Many ecommerce business owners, interstate sellers, and Amazon resellers are frustrated by a recent court ruling that changed sales tax compliance laws. The outcome of the case benefited states by padding their pocketbooks - but placed a hefty burden on small and mid-size business owners. This post will explain what changed, why business owners are upset, what immediate impact these new laws have on your client’s businesses, and what you can do to help them stay compliant.
An Introduction to Nexus
Put simply, nexus is the minimum connection your business must have with a state for that state to collect sales tax on your transactions. If your client’s business meets nexus criteria in a state, they are legally required to collect and pay sales tax in that state.
Nexus Law Evolution - a Timeline
Here’s what happened to lead us to the most recent, and most significant, nexus law change in the past several decades.
1992: SCOTUS Rules on 'Physical Presence' Nexus
Landmark case, Quill vs. North Dakota, results in ‘physical presence’ being named as the driving component in establishing sales tax nexus.
1994-1996: The Dot Com Boom Takes Hold and eComm is Born
Netscape launches and enables new online marketplaces, Amazon and eBay, to strip away geographical barriers for consumers.
2002: Brick and Mortar Retail Giants Go Digital
Walmart and Costco launch online shopping platforms to stay competitive.
2003-2004: eComm Solutions Pop Up Left and Right
Payment processors and ecommerce platforms like PayPal, Instacart, and Magento launch to support ecommerce growth.
2005-2009: The Competition Heats Up
Tech site Newegg, digital content superstore Steam, and discount dealer, Groupon bring new categories and competition to the ecommerce landscape.
2010-2013: Social Media Makes Money on User Data
Facebook, Pinterest, Instagram race to figure out the most effective way to utilize active user data to hawk products and services to users via highly targeted marketing tools.
2014: eComm Revenue Reaches New Highs Year-over-Year
Chatter that started as a mumble comes to a head as revenue tied to interstate ecommerce continues to climb. States across the US start seriously assessing how to get their cut.
2016: South Dakota Introduces 'Economic Nexus'
South Dakota implements a state law requiring online retailers with more than $100,000 in annual sales to pay a 4.5% tax rate.
2018: SCOTUS Re-evaluates Nexus Criteria
South Dakota filed an appeal with the Supreme Court (South Dakota vs. Wayfair), and SCOTUS ultimately agreed that it was time to redefine when and how states collect tax on online and interstate commerce.
Nexus Legislation: 2018 to Today
In 2018, the Supreme Court overturned the physical nexus stipulation, a holdover from the 1992 Quill case ruling, stating that it was unfit and unsound for today's economy. SCOTUS also deemed South Dakota's concept of 'economic nexus' as a better fit for modern commerce, a revolutionary change that opened up the floodgates of states rushing to revise their nexus laws and increase their sales tax revenue.
How much money are we talking about here? The Government Accountability Office estimates that states missed out on $13 billion dollars in sales tax revenue in 2017.
It's important know that economic nexus does not replace physical nexus - it acts in addition to physical nexus. In fact, it's not only possible, it's probable that businesses pulling in healthy revenues will meet the criteria for both types of nexus.
Today, every state from California to New York is scrambling to implement new nexus laws so they can get their cut of unclaimed sales tax money. Naturally, that leaves online retailers and Amazon resellers nervously asking, “what, exactly, does this mean for me and my business?” And it’s important you can answer this question, in order to give your clients peace of mind that you understand the ramifications of economic nexus laws. So let's talk about five ways new nexus laws affect your clients now.
SCOTUS's ruling may affect the largest online retailers less than small businesses.
1. The Broad Impact of ‘Economic Nexus’
The outcome of the South Dakota vs. Wayfair Supreme Court case deemed the physical presence nexus unsound in today’s economic climate - and it’s not a surprising move. Anymore, physical presence in a state often consists of little more than a PO box used as a billing address. That's simply not enough to establish nexus when a majority of transactions occur with buyers in other states.
SCOTUS acknowledged this by ruling that economic nexus is an improved policy that fits better with modern interstate and internet-based commerce. Several states have already incorporated economic nexus laws, while others are working hard to pass legislation as soon as possible.
Screenshot of states stat from ebook
How Economic Nexus is Defined
Economic nexus threshold policies vary from state to state. Here’s a snapshot of how states are defining economic nexus thresholds today.
Revenue-based economic nexus threshold:
Gross revenue from sales is greater than or equal to $X. Typically ranges from $10,000 to $500,000.
Transaction-based economic nexus threshold:
Business does X transactions or more per year. Typically ranges from 100 to 200.
