Wayfair has the potential to change everything.
Upending 26 years of precedent, the U.S. Supreme Court ruled in South Dakota v. Wayfair Inc. that states can require companies to collect and remit sales and use tax if economic nexus thresholds are met, even if they don’t have a physical presence in the state where the consumer resides. While it may take some time for states to act on this new standard (overturning the Quill case from 1992), tax experts say it is important that companies begin preparing now for what could be a complex new tax collection responsibility.
How States Are Reacting
The road forward isn’t entirely clear. Many states have yet to announce whether or how they will impose sales taxes on out-of-state sellers. Even when states do act, experts add, there could be significant variations in their responses—just as there are significant differences among states that already have policies for taxing remote sellers outside their borders.
South Dakota, for example, only taxes businesses that do more than $100,000 in sales or at least 200 transactions into the state annually. Massachusetts taxes those with sales above $500,000 via at least 100 transactions. (These states have been levying these taxes on the theory that there is an economic nexus, or link, between them and the companies selling to customers in those states, as opposed to a physical nexus. But prior to Wayfair, some retailers balked at complying with taxes imposed under these and other nexus variations.)
Meanwhile, it’s always possible that Congress might weigh in on the subject to try to impose some uniformity on how states tax online sellers. Still, waiting for everything to shake out could be problematic. Among other things, companies that aren’t ready to start collecting taxes when mandated could find themselves accumulating uncollected tax liabilities that could result in steep penalties.
In a recent webcast on the topic, Michael Bernard, chief tax officer for transaction tax at Vertex, noted: “If you’re not going to be prepared to file on the date the states are telling you they should be filed, you probably should try to make some estimate of what you’re going to owe, and at least try to start to collect in some manner.”
Five Steps to Compliance
Bernard and the other panelists—Dave Pelton, product line leader for transaction tax at Vertex; Nancy Manzano, tax director in the chief tax office at Vertex; and Rick Heller, managing director, multi-state tax services, for Deloitte Tax—suggested companies may wish to follow a five-step process to prepare for compliance:
- Review your situation. Identify those states where you’re currently conducting business, but are not collecting sales and use tax.
- Understand how your product and services may be subject to taxation in each state. Policies can vary greatly. Some states primarily tax only tangible personal property, for example, while others tax virtually any type of property, including digital goods and services. And some tax services where they’re generated (e.g., architectural services), while others tax them where the benefits are realized (e.g., in the state where the architectural plans were used). Companies need to be clear on their tax obligations in each state.
- Assess operational readiness. Determine whether your organization has the internal expertise and bandwidth and the technological capabilities to manage sales tax collections across dozens of states with differing tax policies. If not, consider adding personnel and investing in software systems that can track tax rates and rules changes and automate much of the compliance process.
- Determine the impact on your financial reports. Some states have indicated they may impose sales taxes retroactively. If that appears likely to impact your company, you may need to account for this contingency under ASC 450 accounting and disclosure requirements and begin to accrue reserves against your potential liability.
- Communicate with your customers about upcoming changes. If you’ll be collecting sales tax from certain customers who weren’t assessed those taxes in the past, let them know in advance—and why you’re doing it—to avoid unpleasant surprises.
Complying with all of the pending changes to state sales tax regimes may be a complex undertaking for many organizations. By starting to prepare now, they can minimize complications and improve their ability to comply with new and evolving requirements.