sales tax under Wayfair, penalties will quickly escalate before the business is even aware. When in doubt, businesses should consider seeking guidance from state departments of revenue. Hagan Barrett, PLLC guides