Small sellers are facing increasingly tough times nearly two years after the U.S. Supreme Court issued its landmark Wayfair decision.
The 2018 South Dakota v. Wayfair Inc. decision, which retired the physical presence nexus standard for sales and use tax purposes, triggered a seismic shift for businesses selling across state lines. Businesses have since been navigating a deluge of state laws and regulations requiring sales and use tax collection from remote retailers.
"While the decision itself is problematic in various ways, the biggest problem has been how states have been implementing it," according to Andrew Moylan, executive vice president of the National Taxpayers Union Foundation. “The problem has been states implementing the Wayfair decision in a way that is unduly burdensome, to small sellers in particular, and unduly burdensome to interstate commerce."
“The longer that time goes on without relief in the form of federal legislation, states taking action to relieve the burdens, or a successful legal challenge, the harder it makes it for small businesses to operate and have the confidence that they’ll be able to access the kind of national marketplace that small sellers need to be able to survive when they’re competing against a lot of big box retailers and others,” Moylan told Tax Notes April 8.
The American Catalog Mailers Association (ACMA) and NetChoice have been working toward a legal test case in the aftermath of the Wayfair decision. Raising concerns over “excessive state laws,” the two groups explained in a June 2019 release that the purpose of litigation would be to “establish judicial pressure on states to adopt laws consistent with the Wayfair simplification factors” and prompt congressional intervention.
However, the COVID-19 pandemic has put those efforts on hold for now. “The status of test case litigation clearly is up in the air, given these circumstances,” ACMA President and Executive Director Hamilton Davison told Tax Notes recently.
The Wayfair majority's decision highlighted several features of South Dakota’s tax system that “appear designed to prevent discrimination against or undue burdens upon interstate commerce,” including sales and transaction thresholds, prospective enforcement, and the state's adoption of the Streamlined Sales and Use Tax Agreement.
Since the Court’s ruling, a patchwork of sales and use tax systems has surfaced among the states — for example, while most states with sales taxes are asserting nexus based on economic activity, there are differences among safe harbor thresholds. And as sellers face varying regimes, some jurisdictions have sparked criticism with their laws.
“There are several states and local jurisdictions that have adopted laws that discriminate against or place a huge burden on interstate commerce,” Davison said, citing Alaska’s local jurisdictions and Illinois as examples. “But the ACMA at this point has not identified a particular state or locality to target its efforts, so our identifying those jurisdictions is not meant to indicate that to be the place where a lawsuit will be brought. In part, the jurisdiction depends on the enforcement policies of the jurisdictions against our members.”
Calling on Congress
“Our concern [is] laws that put our members at a disadvantage, either because they favor in-state businesses or because they require our members to incur a huge burden to comply with their tax systems,” Davison said. “Certainly, any attempt to enforce a state’s laws without enough notice to comply warrants our attention.”
Small seller concerns were the focal point of a March 3 congressional hearing, during which retailers pressed lawmakers for federal legislation to standardize and simplify states’ regimes.
In written testimony delivered to the House Small Business Subcommittee on Economic Growth, Tax and Capital Access, the ACMA outlined post-Wayfair problems and urged Congress to “pass a seemingly simple set of rules that will allow remote sellers to affect sales tax collections on every transaction they do.” The ACMA is also gathering case studies from sellers coping with challenges in an effort to encourage federal legislation.
Representatives for Halstead Bead Inc. and K-Log Inc. were among the witnesses that offered testimony during the hearing itself, both discussing the post-Wayfair complexities and detailing their compliance costs and burdens. Neither company is planning remote seller litigation in any state.
Linda Lester, vice president of K-Log, told Tax Notes that the mood leading up to and during the congressional hearing was positive. There was momentum toward congressional action, according to Lester, who noted that there was talk of hearings before subcommittees in the Senate Finance Committee and the House Judiciary Committee.
Lester had meetings scheduled with eight congressmen the day after the hearing. She first met with Rep. Andy Kim, D-N.J. — chair of the Subcommittee on Economic Growth, Tax and Capital Access — who Lester said “was very receptive to finding a solution.” Congressional aides covered the remaining meetings because House members were called to vote on an early package (H.R. 6074) providing emergency aid to combat COVID-19, which was approved by both congressional chambers and signed by President Trump within days.
