A 2018 Supreme Court decision may have major implications for companies that sell goods and services to customers in states where they have no physical presence. Specifically, any company that has gross revenue from sales of goods and services delivered into a state exceeding $100,000; or 2) sells goods and services for delivery into a state in 200 or more separate transactions, could be liable for collecting and remitting sales tax to that state. Note that this is a low threshold. In theory, a company with sales $6 million to $7 million evenly spread throughout the United States could trigger a sales tax filing requirement in all 45 states which assess a sales tax, plus local jurisdictions. As a result, all companies will need to analyze the sales tax laws in each state in which they sell goods and/or services to determine if and when they will need to register and file sales tax returns, and perhaps collect and remit sales tax.
On June 21, 2018, the U.S. Supreme Court handed down its decision in the South Dakota v. Wayfair, Inc.case related to sales and use tax nexus standards. Wayfair centered on South Dakota’s economic nexus law, which challenges the long-standing physical presence standard upheld by the Supreme Court in Quill Corp. v. North Dakota. Quill held that a state may not tax sales by a seller with no physical presence in the state. Under South Dakota’s economic nexus law, economic activity alone triggers a tax collection obligation; no physical presence is needed. In accepting the South Dakota case, the court agreed to reconsider Quill. In ruling in favor of South Dakota, it overturned the physical presence standard upheld by Quill and Bellas Hess(an earlier ruling). This paves the way for states to impose a tax collection obligation on businesses that have no connection to the state other than a certain amount of economic activity.
The thresholds and requirements to establish economic nexus will likely be different for each state and some states may enact statutes that are more aggressive than others. South Dakota’s economic nexus laws at issue in Wayfair established nexus with South Dakota if the business in the current or previous calendar year: 1) had gross revenue from sales of goods and services delivered into the state exceeding $100,000; or 2) sold goods and services for delivery into the state in 200 or more separate transactions. Much of the focus has now turned to those states with enacted statutes that are similar in application to the law in South Dakota and the potential effective date of such provisions.
While the Court’s ruling will directly affect companies selling merchandise over the internet, the new economic nexus rules apply to all businesses who are “remote sellers” (companies that sell products and services into states where the entity has no physical presence). Since many companies sell products and services into states where the entity has no physical presence, these companies will likely be subject to the sales tax collection and filing requirements in many new states. Some companies might be surprised to learn that their remote services might be taxable under a tax agency’s broad reading of the law. And even if a company does not sell any goods or services subject to sales tax, it is still at risk for state income taxes, as discussed below, so no one is really off the hook.
The elimination of the physical presence requirement has opened the door for all states that impose a sales tax to eventually require remote sellers to collect their tax. However, to require collection a state must have a statute on its books that imposes tax collection obligations on remote sellers. Many states currently have remote seller sales tax collection statutes of various forms on their books, while some do not.
Of the states with statutes requiring collection by remote sellers, there are several threshold requirements. Many states have adopted or suggested future adoption the $100,000 in sales/200 transactions threshold that was upheld in Wayfair, others have higher or lower thresholds. Further, some states’ laws assert additional nexus creating activities and sales tax collection obligations on other factors, such as having “economic presence” in the state, having a related entity physically present in the state, using a marketplace provider in the state, etc. The states without statutes requiring collection by remote sellers would need to enact new laws before collection could begin.
The dates on which remote sellers must begin collecting tax also vary by state. Some of these effective dates pre-date the Supreme Court’s decision in Wayfair; however, most states have indicated they will not seek retroactive liability. Also, litigation is pending in a few states that must be resolved before the state can require remote sellers to collect.
Sales Tax Exposure
All companies should revisit positions they have taken for sales and use tax collection purposes regarding the need for physical presence to establish nexus. While Wayfair involved a statute with prospective application, potential retroactive application and enforcement to the effective date of a state’s applicable statute remains uncertain. For example, if a company sold goods or services to customers in Iowa, where the enacted statute will not become effective until January 1, 2019, the company would not have an accrual at December 31, 2018. On the other hand, a company that has sold goods or services to customers in Massachusetts (where a sales/transaction-based nexus regulation became effective in October, 2017), would need to carefully evaluate the need for an accrual at December 31, 2018. In fact, the Massachusetts Department of Revenue issued a notice on June 22, 2018, that indicated that the “existing regulation…which took effect in October 2017, continues to apply and is not impacted by the [Wayfair] decision.”
