A New World for State and Local Sales Taxation

First, there was the express lane checkout treatment of federal tax reform with all the attendant unsettled implementation and administrative issues.  Then, there was the TV cliffhanger finish to Minnesota’s 2018 legislative session that ensures everyone will tune in next season for the thrilling conclusion to the state’s federal conformity efforts.  And if that wasn’t enough to keep tax practitioners hopping, Department of Revenue staff scrambling, and the billable clocks of lobbyists spinning, the U.S. Supreme Court has now reversed 50 years of precedent^[1] and declared that physical presence in a state is no longer needed to require sellers to collect and remit^[2] sales taxes – knocking down the door to state and local taxation of e-commerce.  It’s a double shot of espresso in an already highly caffeinated tax policy environment.

This latest development has triggered an avalanche of commentaries, analysis, and webinars from experts on what the Court’s decision does and doesn’t mean with respect to tax practice, policy and administration.  From sifting through all this information, a few things become evident.  Important questions remain unanswered.  The ramifications will continue to unfold for quite some time.  And an already complicated and involved 2019 session has become even more complex for the legislature’s tax committees.

“Wayfair 101”

In appearance, taxing sales is simple and straightforward: multiply the sale price times the tax rate and you’re there.  Lurking underneath this superficially straightforward exterior are large amounts of administrative and compliance complexity.  Forty-six states (including D.C.) have a sales tax, with literally thousands of local taxing jurisdictions imposing their own rates within that group of states.  With each state setting its own rules, this results in a myriad of different tax rates, taxable and exempt products and services, exempt purchasers, shipping tax treatment, specialized tax rules, statutory definitions, registration and reporting regimes, and record keeping requirements.

Back in 1992 the Supreme Court ruled in Quill vs. North Dakota that sellers had to have a physical presence in a state before they could be required to collect sales tax in that state.  The ruling was based on the conclusion that, given the realities above, such collections and their accompanying administrative complexities unduly burdened interstate commerce.  Since then, with the rapid growth of e-commerce and remote sales in the internet age, “Quill” had become a major thorn in the side of both traditional brick-and-mortar retailers concerned about competitive disadvantage and state and local governments concerned about tax revenue leakage.  E-commerce grew at a 15% rate for the six-year period that ended in 2017 while the mobile sales segment specifically has been experiencing growth rates of 50% per year, increasing their discomfort.^[3]  And while “use taxes” are the theoretical backstop to capture some of this lost revenue, compliance is nothing more than a personal honor code.  The Minnesota Department of Revenue (DOR) estimates that in any year fewer than 1,000 individual income tax returns include an individual use tax return^[4] (Form UT1), which is required for any Minnesotan buying more than $770 worth of taxable goods in a year if Minnesota sales tax is not applied during the purchase.^[5]

The Supreme Court’s decision in South Dakota vs. Wayfair (featuring justices split 5-4 in a combination that will likely never be repeated) ended this requirement.  The justification was essentially based on three ideas: activities other than physical presence can satisfy the need to have a substantial relationship with the state; the physical presence standard actually creates, rather than resolves, market distortions; and the advancement of software and other technology has lessened the administrative costs of compliance.

In essence, the ruling blessed the switch from a physical presence test to an economic presence or “nexus” test for state sales tax collection purposes.  But as observers immediately pointed out, the ruling itself raises a bigger question that the Court did not directly address.  The Court only considered the Quill physical presence rule and remanded the case back to the South Dakota Supreme Court to determine if anything else in that state’s sales tax laws and administrative rules might create an undue burden and cause the state to trip over the Commerce Clause.  In short, we now know what isn’t needed to pass constitutional muster, but we still don’t know exactly what is needed.

The Court did offer some guidance on this matter in their decision by highlighting three characteristics found in South Dakota sales tax law and its administration that prevent discrimination and offer reasonable protections from undue burdens:

• A threshold for having substantial economic presence in the state – in South Dakota it’s gross revenues of sales in the state exceeding $100,000 annually or at least 200 separate transactions.
• No retroactivity – “reaching back” into history to try to collect sales taxes on past transactions that are now taxable.
• Sales tax simplification to reduce administrative and compliance costs – which includes state level administration, uniform definitions of products and services, simplified rate structures, access to sales tax administration software, and immunity from audit liability for sellers that use this software.