Momentum toward a potential federal solution on remote sales taxation has since stalled. However, Lester explained that congressional intervention on the issue could help not only sellers but also states, particularly as state officials work to address the economic fallout of the coronavirus crisis.
“Sales tax revenues are down nationwide. State and local governments are hurting just as much as the rest of us,” Lester said, noting that those governments “need income just as businesses and individuals need income.”
“This is the perfect opportunity to change to our ‘new normal’ sales tax too. One rate per state with an easy filing form would help everyone, not just businesses, but state departments of revenue too,” according to Lester, who is advocating for a federal fix that would require each state to set one interstate sales tax rate and use a simplified filing form.
Lester, whose "mantra is simplification plus education equals compliance," suggested that federal lawmakers take the rest of 2020 to simplify tax calculation and collection for remote retailers. “Then introduce the new procedures in 2021 with a full education program telling everyone what needs to be done,” she added.
Layers of Complexity
States likewise are focused on the COVID-19 impact, but “the issue for states of finding ways to increase remote seller compliance remains,” according to Richard Cram, director of the Multistate Tax Commission’s National Nexus Program.
An MTC work group in December 2019 released a white paper on Wayfair implementation and marketplace facilitator issues, which featured feedback from business participants. Cram explained that among several concerns shared by the business community, a significant source of frustration is the challenges posed by states with locally administered sales and use taxes.
Those states have been working on simplification, according to Cram, who explained that states have undertaken efforts to centralize administration so that retailers do not have to register in each local jurisdiction. Cram noted that another popular idea is to implement programs permitting remote retailers to use a flat combined state and local use tax rate, such as those programs in Alabama, Louisiana, and Texas.
“I know there is a lot of simplification that needs to be done on the locally administered sales taxes, and states are working on that," Cram told Tax Notes. “But I’m sure the business community wishes it happened yesterday.”
Sourcing can also be an issue in states that have enacted economic nexus regimes and use destination sourcing for interstate sales while intrastate sales are origin sourced.
“That’s a problem because if the in-state seller is going to collect the rate in effect at the rate of their location, the remote seller is going to collect at the rate of the purchaser’s location,” Cram explained. “And there can be differences there. Sometimes it’s higher, sometimes it’s lower.”
Cram further noted that there can be confusion over which rate applies for a business that has in-state locations but also makes remote sales from outside the state. Noting that it would be best if states adopted destination sourcing for both in-state and out-of-state businesses, he explained that it would be "a heavy lift and [would] take some time," adding that in-state businesses like the ease of origin sourcing.
Likewise, remote retailers are seeking state guidance on which items are taxable and exempt, similar to the taxability matrices used by SSUTA member states. Some non-SSUTA states have offered guidance, according to Cram, who noted that Illinois has published a taxability matrix. He added that SSUTA member states have also made a lot of progress in providing guidance on local rates and boundaries, and some non-SSUTA states are in the process of providing or have provided local information that remote retailers can download.
Working to Increase Compliance
Smaller remote retailers have also shared difficulties they have experienced with registration requirements, according to Cram.
“I know the states, as they set up their registration systems, basically focused on brick-and-mortar businesses within their state,” Cram said, noting that the registration processes pose numerous questions and seek extensive information. “I think it would be helpful if they had a streamlined registration process for remote sellers.”
“That’s not the case for most states, except probably the states that are part of the Streamlined Sales and Use Tax Agreement — they have their centralized registration system, which is a lot easier than individual states,” Cram added. However, not all states are members of the SSUTA, such as California, Pennsylvania, and Texas.
“I think states would go a long way to increasing compliance if they made it easier for remote sellers to register,” Cram said.
Another issue has surfaced with states’ economic nexus thresholds, many of which include an annual gross sales threshold that can capture nontaxable transactions such as sales for resale. This requires a lot of wholesalers that don’t make taxable sales to register and file “zero returns,” which businesses have said imposes unnecessary burdens and expense, according to Cram.
“States are figuring out how to remove the obligation to file returns when there isn’t really any tax owed or being collected, even though their sales meet the threshold,” Cram said.
“So the dynamic you’ve got is states are working to increase the compliance rate,” Cram said. “At the same time, there are a lot of hurdles for small remote sellers to get into compliance.”
Need for Education
One significant hurdle for smaller sellers is simply knowing about the Wayfair ruling.
Many are unaware of the Supreme Court’s decision or the shift in state laws, according to Brad Scott, finance director of Halstead Bead, who further noted that sellers who are aware of the changes often don’t realize the changes apply to them.
