Vice President of US Tax Policy and Government Relations Avalara
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What Out-of-State Retail Clients Need to Know Now

Jan 10th 2018
Vice President of US Tax Policy and Government Relations Avalara
Columnist
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The U.S. Government Accountability Office says in a new report that states could boost their revenues by billions of dollars if they weren’t subject to a 25-year-old court opinion restricting their authority to tax remote retailers.

The states are certainly going to take a closer look at this, and you should, too. Here's why:

Ecommerce Clients Be Prepared

Collectively, states are losing between $8.5 and $13.4 billion dollars each year (about $200 million per state) because they aren’t collecting sales taxes from online sales to customers in their states. In some individual states, the lost revenue is extreme. California, for example, is missing out on as much as $1 billion each year. That’s according to a report from the U.S. Government Accountability Office (GAO), which examines “the effects on businesses and state revenue agencies of legislation that would grant states the authority to require businesses to collect and remit taxes on all remote sales.”

With state and local governments increasingly looking for ways to bolster their depleted budgets, many are pushing for legislation in the U.S. Congress that would enable them to collect taxes on remote sales more effectively. At the heart of the matter is a 1992 Supreme Court (SCOTUS) ruling that has been a thorn in the side of state sales tax collection efforts, but that held out a ray of hope.

The Supreme Court’s decision noted that Congress has the power to regulate interstate commerce and could enact legislation allowing the states more leeway in collecting taxes on these out of state sales. On the national level, laws governing ecommerce sales tax collections have not been revisited since 2000, when it was found that “the data available at the time were not well suited” for regulating ecommerce.

Since that time out-of-state sales, has greatly expanded. With more sales taking place between sellers and buyers in different states, states have seen sales tax collections diminish.

Nexus and Quill

In the 1992 Quill v. North Dakota decision, SCOTUS affirmed a 1967 decision which held that businesses could not be compelled to collect sales taxes on transactions made to customers in states where the seller did not have a significant physical presence, or nexus. The Quill case was heard just prior to the advent of the commercial internet and the revolutionary effect that ecommerce would have on the economy.

Quill, then a catalog business supply company, had sales across the country but argued that the states did not have jurisdiction to require the company to collect sales taxes except for on transactions to customers in its home state of Delaware. Furthermore, Quill did not have stores, a sales force, warehouse or other presence in the state of North Dakota. This concept of nexus has been applied to remote sales such as ecommerce ever since.
 
Redefining Nexus

Through dozens of new laws, regulations and court actions across the country, the definition of nexus has evolved as ecommerce has matured and large businesses such as Amazon have introduced more complex shipping, warehousing, click-through affiliate relationships and other dynamics. The most recent trend in state legislative activity has been the passing of “Marketplace Acts,” which designates as the seller the companies that “facilitate retail sales” by a retailer, or who collect payment for a retailer.

This is largely focused on the large national/international online commerce platforms like Amazon, eBay and Etsy, who allow small businesses and individuals to sell directly to each other. Other state actions have focused on redefining other aspects that are core to nexus, such as: 

  • the amount of revenue a business receives from customers in a given state
  • whether they receive referrals from in-state affiliates
  • whether cookies are used on customers’ devices who reside in the state
  • whether inventory is warehoused in a state

As a result, many of these and other national ecommerce sellers are now collecting and remitting sales taxes to the most states, and now the states are focusing more on smaller and mid-sized online retailers as a means to collect what they see as billions in additional sales tax revenue the GAO report suggests they are missing out on.

State Enforcement

As state budgets have tightened, many have focused on sales tax collections as a means of boosting their revenues. The GAO noted that states receive an average of about one third of their tax revenues from sales tax collections, however, some states rely more heavily on these revenues.

States without individual income taxes, such as Florida, Texas, Nevada, South Dakota and Tennessee, for instance, realize more than half of their gross tax revenues from sales tax receipts, and municipalities often see even higher reliance. As noted previously, some states are challenging the Quill v. North Dakota decision by enacting laws to better enable their revenue departments to collect sales taxes on ecommerce transactions.

This has come via new definitions of nexus, as well as new requirements for sellers to report to the state the identities of state residents who made purchases that were not assessed a sales tax. The state can then employ “use tax” laws to compel payment of the taxes directly from the consumers. Colorado, for example, enacted a law requiring sellers to report customers names and purchase amounts.

Types of Sellers Most Likely to be Targeted

The GAO report noted that, under current law, states could collect about 75-80 percent of taxes on remote transactions “if all remote sellers were required to collect tax on all remote sales.” The amount, and success, depends greatly on the type of remote seller.

States already see the greatest success in collecting sales taxes on traditional business- to-consumer ecommerce sales. Since many large online retail sellers also have a physical presence in most of the sales taxing states (such as a retail store or warehouse location), the states can more easily compel these entities to comply with their sales tax collection and reporting requirements.