It’s worthwhile to note that all these simplification elements are part of the Streamlined Sales and Use Tax Agreement – a cooperative state-level effort to make sales and use tax collection and administration by retailers and states more uniform, and therefore simpler.  24 of the 45 states with a general sales and use tax have passed legislation conforming to the Agreement, including Minnesota.

All this provides substantive guidance, but as commentators have noted it is far from a brightline test.  Many implementation and compliance issues and uncertainty still abide in these areas, even for those working within the cooperative Streamlined Sales Tax framework.  As just one example, the question arises: what level of sales activity represents a threshold of “substantial economic presence?”  Minnesota’s “small seller exception” features a lower number of sales transactions threshold than is in South Dakota’s law:

• 100 or more retail sales shipped into Minnesota by remote sellers over 12 consecutive months; or,
• 10 or more such sales if the total value of the sales is $100,000 or more.^[6]

Do states have carte blanche to impose their own higher or lower remote sales thresholds?  And where might constitutional concerns be triggered?

Then there are the sales tax collection issues on which the Wayfair decision is completely silent.  Chief among them are questions surrounding so-called “marketplace providers” and requirements to collect sales tax on third party sales that use their e-commerce platforms.  It’s a big dollar topic.  Amazon has said it has more than 100,000 vendors who each sell more than $100,000 annually, translating into total sales of more than $10 billion.  According to the company, half the items it sells are from third-party vendors.  And states are very aware of this potential sales tax leakage.  As an official from the National Conference of State Legislatures noted last year, “whatever a state is getting in sales tax from Amazon, it should probably be getting about twice that much.”^[7]

Many experts see including marketplace providers both as a logical extension of taxing remote sales and an advantageous and necessary feature to mitigate the risk of triggering Commerce Clause concerns regarding burdens on small businesses.  The administrative efficiency of having marketplaces collect taxes for these small e-commerce businesses is appealing to states.  They point out it could also be a business win for marketplace operators that could attract new vendors with their sales tax compliance services.  Amazon already offers its third-party sellers a sales tax compliance service for a fee.

Others, however, see potential liabilities and inevitable lawsuits if marketplace providers take on this obligation.  In addition, “marketplace providers” is a rather generic term covering a range of operations which vary in their degrees of sophistication and roles in facilitating third-party sales.  Experts note it’s possible that legal challenges may arise if states are overly aggressive in trying to sweep up more passive platforms.

In short, the Wayfair decision fundamentally altered the landscape of sales taxation as we know it.  But it remains an unsettled landscape featuring an abundance of unresolved implementation issues and compliance questions, much of which revolves around the issue of whether the Court’s new standard of economic presence is satisfied.  Or as one commentator put it, “Other than the specific facts of Wayfair, there appears to be no clear guidance that a taxpayer (or use tax collector) tax administrator, or lower court can rely on to determine whether substantial nexus exists.”^[8]

Federal Action: Now More Than Ever?

For these reasons, some are now hoping Congress will pick up where the Supreme Court left off with a legislative solution that provides a uniform standard and ground rules for tax treatment of remote sales and marketplace providers.  Tax policy experts have long argued that congressional action is the preferable venue for addressing this issue.  However, two bills that would deal with the matter – the “Remote Transactions Parity Act” and the older “Marketplace Fairness Act” – have long been stuck in legislative neutral.  Many experts argue the question marks left by the Wayfair decision will be the catalyst for legislative action next year.

What makes this politically intriguing is the role reversal surrounding congressional action on this topic.  Prior to Wayfair, doing nothing meant the physical presence rule remained in force.  State and local governments had strong interests in pursuing federal legislation to caulk the growing gaps in their sales and use tax systems.  Post Wayfair, doing nothing now results in a completely different outcome.  The replacement of a physical presence standard with an ambiguous economic nexus requirement has given revenue agencies seemingly more “room” to maneuver regarding tax collections.  Moreover, the nature of the ruling itself, as one commentator put it, “may signal a new era in which courts provide a tremendous amount of deference to state tax regimes.”^[9]  As a result, while pressure for congressional action from the states may have lessened, some taxpayers, potential taxpayers, and advocacy groups who may have been resistant to federal action are now calling for Congress to nip the potential for over-aggressive revenue collection regimes in the bud.  These interests have also expressed concern that without federal action, the enhanced “freedom” for states will have the unintended consequence of actually disincentivizing cooperation between states and harmonization of disparate state tax systems.