When sellers discover they have a tax obligation, “they’re already behind the eight ball because they owe back taxes plus penalties plus interest in other states,” Scott told Tax Notes. He explained that smaller businesses, many of which are leveraged, cannot survive that financial hit.
“Lots of companies are not aware of this issue and are out of compliance, and you’re not going to hear about them going under,” Scott said. “You’re not going to hear about why they went under. You’re not going to hear about the fact that the owners lost their business, lost their house, lost their retirement, lost their kids’ college tuition. You’re not going to hear about any of that. It’s just going to happen quietly.”
Lester likewise stressed the need to educate smaller sellers, referring back to her mantra of "simplification plus education equals compliance.”
“If you simplify this so that anybody can do it, and then you tell everybody they need to do it, then they will,” Lester said. “Nobody wants to avoid paying taxes and have the stress of dealing with an audit later and not knowing if they’re doing it right. But it’s so complicated that it’s an overwhelming task.”
“I’m pushing for a federal solution that requires each state to set one tax rate for all interstate sales and use a simple one-page filing form. And then you tell everybody that they need to do it,” Lester explained. Under her proposal, sellers ideally would only report and remit interstate sales tax to their home state and the tax monies subsequently would be divided and transferred to the appropriate states.
Lester noted that her proposed federal solution could cut administrative and compliance costs because retailers would answer to only one revenue department. For example, K-Log spent nearly a year and incurred costs exceeding $75,000 to prepare for nationwide sales and use tax collection. Further, the company spends significant money to collect a small amount of tax in most states — while most of its customers are tax-exempt public agencies and schools, those sales are captured in states’ gross sales thresholds that trigger economic nexus.
States’ economic nexus thresholds could also be eliminated if there was a nationwide solution, according to Lester, who finds the thresholds offer no protection.
“This is complex and hard to do whether you have $100,000 worth of sales into a state or $1 million of sales into a state,” Lester said. “We should not be looking at thresholds. If you make it so simple — with one rate per state and one simplified form and then you tell everybody they have to do it — you don’t need a threshold at all.”
Federal Solution Feasible?
Retailers recognize that a federal solution is an uphill battle, in large part because it requires agreement among the states on a shared set of standards. However, Lester noted that a federal mandate would provide a fiscal benefit to states.
“Right now states are getting hardly any money from this because there is so little compliance,” she said. “They may see an increase, but it’s minuscule compared to what they could get. If they made it so simple that everybody could comply, their revenue would go way up.”
Scott likewise noted that simplicity and uniformity among states would increase sellers’ compliance, which in turn would generate greater revenue for states.
“I wish that the states would recognize the benefits of uniformity,” Scott said, explaining that states’ push to overturn the physical presence standard stemmed from Main Street sellers’ concerns that the “big guys such as Amazon and Walmart” had a competitive advantage. However, he noted that the post-Wayfair rules affect not just the larger retailers but all businesses engaged in interstate activity.
“Now you’re looking at wholesalers like us, manufacturers, and distributors that are impacted by this,” Scott said. For example, from the time of the Wayfair decision through March 2020, Halstead spent nearly $200,000 to collect a little under $84,000 in sales tax across 32 states.
One major obstacle to a nationwide solution is the fact that state officials largely look at businesses as a source of revenue, according to Scott. However, he stressed that state officials should be considering how their own constituent businesses are affected by other state policies.
“They should start to recognize that they are not one state operating in isolation, that they are part of a larger picture, and if their policies don’t line up with the other states then it makes it very difficult for their constituent small businesses to perform,” Scott said. “Once they recognize that this is not just about a source of revenue, but it’s also about their own in-state economies that are hinging upon action, then I think that will help.”
“But no one talks about it that way,” Scott added.
Further, congressional lawmakers hear from lobbyists representing Amazon, Walmart, and other big businesses that don’t share the same concerns with small and medium-size businesses, according to Scott.
“Most small businesses can’t afford a lobbyist and can’t put their hand up because they’re out of compliance,” Scott said. “Small businesses die quietly and Congress doesn’t hear about it.”
“Until Congress wraps their head around the fact that small businesses are being set up to fail because of overly complex state and local tax policy, then I don’t think anything meaningful is going to happen,” Scott added.