Once the states of immediate concern have been determined, it will be necessary to register with the state tax agency prior to actually collecting taxes from customers. Further, if a company sells primarily to government, educational or charitable organizations, exemptions might apply, as would sales to a customer who will resell the products—but exemption certificates need to be collected and maintained. If documentation is not received, tax should be charged, collected, and remitted in all states where the company maintains sales tax permits (upon audit, a sale may be deemed taxable if an exemption certificate is missing or incomplete).
Financial Reporting Implications
Based on a state-by-state analysis, if a company believes it is certain that it will be subject to liability for sales and use tax in particular jurisdictions as result of Wayfair, then the liability should be recognized and measured based on the provisions of the applicable laws. In other words, if a company believes that a state taxing authority will require the company to collect and remit sales and use taxes beginning June 21, 2018, then an obligating event has occurred. Accordingly, the company should record a liability as of that date (or as of the effective date of a particular state’s law, if later). Importantly, such liability does not represent a loss contingency, but rather represents a contractual obligation pursuant to applicable law. Thereafter, satisfaction of the liability would be based on the guidance in ASC 405, Liabilities, which requires the debtor to derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either the debtor pays the creditor and is relieved from its obligation for the liability, or the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.
On the other hand, if there is uncertainty about whether a company will be subject to liability for sales and use tax as result of Wayfair, ASC 450, Contingencies, provides accounting guidance for loss contingencies, which include existing conditions involving uncertainty as to possible loss that will be resolved when one or more future events occurs or fails to occur. As such, sales and use tax should be assessed as a loss contingency pursuant to ASC 450. An estimated loss from a loss contingency is accrued if it is probable that a liability has been incurred as of the date of the financial statements and the amount of the loss can be reasonably estimated. If a company concludes it is probable it will be subject to sales and use tax, then the liability should be recognized and measured based on the provisions of the applicable laws. Thereafter, derecognition of the liability would be based on the guidance in ASC 405 discussed above which requires the debtor to derecognize a liability if and only if it has been extinguished.
OBSERVATION: The accounting guidance in ASC 740, Income Taxes, including the guidance related to uncertainty in income taxes, does not apply to sales and use tax because sales and use tax is not a tax that is based on income.
Financial Statement Disclosure
Companies may also need to consider including a note disclosure in their financial statements related to the impact of Wayfair. The following is an example that may be modified, as needed, for individual situations:
On June 21, 2018, the U.S. Supreme Court issued an opinion in South Dakota v. Wayfair. The State of South Dakota alleged that U.S. constitutional law should be revised to permit South Dakota to require remote sellers to collect and remit sales tax in South Dakota in accordance with South Dakota’s sales tax statute. Under the U.S. Supreme Court’s ruling, the longstanding Quill Corp v. North Dakota sales tax case was overruled, and states may now require remote sellers to collect sales tax under certain circumstances. We began collecting sales tax in [identify states or all 45 states that have sales tax]. Pursuant to South Dakota’s statute, we are not required to pay sales tax retroactively. In addition, we have recognized liabilities for contingencies related to state sales and use tax deemed probable and estimable totaling $XX,XXX at December 31, 2018, which are included in Accrued Liabilities in our consolidated balance sheets.
Income Tax Implications
Additional questions have arisen as to whether Wayfair affects the accounting for state income tax nexus positions for companies that have not previously filed state income tax returns based on the physical presence standard in Quill. Although Wayfair addresses nexus considerations for state sales and use tax purposes only, many states have enacted laws which say that a company must file state income tax returns there if their sales exceed a certain threshold—typically in the range of $300,000 to $500,000, depending on the state, even if the company does not have a physical presence there. These laws have been on the books in many states for several years with the states taking the position that the old physical presence requirement only applied to sales taxes, and the state courts have upheld these rules. The recent Supreme Court case seems to indicate that these state income tax rules are valid. Some of these states might apply these income tax filing obligations retroactively, since the laws have been on the books for many years in some instances, enhancing the potential exposure. As a result, some companies may determine that Wayfair changes their judgment regarding their particular facts and circumstances related to economic nexus for state income tax purposes.
Potential for Congressional Response
While previous congressional proposals to address sales and use tax nexus have stalled, Congress may now act given that Quill has been overturned. For example, Congress could move to reverse Wayfair and affirmatively require physical presence as the appropriate nexus standard for sales and use tax purposes. On the other hand, Congress could take a more limited approach and require the adoption of the Streamlined Sales and Use Tax Agreement, or similar simplification requirements, for states wishing to impose a tax on remote sellers through the enactment of sales-based nexus standards. In an attempt to clarify interstate sales tax collection requirements in light of Wayfair, a bipartisan group of lawmakers introduced the Online Sales Simplicity and Small Business Relief Act, in September.
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