Nonprofit Accounting Basics

25 Years in the Making: Supreme Court Empowers States to Tax Online Retailers (the Wayfair Decision)

Jul 18, 2018


Court Ruling

Last week, the U.S. Supreme Court overturned a 1992 precedent prohibiting states from requiring businesses to pay sales tax unless they had a tangible physical presence within the state. That case, Quill v. North Dakota (U.S., No. 91-194, 5/26/1992), was decided long before electronic commerce came into being.

The current case, South Dakota v. Wayfair, Inc. (U.S., No. 17-494, 6/21/2018), determined that the physical presence rule in Quill was “unsound and incorrect,” as it allowed states only to levy sales taxes on businesses with a brick-and-mortar location within the state, or with employees working within that state. The Court reasoned that the prior ruling incentivized businesses to avoid physical presence in states, thus leading to a “judicially created tax shelter.” Thus, many online businesses have been enjoying an unfair advantage over traditional brick-and-mortar businesses when it came to sales taxes, causing states to lose out on enormous sums of sales tax revenue.

As the original case dealt with mail order catalogs, Justice Kennedy explained “the internet’s prevalence and power have changed the dynamics of the national economy” and that the “expansion of e-commerce has also increased the revenue shortfall faced by the states seeking to collect their sales and use taxes.” The Court ruled that the correct standard in determining the constitutionality of a state law is whether the tax applies to an activity that has “substantial nexus” with the taxing state.

State Impact

In the wake of Wayfair, states are likely to act very quickly to enact or expand their own laws to define sales tax nexus in the online age. The Government Accountability Office estimates that state and local governments could have collected up to $13 billion in additional tax revenue in 2017 if they had been able to require sales tax from online retailers.

Some states have already taken steps to get around the Quill physical presence rule. Currently, there are 31 states with laws expanding their definition of physical presence in order to tax online sales. However, these laws are not uniform and include a combination of 22 states that that have adopted New York’s “click-through” nexus law, 10 states that have adopted Colorado’s “notice and reporting” law, three states that have provisions that entirely ignore physical presence, and two states that have adopted Massachusetts’s “cookie” nexus provision. Going forward we may see states revising their sales tax provisions to come more into a national consensus, or possibility even federal action on the subject.

Unless Congress acts to provide a uniform definition of sales tax nexus, each state is entitled to enact and enforce its own standards in this area. For example, the standard for nexus in South Dakota (whose law was at issue in Wayfair) is $100,000 in annual sales revenue or 200 separate annual transactions from customers located in South Dakota.

Nonprofit Impact

This ruling will affect nonprofit organizations that sell their magazines, manuals, and other taxable items online or through the mail. As many nonprofit organizations do not have a tangible physical presence in the states where they sell their items, up until now they have not been required to pay sales tax in those states. Now these same organizations may be required to collect and withhold sales taxes, depending on each state’s new laws.

Additionally, many nonprofits use third-party fulfillment vendors to process and ship their products. Nonprofits should check their sales order systems and work with their third-party fulfillment vendors to ensure that they are tracking, collecting, and remitting sales tax for the appropriate jurisdictions.