The U.S. Supreme Court’s June 2018 opinion in South Dakota v. Wayfair, Inc. dramatically changed the sales tax environment for sellers operating in the U.S. by permitting states to require “remote sellers,” meaning those with no in-state physical presence, to collect their sales tax based solely on their economic presence within the state.
As of early 2022, three years after Wayfair’s publication, all states with a sales tax have enacted some kind of “economic nexus” sales tax legislation. Even though states’ guidance in this area has become more robust during this time, significant technical and practical concerns remain.
Given these complexities, CFOs need to ensure that their organizations’ Wayfair response plans are comprehensive and up to date. Here are three key actions that CFOs can take to help their organizations manage state tax risks in this area.
1. Keep up with changes
One of the main considerations for CFOs is to stay informed on updated economic nexus changes. CFOs are not expected to know all the details relating to the nexus, or the threshold for collecting taxes for each state, but as the executive ultimately responsible for the financial well-being of the company, it’s beneficial to be proactive to stay informed about tax law updates.
Many resources are available to taxpayers and organizations to stay current:
- Consult economic nexus matrices to find state relevant regulations and thresholds. Be sure they are regularly updated to reflect changing state tax laws.
- Attend webinars and conferences hosted by tax organizations, service providers and state tax administrators for regulation updates.
- Sign up for online newsletters published by tax organizations and advocates.
Here are two key examples of Wayfair-related emerging issues that CFOs should watch:
Taxes other than sales taxes: While Wayfair is commonly thought of as a sales tax case, it is fundamentally a nexus case standing for the idea that economic nexus is a concept that may legally be used for any kind of tax. As a result, post-Wayfair, nine states (Hawaii, Indiana, New York, Maine, Massachusetts, Oregon, Pennsylvania, Texas and Utah) and five cities (Chicago, San Francisco, Portland, Ore., Philadelphia and Allentown, Pa) have enacted economic nexus standards under their income, franchise and/or gross receipts taxes.
A company might explicitly register in a state for sales tax only to trigger an economic nexus audit for one or more other taxes. Even though the emergence of the pandemic has slowed states’ adoption of economic nexus laws outside of the sales tax context, this trend is expected to pick up later in 2022. For all these reasons, CFOs should view their company’s economic nexus footprint holistically, rather than focusing solely on sales tax.
Marketplace facilitator laws:
For many years, sellers have hired companies like Amazon, eBay or Etsy to facilitate their online sales. Before the advent of “marketplace facilitator” laws, it was unclear who (the seller or the website operator) was required to collect tax on sales made through the site. Post-Wayfair, every state with a sales tax has enacted a “marketplace facilitator” law, which generally shifts the sales tax collection obligation from the seller to the website operator.
Even though this generally reduces their administrative and compliance costs, companies should carefully review their marketplace facilitator contracts to ensure they understand the details. For example, in some instances, the sales tax collection obligation can be shifted back to the seller if the parties agree to it in writing.
By staying aware of relevant state tax changes that could impact their companies, CFOs will have a better chance of strategically managing the short-term and long-term risks caused by those changes.
2. Identify internal resource burdens caused by Wayfair
Another area for CFOs to consider is the effect Wayfair may have on internal operations within the company. CFOs should examine and recognize the potential resource burdens additional work may bring to the workforce and internal systems.
Economic nexus has significantly increased the sales tax registrations, collections and reporting requirements for many organizations resulting in a need for additional assistance. This could be costly for a company that was not prepared for the increased workload. Extra costs can be associated with additional employees, outsourced vendor fees and software upgrades.
Technology, automation and outsourcing: Prior to Wayfair, remote sellers could generally limit the complexity that their sales tax function had to deal with by managing the business’s physical footprint. Because Wayfair increased the number of state and local taxing jurisdictions that remote sellers had to deal with, many sellers started evaluating capacity-building solutions such as in-house technology solutions or even outsourcing their sales tax compliance function to a vendor
Since companies of different sizes and product/service mixes have dramatically different needs, neither a technology solution nor outsourcing is necessarily the “best” approach for all businesses. As a result, CFOs should evaluate a wide range of approaches to ensure that they select the best one for their company’s needs.
3. Quantify the risks of noncompliance
CFOs should also understand and quantify the risks of not complying with reporting obligations established by states following the Wayfair decision. Because each state has created its own nexus law, which includes the criteria for when a company should start reporting, they’re becoming more aware of companies that don’t register and start reporting when they are expected to.
Therefore, states have begun to ramp up their audit enforcement, which is a huge risk for noncompliant companies, as it typically leads to large, unexpected tax liabilities, including penalties and interest. CFOs should be aware of any potential exposures due to noncompliance to prepare for and mitigate any risks.
Current state audit environment: Initially, some states took a more lenient posture towards enforcing their economic nexus laws, particularly those who enacted laws soon after Wayfair’s publication, often citing the emerging nature of those laws. However, more than three years later, this lenient attitude has largely ended, and states are actively conducting economic nexus audits. Most sales tax audits have historically covered a 36-month period, so because many states’ economic nexus laws took effect just over three years ago (October 2018 or later), they naturally have a 36-month period ready to audit right now.
Sales tax registration forms: Even though there are a variety of ways that state taxing authorities identify sales tax audit candidates, one area that CFOs want to be particularly careful about is completing sales tax registration forms in new states.
Companies that register for a sales tax identification number in a state must disclose the first date upon which they created sales tax nexus there. Many states have begun questioning the companies’ assertion of their “start date.” For instance, take a company that met the economic nexus threshold of $100,000 in June 2021 but did not register and collect tax until October 2021. This company would be liable for the sales tax that should have been collected during those gap months.
Early on some companies took on the strategy of trying to hide prior period nexus by registering prospectively. This strategy is now considered to be ineffective and may subject the company to significant penalties and interest.
Do you have the needed data to manage economic nexus risks?
The following list contains key questions that CFOs should be asking to ensure they have the data needed to effectively manage their company’s economic nexus footprint in 2022 and beyond:
- How much revenue do you earn from selling goods and services to purchasers in each state (based on where your customer takes physical possession)?
- Do you know state-by-state differences in the taxability of the goods and services you sell, such as the taxability of shipping and handling?
- What was your company’s pre-Wayfair nexus footprint?
- How do you track the correct rate, especially at the local level?Do you manually enter the sales tax rates into your software system?Not charging the correct sales tax rate can lead to additional tax risk during a state sales tax audit.
- Do you have an effective process in place to obtain, validate and retain sales tax exemption certificates in all states that you sell to? Sales of tangible goods are generally deemed taxable absent documented proof of exemption, and companies who have nexus in many states are often required to collect exemption certificates from many states
- Has your business considered a sales tax technology, automation or outsourcing solution?
- How do you stay up to date with new nexus and taxability legislation?
- How are you monitoring both physical and economic nexus as your company grows?
Interested in learning more?
Wipfli advisors understand the nuances with each states’ economic nexus requirements and can assist your company in all matters relating to state tax compliance and consulting. One of the largest areas of sales tax audit risk comes from not having a system in place to track and retain customer exemption certificates on file. Contact us for more information or assistance.
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