'Dearth of Lawsuits'
Following the Wayfair decision, many people relished the thought that the Supreme Court had resolved the decades-long debate over remote sales taxation, according to Moylan.
“I think we see that at the congressional level, this sort of pervasive feeling that the issue was solved by the Supreme Court and there isn’t much for us to think about now,” Moylan said. “And I think that’s been true in the legal realm as well.”
Moylan noted that larger players may have opted not to pursue lawsuits for various reasons, such as concerns over litigation-related expenses or strategic decisions to comply with states’ systems with the help of their lawyers and accountants.
“It’s led to this sort of dearth of lawsuits,” Moylan said. “And it’s because it’s falling to a lot of these smaller operators to bring some of those cases. But it is very expensive and very difficult to do that, even in some of the more egregious situations in places like Kansas, which has no de minimis threshold, or Louisiana, which arguably has the most complex sales tax code in the country.”
And as varying administrative requirements and collection standards have emerged since Wayfair, larger vendors appear to be in a better position to monitor and manage the wide range of regimes. Cram noted that big retailers “already have a handle on” things like filing returns in multiple states and tracking different tax bases and exemptions.
“And they would be the ones with the resources to seriously litigate,” Cram said. “The small remote sellers are the ones who probably are experiencing the most issues, and they probably have the least resources to go through an expensive litigation process. So you kind of have that dynamic in the background.”
Looking Ahead
Darien Shanske, professor with the University of California, Davis, School of Law, told Tax Notes that “in general, the states have taken a reasonable position in their choice of thresholds.” There might not be many plaintiffs to litigate because states’ safe harbor thresholds carve out a significant number of sellers, he explained.
“But I’m sure there will be some,” Shanske said. “And there will be groups that will be interested in finding the small plaintiff who just crossed the volume threshold or had to deal with several different local jurisdictions in a state, such as Colorado or Louisiana. But it will take a while for those to come up through the system.”
“But even if they do come up through the system, it will only be for a handful of sellers that are big enough to sort of cross the threshold, but not big enough for it to be kind of laughable,” Shanske added. “If Amazon happens to only have three sales in Alaska next year, no one is going to say it’s an undue burden on them, no matter how many jurisdictions Alaska has."
Jamie Yesnowitz of Grant Thornton LLP, who also testified during the congressional hearing on small businesses, predicted that one of two issues will form the basis of “the first post-Wayfair lawsuit that reaches a significant stage of litigation.”
“Either the case will touch upon a challenge to a state’s remote seller law that does not completely line up with South Dakota’s remote seller regime that the U.S. Supreme Court endorsed in Wayfair, or the case will challenge the ability of a state to require marketplace facilitators to collect and remit tax,” Yesnowitz told Tax Notes. “I would tend to think that the challenge will arise from a group of growing, moderately sized businesses with some internet retail presence, or perhaps an industry-focused organization representing these types of businesses.”
New Nexus Considerations
Justice Anthony Kennedy’s opinion in Wayfair made clear that physical presence is no longer required to satisfy the substantial nexus prong of the test under Complete Auto Transit Inc. v. Brady. However, states are still subject to the substantial nexus requirement.
“Such a nexus is established when the taxpayer [or collector] ‘avails itself of the substantial privilege of carrying on business’ in that jurisdiction,” according to the Wayfair opinion, quoting the 2009 opinion from Polar Tankers Inc. v. City of Valdez. The Court determined that nexus was sufficient “based on both the economic and virtual contacts” that the vendors had with South Dakota.
Specifically, South Dakota’s economic nexus thresholds — $100,000 in annual sales or 200 individual transactions per year — were considered sufficient to show that a “seller availed itself of the substantial privilege of carrying on business in South Dakota.” Further, emphasizing the Wayfair retailers’ significant size, the opinion noted that they “undoubtedly maintain an extensive virtual presence.”
The Supreme Court, however, did not establish another bright-line nexus test based on South Dakota’s thresholds. And not all states have adopted South Dakota’s specific thresholds, which has left open the question of whether different state standards would survive a judicial challenge.
“The substantial nexus requirement is there to make sure that there is sufficient connection with the state to make it fair and reasonable for the state to expect the vendor to collect taxes,” Shanske explained. “And there will be some litigation about what substantial is.”
“But most states seem to be moving to pretty reasonable bright-line tests,” Shanske said, noting that the thresholds based on the volume of transactions are potentially more susceptible to challenges.