In short, the states are most likely to go after sellers who use the large platforms, such as Amazon, eBay and Etsy. States are less effective in their collection efforts for B-to-C e-marketplace sales and catalog sales, but new legislation aimed at marketplaces is showing positive results for state collection agencies.

The GAO reports that “nearly half of potential revenue gins … would come from collecting sales taxes on all e-marketplace sales.” Business-to-business sales are a larger part of the ecommerce share, but the opportunity for states to increase collections in this are area is lower, since many of these transactions are non-taxable, and the taxable transactions already have a high rate of voluntary compliance.

Compliance Challenges for Businesses

While state officials see requiring collection of sales taxes on all online transactions as a boon, and one that would not significantly burden the states financially to enforce, even the GAO notes that, “some businesses would likely see increases in several types of costs if required to collect taxes on all remote sales. These costs would be higher for businesses not currently experienced in multistate tax collection.” Not to mention the logistical challenges many smaller businesses, especially those in non-sales tax states who have no experience in the matter, could face with enforced compliance with all states and local governments.

At present, 45 states and Washington D.C. have sales taxes on goods and some services, and 37 of these have local city or county sales taxes. In total, there are as many as 16,000 sales taxing jurisdictions in the U.S., all of which have varying rates, product taxability rules and exempt-status regulations. Among the most significant impacts to businesses, the report notes that increased costs would be associated with software, audit and assessment capabilities, and research and liability.

How Retail Clients Can Prepare for New Sales Tax Laws

Ecommerce has largely been a wild frontier since its inception, in part because the phenomenon was too undefinable and broad to attempt enforcement and the technologies available in the earlier days of online sales was not capable of accurately and efficiently managing the sales tax management and collection processes.

While large national brick and mortar retail chains have managed sales tax compliance across the U.S. for decades, those organizations had the resources to maintain large staffs of tax professionals and administrative personnel who were tasked with manually keeping up with the myriad of sales tax rate and compliance changes across hundreds or thousands of jurisdictions, and then processing accurate and timely sales tax returns, as required. This process was altogether too complex, expensive and cumbersome for smaller and even mid-sized entities.

Although early developments in ecommerce software eased that burden to some extent, the programs were exorbitant in cost and relied on disc-based software that required IT departments to implement across often disparate and geographically dispersed computer systems. This inevitably resulted in gaps in compliance with rates and special taxability rules applied by some jurisdictions.

While decreasing tax staff, the costs and IT staff requirements remained high, these systems were not amenable to smaller and mid-sized sellers. This is roughly where the 2000 study came in: The technology reduced the need for large staffs of tax personnel, but it still wasn’t adequate to handle other challenges of sales tax compliance for multistate sellers, notably rapid changes and IT headaches.

The states soon developed online sales tax reporting systems, but with each state operating and maintaining these disparate systems, there was no singular online interface for businesses to comply with multiple states. With the availability of high speed connectivity, however, cloud-based software applications were developed and grew in popularity among businesses with multistate compliance requirements, enabling interconnectivity with online sales platforms.

As these compliance functions have eased, states have increasingly looked for ways to enforce even small businesses to collect sales taxes on multistate transactions. That time has come.

With automated, cloud-based sales tax management technologies, even small businesses have the ability to effectively manage sales tax compliance and collections, in real-time, across all U.S. sales taxing jurisdictions. Where the earlier, disc-based software aided compliance by eliminating the need for large tax staffs, the more advanced cloud-based systems have eliminated the need for IT departments, further reducing the costs and complexities associated with software implementation and maintenance. Furthermore, they automatically tie into the sales platforms, providing real- time rates, and high accuracy.

The Changes are Coming Soon

The new GAO report offers powerful ammunition to the states in their efforts to broaden their ability to collect sales taxes on all transactions impacting their citizens. With technology providing affordable tools for any size business to manage the sales tax processes, and providing states with increasing ability to monitor transactions for compliance, it is inevitable that more sales tax compliance will be required by small businesses within the next few years, possibly sooner.

Steps for Online Retail Clients

First, ensure your clients' business is accurately tracking and reporting to all states that you know you have an obligation to do so. The best way to do this is to use an automated sales tax system that includes accurate and reliable sales tax matrices for all types of transactions and product types. The system should also seamlessly integrate with your online sales system, shopping carts and other business apps.

Next, sellers must stay up-to-date on sales taxation issues that may affect them. With 45 states, the District of Columbia, Puerto Rico, and tens of thousands of potential taxing jurisdictions, it’s nearly impossible for most small businesses owners to do this. A better option is to turn to a trusted sales tax professional who is experienced in multistate tax compliance and can offer assurance that your business is compliant.
 

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