It’s been over two years since the Supreme Court’s decision in South Dakota v. Wayfair, and its impact has been substantial. Add in the onset of the coronavirus pandemic, with its role in driving individuals toward online shopping, and you have a seismic impact in the tax world. In this podcast, Jennifer Karpchuk, shareholder and state and local tax practice cochair for Chamberlain Hrdlicka Attorneys at Law in Philadelphia, joins us to dissect current developments related to Wayfair and COVID-19. Karpchuk - and Ilya Lipin, managing director of state and local tax at BDO, will talk more on the pandemic's impact on taxes at PICPA's inaugural Tax Con webcast on Nov. 10-11.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
It's been over two years since the Supreme Court's decision in South Dakota v. Wayfair, and its effect on the national and local economy has been sizable. Add in the impact of the COVID outbreak seven months ago, and now seems like a perfect time to talk about the dramatic changes that have been heaped upon the tax landscape as a result of these two seismic events. To do this, we are with Jennifer Karpchuk, shareholder and state and local tax practice cochair for Chamberlain Hrdlicka Attorneys at Law in Philadelphia.
It's been over two years since the Supreme Court's decision in South Dakota v. Wayfair. Before we dive into particulars, can you talk to us a little bit about the overall effect the decision has had on the economy and business environment thus far?
[Karpchuk] In Wayfair, obviously, the court upheld South Dakota's economic nexus law and threw out the previous, the old physical presence standard. For those states that moved to economic nexus thresholds, many quickly saw the benefit of the laws in the form of increased revenue from e-commerce. And our economy is increasingly becoming reliant on e-commerce, so a physical presence requirement certainly was hindering states’ ability to collect on sales into their states.
Turning to more recent months, COVID-19 has heightened an economy that was already highly dependent on e-commerce. So we had the work-from-home environments, quarantined environment. Many people were then turning to e-commerce more than ever for their shopping needs. Post-Wayfair, a lot of states then have been able to capitalize on the increased reliance on e-commerce through these Wayfair laws and that's likely softened the fiscal impact of COVID-19, at least as far as sales tax revenue is concerned.
What impact has the decision had on matters of economic nexus in particular?
[Karpchuk] Well, Wayfair was sort of the push that states needed to hop on the economic nexus bandwagon and they did that very quickly after the decision. Some already had implemented economic nexus laws in anticipation of the court upholding South Dakota's law. Others implemented it during the remainder of 2018 and into 2019. Within two years of the court's decision in Wayfair, of the states that impose a sales tax, we had all but two of them implementing economic nexus. And the only holdouts that we still have today are Florida and Missouri.
In addition to economic nexus, sort of the corollary we have are these marketplace facilitator laws that were implemented after Wayfair. In fact, all but one of the states that impose economic nexus also implemented these marketplace facilitator laws throughout the past two years. Those laws essentially require businesses like Amazon and Etsy to be collecting and remitting sales tax on behalf of their third-party sellers. One of the benefits to the state is that economic nexus combined with marketplace facilitator laws allows the states to collect more sales tax from fewer entities, which results in simpler compliance.
What exactly are the thresholds related to Wayfair and how has COVID-19 affected those?
[Karpchuk] The original Wayfair thresholds were annual thresholds of either $100,000 into the state or 200 transactions. Some states implemented an additional test there. So, it would be $100,000 into the state and 200 transactions. However, as time went on after the decision, a number of states ultimately did drop that 200-transaction threshold and just went with the monetary threshold. The most common monetary threshold was $100,000.
There are some states that did not adopt the South Dakota model. Some of those were New York, California, and Tennessee. And Tennessee, actually, in June had implemented legislation that will be lowering its $500,000 threshold down to the $100,000 threshold, effective for October 1st. Some states with these higher thresholds may decide to follow suit as COVID-19 and its fiscal impact drags on and falls more in line with what the standard Wayfair $100,000 threshold has been.
There's always a chance that states may find it tempting to drop below that $100,000 threshold. Kansas is sort of this unique outlier there with the Department of Revenue's position being that a single sale of any denomination is sufficient to create nexus now. Apart from the fact that Kansas' own attorney general disagrees with the Department of Revenue, that's something on the back burner that maybe some states would be tempted to look to, but I think it's unlikely that most states would actually try to do that once they think it through and drill down to what the compliance costs would be, coupled with the potential additional revenue. It just doesn't make a lot of fiscal sense. I think what we'll see is that a lot of states will stick with the $100,000 threshold and ones with higher thresholds, we may see them deciding to lower it slightly.
How does Wayfair and this intermingling with the COVID response affect income and gross receipts taxes?
[Karpchuk] Prior to Wayfair, some states already had factor presence, nexus or economic nexus laws on their books for income or gross receipts tax purposes. And there was this debate over whether physical presence standards applied equally to sales taxes as it did to income and gross receipts taxes. The U.S. Supreme Court declined to address any of those cases. With the physical presence test in Wayfair, that debate has been eliminated. Post-Wayfair, a few states and localities did adopt economic nexus provisions for purposes of their income or gross receipts taxes. One of those was Philadelphia, for purposes of its business income and receipts tax. Another was Washington for its business and occupation tax. With COVID, we see there are revenue shortfalls and really there are a number of options that can be used to try to fill those gaps. But three notable ones would be either raising the rate of current taxes, implementing new taxes, or changing who the tax applies to.
For states with gross receipts or income taxes that have a physical presence requirement or a factor presence nexus with a higher monetary threshold, it may become attractive to those states to consider changing the nexus standard to an economic nexus standard that is consistent with the state sales tax economic nexus provisions.
One thing to keep in mind, though, for income tax purposes at least is that Public Law 86-272 would still offer some protections to certain taxpayers. Just as a reminder, Public Law 86-272 prohibits states from imposing an income tax on an out-of-state company that has its only activity in the state of solicitation; it only sells tangible personal property and all the orders are accepted out of the state and the product is shipped from outside of the state. Assuming that states did move to adopting economic nexus for income and gross receipts tax purposes, there would be some protection for Public Law 86-272 purposes. But again, that would not extend to certain taxpayers. It wouldn't extend to taxpayers that are subject to gross receipts taxes and it wouldn't extend to taxpayers that are in the business of services.
What is the environment right now around expansion of taxation of services, and has that been affected or exacerbated at all by the pandemic?
[Karpchuk] Historically speaking, in most states, services are not subject to sales tax, unless they are specifically enumerated in the statute. In recent years, there have been pushes to try to tax some services. Particularly, we're seeing a trend toward digital services and trying to tax them. For instance, recently, we've had some states and localities that are moving toward taxing streaming services like Netflix. Even before the start of the pandemic, we saw pushes to tax digital advertising. None of those were successful, but there were a number of states that tried it. If states want to create a new revenue stream to make up for COVID-19 revenue shortfalls, I think we will see some states starting to push to tax some services that aren’t currently subject to tax, in particular digital services.
Is there a scenario you see where we might see a rise in audits related to Wayfair, and why would that be if it comes about?
[Karpchuk] Certainly. Again, going back to the revenue shortfalls caused by COVID-19, there will be a need to recoup lost revenue in some of these states and, apart from new taxes or raising rates, another option is increasing audits to increase collections. A number of states have lists of taxpayers that they believe should be filing in their state post-Wayfair. For instance, in the aftermath of Wayfair, Pennsylvania sent letters out to taxpayers that it believes should be filing and let them know about the change in the law and that they thought they had an obligation. An easy target for audits and increased revenue would be those companies that states have known about and who have still failed to abide by economic nexus requirements to file returns and pay taxes within the state, so there are certain to be an increase in audits related to Wayfair.