Economic nexus for sales and use tax
A nexus is the requisite contact between a taxpayer and a state before the state has jurisdiction to impose tax on the taxpayer or require it to collect tax. The rules regarding where retailers must collect and remit sales and use tax have become increasingly complex in recent years. This is the result of sales transactions becoming more complicated, the increasing ease with which remote sellers can sell into a state without physical contact due to the internet, and the elimination of the physical presence requirement in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080, 2018 BL 219995 (2018).
In 2018, the U.S. Supreme Court issued a decision in South Dakota v. Wayfair, Inc., overturning the physical presence requirement for sales and use tax nexus. Today, sales tax nexus may be established when a business’s retail activity in a state meets a certain dollar amount and/or number of individual transactions.
Economic nexus vs. physical presence standard
Since the Wayfair decision allowed states to impose taxes on out-of-state taxpayers based on economic nexus, states and localities have become more emboldened about expanding their jurisdiction to tax multistate taxpayers in a variety of ways. States will look broadly at both physical and economic presence to determine nexus. Most states base their nexus standard on both physical presence and economic nexus.
Because nexus can be imposed on nonresident businesses that meet a specific economic threshold, businesses may have nexus in significantly more states than they had previously – especially businesses making online sales of taxable tangible personal property or services.
Currently, every state imposing a sales tax has an economic nexus provision. This does not mean, however, that the concept of physical presence is gone for good, as having a physical presence will generally still create nexus in states that have adopted economic nexus provisions.
As states continue to respond to Wayfair, taxpayers and practitioners must grapple with the effect these changes will have on the complexity of sales tax nexus and related compliance issues.
Destination-based vs. origin-based sourcing of sales tax
Every state that imposes sales and use taxes provides sourcing rules to identify the location of a sale and to determine which jurisdiction is entitled to the revenue generated from tax on the transaction. However, sourcing can be a complicated endeavor for taxpayers to determine. Sourcing rules vary from state to state and may depend upon the object of the transaction; the rules may be further complicated by the type of transaction and mode of delivery. As more and more taxpayers find themselves with nexus across the states, sourcing may become a more important issue as taxpayers have more states in which to source sales.
Sourcing rules generally attempt to incorporate the destination concept to impose the tax where the good or service is consumed or delivered. However, a state may choose to source sales on either a destination basis or on an origin basis, or even vary rules for interstate and intrastate transactions.
Destination-based sourcing is often used for sales of tangible personal property because the final destination of a transferred good can usually be determined. Because determining the destination of a sale of services can be difficult, some states use origin-based sourcing rules for those transactions. Origin-based sourcing rules, on the other hand, are easily enforced but can lead to economic distortion as they often result in a destination state receiving little or no tax. Most states use destination-based sourcing for interstate sales of tangible personal property.
Economic nexus threshold calculations
The state economic nexus thresholds established in the wake of Wayfair describe the extent of sales made into a state, in terms of dollar amounts and/or number of transactions, sufficient to require a remote seller to collect and remit the state’s sales tax. Predictably, the advent of economic nexus hasn’t suddenly created uniformity among states; economic nexus threshold dollar amounts and transaction numbers vary from state to state.
Beyond the differences in the economic nexus thresholds themselves, the new rules have created new gray areas in calculating whether the thresholds have been met. States have different rules on which sales count toward the threshold (e.g., exempt or wholesale sales, or sales made through a marketplace) and have varying time frames within which the thresholds are calculated. Now that all states that impose sales tax have implemented economic nexus laws, an increasing number of taxpayers will require guidance on precisely how to calculate whether thresholds have been met.
Tax collection in the sharing economy
The sharing economy, also sometimes called the “on-demand economy,” has created an opportunity for individuals who aren’t ordinarily in the business of selling to offer their homes, cars, transportation services, and other items for sale, use, lease, or rent to a global customer base through online platforms.
These third-party platforms handle the details, usually for a fee, of arranging the transactions between the buyer and the owner-seller or the service provider. Many of these platforms have no ownership interest in the goods and do not directly provide the service offered for sale. Some third-party vendors, such as online travel companies, acquire hotel rooms or airline seats and then resell them to customers.
For goods and services flowing through the sharing economy that are subject to state sales and use tax, one of the major questions is: Who is responsible for collecting and remitting the tax due – the owner of the property, the provider of the services, or the third-party platform? Existing state tax laws and rules, drafted for a different era, often don’t provide a clear answer for sales made as part of the sharing economy. However, states are increasingly imposing collection obligations on third parties who facilitate the short-term rental of an owner’s vehicles.
Marketplace facilitator transactions
Another area that’s seen rapid policy changes is the tax collection obligations of online retail marketplaces. More sellers are using marketplace platforms to facilitate their sales of tangible personal property and services online. Due to their small size, many of these sellers are unlikely to create nexus with any state outside the place where they are headquartered.
However, the total sales by all sellers made through these marketplace platforms represent a large amount of uncollected sales tax revenue. Like the adoption of economic nexus laws to collect taxes from remote sellers, states have recently adopted requirements for marketplace facilitators to collect tax on sales made through their platforms. These laws still leave many unanswered questions, such as the proper way to calculate whether a facilitator has met a sales threshold, whether a facilitator must collect other taxes, and the administrative requirements for both facilitators and sellers.
Cryptocurrency as a taxable sale
A major consideration from a state tax perspective is whether the purchase of virtual currency or cryptocurrency is a taxable sale for sales and use tax purposes, or how to treat the purchase of tangible personal property or services with cryptocurrency. Therefore, tax preparers and taxpayers should seek guidance on how to calculate the sales tax due on purchases made with virtual currency or cryptocurrency, and how to report such sales to state taxing authorities.
Many states haven’t yet issued guidance on the tax treatment of virtual currency or cryptocurrency. In states that have not addressed the tax issues arising from the use of virtual currency or cryptocurrency, taxpayers may want to examine the state’s approach to taxing the sale and use of other types of currency or other intangible property, as well as research whether the state conforms to the federal tax treatment of convertible virtual currency.
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