The ripple effect of the landmark Wayfair decision (“South Dakota vs. Wayfair”) continues to confound CFO’s, accountants, and financial analysts throughout the US. In Part One of our series on the evolution of multi-state tax policy and its impact on interstate businesses, we noted that [sales tax] “registration poses pitfalls and opportunities.” And that “registration alone could instigate scrutiny and lead to state audits and large-scale assessments.”
Now, we are seeing a new trend…state policymakers aggressively pursuing newly registered companies for additional tax liabilities and other potential areas of tax exposure, taking advantage of Wayfair’s “slippery slope” regarding economic nexus. States are increasing their revenues, while companies, large and small, are feeling the pain.
Three years after Wayfair, all states with a state sales tax have passed economic sales tax legislation (Missouri takes effect in 2023). However, the threshold for sales tax registration is inconsistent from state to state and provides unequal treatment for small companies with large volume/small dollar amount transactions. Small and medium-sized businesses are less likely to have the resources to comply with the wide-ranging variation in state laws and economic nexus thresholds.
Beyond Sales Tax
One thing that is crystal clear: the Wayfair decision added even greater legitimacy to “factor presence nexus” for business activity taxes such as income tax, franchise tax, or gross receipts tax. In 2002, the MultiState Tax Commission (MTC), an intergovernmental tax agency, created model legislation to help states determine how to tax business activity without any physical presence requirement. The MTC suggested that states rely on factors such as payroll, sales totals, or a percentage of total sales or payroll to indicate the extent to which a business is operating in that state.
California, New York, Connecticut, Colorado have had economic income tax nexus rules on the books for over a decade. Texas, Washington, Ohio, and Oregon have economic nexus statutes for non-income taxes such as franchise and gross receipts taxes. Even localities such as Philadelphia have economic income tax nexus statutes. The factor presence trend is likely to continue at the state and local levels.
Ohio was among the first of nine states to legislate a “sales factor presence” as the nexus standard. The Ohio Supreme Court upheld a sales factor threshold as “an adequate quantitative standard” and a constitutionally allowed tax. While some observers criticized the decision, the Court dismissed the argument noting that any amount could be used as long as it was high enough to ensure fairness in interstate commerce.
That Ohio case has given other states confidence to establish similar standards. States can now set an arbitrary sales factor threshold and use that to claim nexus. Taxpayers will not be able to rely on past confusion relating to the number of transactions or dollar limits as protection from a nexus determination. Factor presence nexus standards may be as dramatic a gamechanger for income, franchise, and gross receipts tax as Wayfair was for sales tax.
States have the wind at their back with Ohio’s Supreme Court ruling and the MTC’s recent guidance (August 4, 2021) regarding the taxability of business conducted online.
Since the enactment of the Interstate Commerce Act (PL 86-272), which generally protects a company from state income tax if its only activity is sales solicitation of tangible goods, Congress has not fully updated the statute or passed new laws to account for today’s interstate commerce, i.e., online business activities and e-commerce.
In its updated 2021 guidance, the MTC acknowledged that the Wayfair case did not directly address PL 86-272, but it fundamentally changed how states determine sales tax nexus. By eliminating the physical presence requirement for sales taxes, the Court allowed for new ways to determine whether a company is conducting business in a state.
The revised MTC provides multiple examples to clarify which “activities conducted via the internet” would be immune from state income tax and which would not. The MTC said, for instance, that offering static FAQs about a product on a website does not create income tax nexus. In contrast, when a business “interacts” with a customer on that business’ website (or app), that business is now engaging in activity within its customer’s state subject to income tax. Under this new MTC guidance, examples of “unprotected activities” include soliciting or receiving online credit card applications and placing internet cookies on customers’ computers designed to gather market or product research data.
The MTC’s guidance is just that; it is not binding on states. But it does help state policymakers develop legislation to fit their economic needs and political environment.
So, how does the new multi-state tax policy [r]evolution impact business planning and operations? And what can you do to minimize your tax burden?
- Registering with state tax agencies for sales taxes has caused additional scrutiny and tax exposure in other areas of taxation;
- Complying with different state laws presents hardships for small businesses, especially those with small dollar-value products;
- Wayfair and other cases have created spillover into income tax, franchise tax (gross receipts tax), and other indirect taxes;
- Anyone pursuing M&A activity or looking for financing should carefully review potential state nexus and associated tax exposures;
- Service businesses have no protections and never did on the Interstate Commerce Act (PL 86-272);
- Consider filing $0 returns to get the statute running in states with factor presence nexus.
Post-Wayfair, companies should pay greater attention to all state-imposed taxes, not just sales tax, and review their economic tax footprint with a nexus review and exposure analysis. Be prepared by contacting your state and local tax advisor, who follows this ever-changing landscape and can help you proactively protect your business and hard-earned revenues.