All active state economic threshold policies include one or both of the common attributes listed above. If a business meets or exceeds the dollar amount or transaction count defined in a state, that business has economic nexus. Just to make things a bit more complicated, some states also have less common rules in place, which are outlined below.
Less Common Attributes:
- Remote seller that has a referral/reseller agreement with an in-state retailer
- Use of in-state servers, services, or payment processing
- Affiliate, marketplace, click-through, or “cookie” nexus
Timelines also vary from state to state. While some tax jurisdictions use last year's sales data to determine nexus, others use current year data. Some even use both, meaning if your clients business met nexus requirements last year or in the current year, they may owe tax to the state.
The rules surrounding economic nexus thresholds are extremely varied and are evolving rapidly.
The Court ruled that tax nexus based on physical presence is not relevant in today's economy.
2. New Nexus Laws Complicate Compliance
One of the biggest pain points for online and interstate retailers is that businesses must now register, collect, and remit tax in significantly more jurisdictions.
Here's why it's difficult to manage:
- There are 10,000+ tax jurisdictions in the US
- Your clients must accurately identify which states you have nexus in based on each state's economic threshold
- When a new state implements economic nexus laws, businesses must remit taxes in that state if they meet the threshold
- You and your clients must stay up-to-date on nexus policies, rates and changes for all states you do business in
- Each state has its own filing schedule and deadlines, which your clients must keep track of to avoid late or nonfiling fees
Small and midsized business owners are overwhelmed, and they’re looking for solutions. Make sure you’re capable of offering one.
Since the South Dakota vs. Wayfair ruling, many states have already passed legislation to enforce similar rules, and others plan to pass new laws soon. Robert Schulte, a former Senior Sales Tax Auditor for the State of California, explains: “The Court breezily disregards the costs that its decision will impose on retailers, especially small businesses.
Quill's incentive for businesses to avoid a physical presence in certain states was a concern to the Court.
Correctly calculating and remitting sales taxes on all e-commerce sales will likely prove baffling for many retailers. Over 10,000 jurisdictions levy sales taxes, each with different tax rates, different rules governing tax-exempt goods and services, different product category definitions, and different standards for determining whether an out-of-state seller has a substantial presence in the jurisdiction.”
3. Managing Complex Sales Tax Compliance is Expensive
With more states to remit in, more tax rates to keep straight, more policies to monitor, and more tax deadlines to keep track of, many small and medium business owners are turning to accountants and sales tax experts for help.
For many small ecommerce companies, the financial burden of paying sales tax on more transactions and paying for compliance help may be prohibitive enough to put them out of business. For those who figure out a way to make it work, consumers will likely bear the bulk of the cost as product prices go up to cover the increased costs.
This leaves the door wide open for high-volume retailers with established accounting departments, more resources, and bigger profit margins to monopolize the online retail space.
It's anticipated that well-established online retail giants like Amazon will have an easier time absorbing additional compliance costs since they already have resources in place that can help them adapt.
State budgets have suffered from a decline in brick-and-mortar retail sales.
4. More Nexus Means More Audit Risk
The more jurisdictions your clients are required to file taxes in, the more likely they are to miss a filing deadline, make a simple calculation error, or get flagged for a random audit. Audit risk factors include improper POS sales tax setup, neglecting to change rates when laws change, forgetting to run regular software updates, poor inventory and sales tracking, and inconsistent, unorganized, or inaccurate recordkeeping.
This is yet another reason business owners will be looking to you for help in simplifying compliance. Having someone who understands nexus and its impact on business is invaluable in today’s economic climate as states scramble to take their piece of the sales tax pie.
Become an instant sales tax expert with LumaTax. Learn more.
5. New Laws Affect All Interstate Sellers
Economic nexus doesn’t discriminate. Regardless of what type of business your client owns - online or brick and mortar - if they meet the economic threshold for interstate commerce, they now owe taxes in multiple jurisdictions. This can be easy to overlook since most of the press has been focused on online retailers, but it’s vital that you understand where your client’s businesses fit into the mix.
The impact of the ruling on online retail is uncertain at this time but it's unlikely to slow the explosive growth.
What Economic Nexus Means to Your Accounting Business
It’s true that there are lots of downsides for small and mid-size interstate retailers when it comes to new nexus regulations. Complicated, rapidly evolving laws, confusing deadlines, inconsistent policies, more cost, and higher audit risks round out the top five.
However, this presents a golden opportunity for you to offer sales tax compliance solutions and to attract new clients to your firm in the process. Bring LumaTax on board to manage all the logistics and filing, and economic nexus can quickly become a profitable service your firm provides to all your clients.