By Jason C. Skrinak, CPA
The U.S. Supreme Court case South Dakota v. Wayfair Inc. focused on how states were interpreting economic nexus – not just for sales and use tax purposes, but also other types of state and local taxes. The case was settled more than two years ago, but taxpayers continue to learn how economic nexus impacts them, what potential tax exposure could exist, and how they wanted to address this tax exposure. However, COVID-19 and the financial impact it had on businesses and state economies took center stage, and the impact of the Wayfair case took a back seat.
COVID-19 had many far-reaching effects, including how consumers shopped and purchased goods and services. Businesses had to quickly respond to a lack of foot traffic in their physical locations, which led to increases in their online presence. As consumers shopped for various products to assist them through the pandemic – from home-office furniture and supplies to new entertainment streaming options for the family – businesses were ensuring their products were available for immediate purchase online. Many businesses that had been accustomed to operating solely in a physical location in one state were now selling into multiple states.
Wayfair provided that businesses have a sales and use tax reporting requirement when they have $100,000 or 200 separate transactions within South Dakota. Most states have since implemented similar rules for economic nexus for sales and use tax purposes, while some states have used similar economic nexus standards for other types of taxes. Sales into new states mean new determinations are needed. Do you have nexus and, therefore, a tax filing requirement in a state? Is the sale into that state taxable and, if so, what is the tax rate (certain purchases may have different tax rates and localities may have an additional rate over and above the state rate)? What is the purchase price at which tax is calculated, and is shipping or other charges included in the taxable purchase price? How do you register for tax collection and remission with that state? How are tax returns handled in a state, including what are the due dates and does the state offer a discount for timely filing and payment?
It is very possible that a business may determine that it will simply not follow a state’s economic nexus requirement. This, ultimately, is rolling the dice and hoping a state does not identify the taxpayer and seek payment. By not charging, collecting, and remitting a state’s sales and use tax, a business would be ultimately taking on the potential tax liability of the customer. Also, be aware that states have endured a severe negative economic setback due to COVID-19, and they will be looking for opportunities to increase revenues and lessen the economic strain on their states. The Tax Policy Center recently posted an article online estimating possible revenue shortfalls close to $75 billion in the 2020 fiscal year, and possible as much as a $125 billion shortfall in revenues for the 2021 fiscal year.
As states seek ways to resolve current and future impacts from COVID-19, I expect states to be extremely aggressive in identifying businesses that are not in compliance with their tax requirements. Here are some of the steps they may take:
- Increased discovery - States will increase their discovery efforts through the use of business activity questionnaires and increase focus on matching businesses that are registered within the state for other taxes or other purposes (such as the registration of a vehicle or an approved vendors list) with a state agency. Another area of increased discovery is auditing related entities, including transactions between related entities.
- Addressing internal policy – States will likely review internal policies for items that are not clear-cut and update these policies to favor the states. An example could be clarifying the assumed treatment of a service as being exempt to being classified as a taxable service on tangible personal property. Another might be the taxation of membership dues for professional organizations when the fees include a minimal tangible personal property benefit included with the charge.
- Increasing tax rates and base – The easiest way for a state to increase revenue will be to increase the rate of tax or to increase the base in which the tax is calculated. The rate, specifically for sales and use tax, could be increased at the state level, the local level, or both. As far as the tax base, sales and use tax has typically been a tax on the retail sales of tangible personal property and select services. An example of increasing the base for which a state’s sales and use tax is calculated can be found in recent trends of states taxing additional services.
As businesses do their best to navigate the financial uncertainty surrounding COVID-19, it is imperative to keep a watchful eye on their multistate business operations and how the states are reacting to business within them.
Jason C. Skrinak, CPA, is the founder of Pivot Strategic Consulting in Harrisburg and is a member of the PICPA Legislation and State Taxation committees as well as the PICPA Conference on PA Taxes Subcommittee. He can be reached at firstname.lastname@example.org.
For more insight from Jason Skrinak, check out PICPA’s Past, Present, and Future of State and Local Taxes webcast on Sept. 29. Also, you can get more updates on federal, state, and local taxes at PICPA's all new Tax Con webcast on Nov. 10-11. Sign up and you'll hear from representatives from the IRS, Pennsylvania DOR, and revenue departments from surrounding states and major cities.
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