Placing Importance on Pike
However, it doesn’t appear that the nexus test has to do all the work when it comes to contesting states’ tax systems after Wayfair, according to Shanske.
Addressing concerns of undue burdens on interstate commerce, the Wayfair opinion observed that South Dakota’s regime “affords small merchants a reasonable degree of protection,” pointing to the safe harbor thresholds, prospective enforcement, and adherence to the SSUTA.
The Court further noted that “other aspects of the Court’s Commerce Clause doctrine can protect against any undue burden on interstate commerce,” referencing the U.S. solicitor general’s position that “tax-collection requirements should be analyzed under the balancing framework of Pike v. Bruce Church.” The opinion did not expressly endorse a Pike analysis for future challenges, but it appears to have “left open the possibility for a Pike balancing type of challenge,” Shanske and two other professors observed in a 2018 article.
Shanske also co-wrote an amicus brief on behalf of four U.S. senators in the Wayfair case, urging the Court to overturn the physical presence test from Quill Corp. v. North Dakota and promoting the Pike balancing test to assess whether a state imposes undue burdens on interstate commerce.
“Pike balancing is made for this problem,” Shanske said, explaining that Quill’s physical presence test wasn’t the proper test for the problem.
“The Court had other doctrinal tools even in 1992,” Shanske said, noting that footnote 6 of Quill echoed Pike language when discussing undue burden concerns. “Clearly, the Pike test was there and that’s what the Court should have used. The Court shouldn’t have come up with this artificial bright-line test.”
“States are allowed to have vendors collect their taxes if they have substantial nexus with the state. But they’re not allowed to impose an undue burden on vendors collecting their taxes,” Shanske said. The example of home rule states in which localities have different tax bases and tax rates is a Pike balancing issue, Shanske explained, noting that problems could arise as taxpayers attempt to track down and comply with localities’ varying rules and rates.
In a June 2019 article, Richard Pomp, the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law, discussed Wayfair’s elevation of the Pike balancing test “into a key feature of commerce clause jurisprudence” and offered examples of potential issues.
“There will be renewed interest in Pike balancing, which has previously played no significant role in state taxation,” according to Pomp. “I am somewhat skeptical that the doctrine can bear the weight that will now be placed on it or how it will be distinguished from just plain old ‘undue burdens.’ The most likely litigation will take place at the municipal level, dealing with discrimination, undue burdens on interstate commerce, and violations of the Internet Tax Freedom Act.”
Conceivable Challenges
If a challenge arises out of a remote retailer statute, Yesnowitz predicted that "such challenge might allege that a particular remote seller law does not afford the business a reasonable degree of protection in a large market state that has adopted the $100,000 sales threshold, on the basis that such threshold might be considerable in the South Dakota market but is very limited in a large market state."
“Alternatively, the challenge could target a state that is not a party to the Streamlined Sales and Use Tax Agreement and hence requires additional administrative and compliance costs in order to conform, resulting in an undue burden on the remote seller,” Yesnowitz added.
Moylan said future litigation is likely to be more successful in “black-and-white cases” against states such as Kansas or Louisiana or the few states that are retroactively seeking sales tax from out-of-state sellers. However, there is more of a gray area in non-SSUTA states that have implemented safe harbor thresholds but have only adopted some of the simplification measures that the Wayfair decision highlighted when explaining the SSUTA, according to Moylan.
“What if a state checks only some of those boxes from the Wayfair decision — does it matter which ones they check?” Moylan said. “Are some more important than others? Or are all of them important? Those are real open questions."
Mulling Marketplace Issues
In the wake of the Wayfair decision, a wave of marketplace facilitator laws also swept across the states and raised another set of potential issues. Yesnowitz noted that “Wayfair was completely silent” regarding a potential challenge involving marketplace facilitation.
“It stands to reason then that a party which is not the seller or purchaser in a transaction, but is now compelled to collect and remit sales tax on all transactions that cross a particular platform that it might be running or otherwise associated with, might have to expend significant resources to determine whether particular transactions are taxable or not,” Yesnowitz said.
“Further, that party might have to spend a lot of time and energy in determining whether it is the marketplace facilitator for a transaction, or whether another party that may be involved in the marketplace platform might have that responsibility,” Yesnowitz added. “That party might claim that serving as the tax collector in numerous jurisdictions is an undue burden and goes beyond what the Supreme Court said was reasonable in Wayfair.”