Meanwhile, Here in Minnesota

In many ways, Minnesota is likely positioned as well as any state in the nation in responding to the overturn of Quill.  We have long had statutory language regarding remote sellers in place in anticipation of either court or congressional action.  We more recently added marketplace provider language.  According to DOR, with the overturn of Quill, both laws will become effective on October 1.  And most importantly, we are a member state of the Streamlined Sales and Use Tax Agreement which the Supreme Court indirectly “blessed” in its ruling and thus provides the best assurance possible of not having to worry about triggering “undue burden on commerce” problems in the eyes of the courts.

So what defines the post-Quill world in Minnesota?  Lawmakers’ attention will immediately be drawn to the additional revenue showing up in November’s economic forecast.  It’s important to recognize that expectations of a major windfall need to be tempered for the simple reason that a lot of e-commerce sales already had nexus (Amazon, for instance, has had nexus in Minnesota via its Shakopee warehouse) and were therefore being taxed.  The federal Government Accountability Office’s estimates of state tax revenue gains nationally are about half of what earlier academic studies estimated for this reason.

Nevertheless, it represents real money.  House Tax Chair Greg Davids told State Tax Notes that e-commerce provisions are projected to generate an additional $150-$210 million annually for the state, but DOR is currently updating those estimates.  That original estimate accompanied his bill in 2018 to adjust the state’s general sales tax rate down in a revenue-neutral way to reflect increased tax collections from remote sales.  That’s one of several policy options which will likely be debated in 2019.  With federal conformity still in limbo, it would not be surprising to see the new revenues grease the implementation of a state conformity plan or finance some more ambitious state tax reform.

Then there are the inevitable administrative issues and hiccups surrounding compliance.  Even though Minnesota is statutorily well prepared, issues are bound to pop up prompting discussion and debate in the 2019 session.  Here’s a sample of the issues we have heard discussed and seen mentioned.

• Challenges the implementation date presents.  Minnesota’s October 1 implementation date lines up with many other Streamlined Sales Tax states and seems to function as an attempted compromise between the practical recognition that it will take time for businesses to come into compliance and the political reality that both states and many retailers don’t want to experience another tax-free e-commerce Christmas season.  However, some have expressed concern that this is too rushed for smaller sellers who lack the compliance software and systems that large seller counterparts have in place and ready to go.  They note such software is hardly “plug and play” – implementation requires a lot of time, effort, and testing with respect to operating and updating the system and ensuring compatibility with financial systems.  This challenge is compounded by simple demand realities – many vendors are simply overbooked because of the ruling.

• Who collects the tax?  Minnesota's Marketplace Provider law was written when the assumption was that use of the platforms created the nexus.  But as a result of the Wayfair ruling both the platforms and many of their sellers will have nexus.  If both have nexus, when are platforms supposed to collect the tax and when should the sellers collect?  Are the Minnesota Marketplace Provider statute's current default rules on this the best approach - both from an ease of compliance and administrative view?  And must the platform collect tax for sellers that don’t meet the thresholds?

• Who is liable for the audit result?   If a company like Amazon fails to collect tax on a taxable item, who gets the assessment – Amazon, or the actual seller of record?

• When are thresholds hit?  One issue that continues to surface is related to the sales threshold – especially in the “business to business” area.  Many wholesale businesses may have a small retail sales segment.  If they make $1 million of sales for resale; and $10,000 of sales at retail, do those combined amounts meet the threshold, therefore necessitating the business to collect tax on the $10,000 in retail sales?

There are undoubtedly many other administrative and interpretive issues in the works now and over the coming months pertaining to special situations that will make DOR a factory of Revenue Notices and fact sheets for the foreseeable future.  It seems quite likely that in some circumstances, these administrative edits and clarifications will be insufficient and some clean-up of the statutory language will need to be enacted.  Doing so would provide taxpayers assurance that some of the key decisions are in a form that can only be changed by the legislature while also providing transparency regarding the decisions being made.

All this, of course, is occurring in a context featuring unresolved federal conformity matters which are demanding legislative attention and already stretching DOR’s resources thin.  Throw in the need to create another two-year state budget with all its accompanying tax policy issues and the fate of the provider tax and tax committees and the new administration will have their hands more than full.  Taxpayers should hope that whatever reconstituted state governance arises out of the November elections results in productivity that matches the size of the “to-do” list.

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