Wayfair Decision Imposes New State Tax Burden on Foreign Businesses Selling into the U.S. UPDATED by Karen A. Lake, CPA
Posted on September 24, 2019
The U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair has had far-reaching impact on the state and local sales tax (SALT) obligations and previous competitive advantages of online and foreign businesses that sell products into the U.S.
The court’s ruling eliminated the prevailing physical presence test, which required sellers to collect sales tax from customers who live in states where they own property or employ workers. Instead, the court, under Wayfair, introduced an economic nexus test based on the sellers’ sales volume into each state. More specifically, U.S. states may now impose sales-tax collection obligations on foreign and domestic sellers that conduct more than $100,000 in sales or more than 200 transactions in their jurisdictions in a given year, regardless of whether the sellers have a physical presence in that locale. This economic nexus standard varies by state.
While the majority of U.S. states that enacted new economic nexus laws have adopted the Wayfair standard, requiring out-of-state sellers to collect and remit use and sales tax when sales reach $100,000 or 200 transaction in a given year, states with large populations, such as California, New York and Texas, have established a higher threshold of $500,000 in annual sales. As of this date, Florida and Missouri are the only two states that impose tax on sales but have not enacted economic nexus laws under the Wayfair standard.
As a practical example of the economic nexus law, consider a foreign company selling tangible goods from its headquarters in South America into the U.S. If sales meet the sufficient dollar/transaction threshold in a particular U.S. state, the company is required to collect sales and/or use tax on all orders received from customers in that state. This rule applies even when the company does not have a permanent establishment (PE) in that state. Companies whose sales meet the test for establishing a meaningful and substantial presence in multiple states are required to collect and remit sales tax in each of those jurisdictions. With these updated economic nexus laws, states now have the ability to enact or enforce dollar sales and/or transaction threshold and compel more companies outside of their borders to collect tax on sales made to in-state customers.
The Wayfair decision places a significant administrative burden on foreign businesses. International tax treaties generally apply solely to income taxes on the federal level. As a general rule, tax treaties do not apply to U.S. states, and bilateral tax treaties generally do not apply to non-income taxes at the state level. Therefore, foreign companies with U.S. customers may not escape sales and use tax obligations on the state and local levels. Instead, these foreign entities may have potential U.S. tax collection and filing responsibilities when they meet a particular state’s dollar sales/transaction threshold regardless of whether or not they have a permanent establishment (PE) there.
It is important to note that while the U.S. Commerce Clause prohibits states from imposing excessive burdens on interstate commerce without Congressional approval, the Supreme Court has demonstrated its authority to “formulate rules to preserve the free flow of interstate commerce” when Congress fails to enact legislation. In its opinion in Wayfair, the court affirmed that the dollar/transaction threshold satisfies South Dakota’s burden to establish economic nexus and impose tax on businesses that are “fairly related to the services provided by the state,” including “the benefits of a trained workforce and the advantages of a civilized society”. This final factor, which demonstrates a fair relationship between the taxes imposed and the service provided by a state, can be easily applied to foreign companies that conduct business in U.S. states.
Foreign businesses must consider how the Wayfair decision will affect their sales and profits, and they must take steps to comply with state-level taxation going forward. This may involve assessing the volume of their transactions in each U.S. state, gaining an understanding of and a method for applying the SALT regimes in each U.S. state to their sales orders, and developing communication to let customers know that sales tax will be added onto future purchases.
About the Author: Karen A. Lake, CPA, is a state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of the law and subsequent guidance issued by the Internal Revenue Service.