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Economic Presence vs Physical Presence: Sales Tax Considerations After Wayfair

Economic Presence vs Physical Presence: Sales Tax Considerations After Wayfair

Service Businesses  |  Manufacturing & Distribution  |  Government Contractors  |  Construction & Real Estate

In June 2018, the United States Supreme Court issued their ruling in the case of South Dakota vs. Wayfair, which cleared the way for states to collect sales tax from businesses that do not have a “physical presence” in the state, but do have an “economic presence” in the state.

While much attention has been given to the impact on online retailers, the decision potentially impacts the sales tax obligations of any business that makes remote sales to out-of-state customers. While some states are still reacting to the decision, many states have already implemented laws that require remote sellers to collect and remit sales tax on sales to out-of-state customers without having a physical presence in the state. Understanding this new and still evolving sales tax landscape is important for any company that conducts business in multiple states.

Economic Presence vs. Physical Presence

For more than 50 years prior to the Wayfair decision, the U.S. Supreme Court held that a state can only collect sales tax from a business that has a physical presence in that state. The definition of physical presence varies state to state. Generally, things like an office, an employee, a warehouse, or affiliates create physical presence. The Wayfair decision did not eliminate the physical presence standard for sales tax. Rather, it added the broader economic presence standard to the physical presence standard. We wrote about that here.

To have an economic presence in a state, a business simply needs to have sales to customers in that state. For example, a Maryland business that sells and ships products to customers in Virginia through a common carrier has an economic presence in Virginia just by making a sale to a Virginia resident. A physical presence established by property or employees is unnecessary under the economic presence standard.

Economic Presence Thresholds

The “good” news is that most states that have implemented an economic presence standard have also implemented thresholds that businesses must meet or exceed in order to be subject to sales tax collection. The thresholds vary state to state and can be based on both volume of sales and total sales revenue.

Going back to the prior example, under Virginia law a Maryland business making sales to Virginia customers would need to register, collect and remit sales tax only if they have either:

  1. More than $100,000 in annual gross revenue from sales in Virginia or
  2. At least 200 annual sales transactions in Virginia

These thresholds exist in many — but not all — state economic presence standards and help to reduce some of the potential state sales tax burden that a business might otherwise incur as a result of the Wayfair decision. Businesses that make remote sales to customers in other states will want to be aware of the states where they have a large volume of sales or derive significant revenue from and determine if they have a sales tax obligation in those states.

Sales Tax Considerations Post-Wayfair

In its decision, the Supreme Court pointed to South Dakota’s law against retroactively applying the economic presence standard as proof that the South Dakota law does not create an undue burden. As a result, states are unlikely to impose the economic presence standard retroactively. States can and likely will be seeking sales tax from businesses subject to sales tax beginning with the effective date of the economic nexus law.

Learn more about economic nexus in this whitepaper, What The South Dakota v. Wayfair, Inc. Decision May Mean For Your Business.

Businesses will want to be proactive in reviewing their state sales activity. In states where a sales tax obligation now exists, the business should register for a sales tax account in that state.

The business type most directly impacted by Wayfair is online retailers who, prior to the decision, were able to use lack of a physical presence in a state as an argument against collecting and remitting sales tax. However, any business, not just online retailers, that makes remote sales is potentially impacted by Wayfair. Digital content, online learning, sale of products via catalog or phone, or any other remote sale activities could lead to economic presence, provided the business exceeds the state-specific thresholds.

Additionally, businesses that provide out-of-state services or occasionally conduct business out-of-state may want to reevaluate those activities post-Wayfair. Historically, some states did not collect sales tax from out-of-state businesses who performed work in the state for less than a specified number of days annually. While that business might be under the physical presence threshold, the work done in the state might exceed the economic presence thresholds. For example, a service company that performs work in a certain state for only a few days per year might fall under the physical presence standard but they might be liable for sales tax based on new economic presence standards.

Businesses that discover they now have a sales tax obligation in a state under economic nexus standards are required to register for a sales tax account, collect sales tax, and remit sales tax in that state. A business with sales tax obligations in multiple states may want to consider automating their state sales tax processes, as sales tax remittance can be a quarterly or monthly obligation depending on the volume of sales.

For more insight on sales tax compliance, check out our blog post, 5 Rules To Follow When Creating A Tax Compliance Strategy.

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Published on December 17, 2019