What Is Wayfair?
In June of 2018, the Supreme Court in a 5-4 decision (South Dakota v. Wayfair) overturned a long-standing ruling on factors that determine whether a company has a sales tax filing requirement in a given state. This filing requirement is referred to as “nexus.” The prior guidance to determining nexus was referred to as the “Quill” decision (1992) and required a physical presence (e.g., people, property, installation services, warehouses, etc.) in a state to trigger a filing requirement in that state.
Under the new guidance, referred to simply as “Wayfair” or “Economic Nexus,” the state of South Dakota now applies an economic threshold standard to determine a seller’s sales tax filing requirements, regardless of physical presence. South Dakota Senate Bill 106 imposes a sales tax collection, reporting and remittance obligation on remote sellers without a physical presence in South Dakota when sales exceed $100,000 or sales occur in 200 or more separate sales transactions.
The Wayfair decision is opening the door to other states to follow suit enacting their own similar laws. Wipfli has been tracking the various states with respect to economic nexus enactment dates. For an up to date listing, click here.
Who Is Impacted?
Companies that have remote sales or engage in a large amount of e-commerce, meaning that they do not have any physical presence (as defined above) in a given state, are obviously the most impacted. Physical presence also includes sending people based in another state into a state temporarily for services or even solicitation. This includes not only companies selling tangible personal property but also those selling services across state lines, such as software subscriptions, digital products and audio-visual works.
Virtually all companies are impacted by the Wayfair decision. More and more states are becoming aggressive in tracking down companies that sell to end-user customers in their state by using information available to them internally and from data provided by third parties. Note that the physical nexus standards still apply to all companies doing business in a state. To the extent a company’s sales are under the economic nexus filing thresholds and they have a physical presence in a state, they are still required to file sales tax returns in that state.
In all states that have enacted economic nexus provisions to date, excluding Illinois and Minnesota, the filing thresholds are based on gross revenue or sales sourced to a state on a destination basis. Not only taxable sales but also exempt sales are combined to determine if a filing requirement exists in a state — but the measurement date may be different from state to state. Some states measure gross revenue for the prior calendar year, and other states measure gross revenue the most current 12-month period.
Wipfli recommends that a company file sales tax returns in all states where the thresholds have been met, even if taxable sales are zero to toll the statute of limitations. If you decide not to file a sales tax return in a state, you should request and obtain exemption certificates from customers in all states, to the extent your products are taxable in a state and a customer can exempt the purchase by issuing a properly completed exemption certificate. Whether you agree with the ruling or not, all companies will now need to review their internal procedures on obtaining and securing customer exemption certificates.
What’s the Risk?
The biggest risk is that companies are either not fully understanding the true impact of the decision or are not performing a nexus review given their situations (standard and unique). Additionally, some companies are reacting by registering in any state that they may possibly now have nexus with, which could unknowingly open the door to past transactions that were not reported.
Most states have a voluntary disclosure agreement (VDA) policy that will allow companies to come forward anonymously through a third party to obtain a limited lookback period, relief from penalties and, in some cases, a reduced interest rate. Keep in mind that a company that registers to collect and remit sales tax without understanding their prior risk will likely preclude themselves from participating in a VDA program.
How Does Wayfair Impact My Financial Statements?
Ultimately, companies that report generally accepted accounting principles (GAAP) financial statements should seriously consider having a nexus study completed to determine their potential sales tax exposure in various states. The nexus study should address not only sales tax considerations but also income, franchise and gross receipts tax filing requirements.
While Wayfair is obviously going to most significantly influence online sales, it is important that companies realize that other states are becoming very aggressive in enforcing this concept of nexus. For example, many states are data mining right now to find out-of-state non-filers. In early November, the state of Indiana paid $2,000 to a data analytics company to obtain 6,000 names using credit card information and proprietary information. In May 2018, Amazon was required to disclose third-party sellers’ sales information to the state of New York and most recently to the states of California and Wisconsin.
Nothing about the above paragraph was welcomed news. But the reality is when it comes to accounting for contingencies, assessing the likelihood of assertion is a key consideration. When it comes to sales and use tax exposure, the likelihood of exposure just increased exponentially. Again, not welcomed news, but news that needs to be addressed immediately.
How Might This Play Out?
Here’s a case study on how the Wayfair ruling could play out:
After hearing about the Wayfair ruling, ABC Company held a meeting to determine their nexus in various states. From the meeting, they determined that while they don’t have a large volume of e-commerce, they certainly have been selling to customers in various states and have not collected and remitted sales tax in any state other than their home state. They engaged their accounting firm to conduct a nexus study to determine where they had filing requirements in their top 15 states. The completed nexus study identified sales, income and franchise tax filing obligations in eight states not only going forward but also for prior periods.
The next phase of the review was to quantify the amount of tax risk in the eight states for the past four years.
The risk amounts were quantified and a matrix was created showing a worst-case scenario, a most-likely scenario, and a best-case scenario based on research performed. After factoring in various state tax rates, potential interest and penalties, the worst-case scenario yielded a potential cumulative liability of $1,000,000, the most-likely scenario yielded a liability of $560,000 and the best-case scenario yielded a potential liability of $435,000.
Based on these numbers, the company elected to accrue a tax reserve liability of $560,000 and determined they were going to move forward with voluntary disclosure agreements to limit their exposure for prior years. In a voluntary disclosure situation, a state will limit the look-back liability of the company to either three or four years and not impose negligence penalties. The company also created new policies and upgraded to a sales tax technology solution to help properly account for these sales moving forward.
Wayfair has drastically changed the calculous regarding accounting for sales and use taxes. Thoughtful consideration and analysis will be needed to ensure organizations are managing their compliance obligations. If you want to learn more about the Wayfair decision and how it may impact your business, contact us today.