Cookies, clicks and Wayfair: Why economic nexus started

It seems like yesterday when only physical nexus ignited a company’s sales tax obligations in a state. Six years ago this month, that changed with one court decision.

These days selling a certain amount remotely into a state or other tax jurisdiction (one that has a sales tax, anyway) means your company must collect and remit sales tax – a complication of doing business that’s probably going to only get more complicated in the years ahead. How and why did this come about?

Evolution of sales tax obligations

“Nexus” means a company has a connection to a tax jurisdiction sufficient to allow that jurisdiction to make the company adhere to sales tax rules.

Originally, nexus was physical, often because a company had an office, employees or some other non-electronic presence in a state. With the rise of the computers in business and commerce, states did try – and still try – to enforce physical nexus created electronically.

For instance, businesses have been considered to have a kind of binding physical nexus if they put tracking cookies on customers’ computers. In 2017, Massachusetts enacted a prescient sales tax rule called Cookie Nexus, which required companies that sold more than $500,000 worth of goods or services and conducted 100 separate transactions in Massachusetts collect and remit state sales tax if that company placed internet tracking cookies on customers’ computers. (This rule has since been challenged in court.)

Click-through nexus laws, which many states still maintain, were also born in the age of electronic shopping, as an out-of-state business created a “physical” connection to a tax jurisdiction by agreeing to reward persons in a state for referring potential purchasers through links on a website.

Something about those Dakotas …

The Wayfair case of some six years ago saw three internet-sales companies – home goods and furnishings vendors Wayfair and Overstock and electronics vendor Newegg – challenged by the state of South Dakota to be mandated to collect and remit sales tax on the vendors’ large numbers of sales into the state. South Dakota courts had already earlier found in favor of Wayfair.

Not so the U.S. Supreme Court on June 21, 2018, when it found in South Dakota v. Wayfair, Inc. et al that an out-of-state seller could establish nexus through economic e-commerce activity alone. In the case, SCOTUS actually overturned its 1992 Quill Corp. vs. North Dakota decision and decreed that physical presence in the internet age is no longer required to create nexus. “Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the states,” the High Court Wayfair opinion read.

The Court also reasoned that the South Dakota law regulating Wayfair did not overly burden retailers because only merchants doing a large annual business in the state were required to collect. This logic remains contentious to today, as we’ll see.

Given states’ revenue shortfalls and nagging budget deficits, the Wayfair decision opened the floodgates to individual states mandating that companies that sell products in those states and that exceeded a dollar or transaction threshold had to collect and remit sales tax.

States have steadily become more serious about enforcement for non-compliance, too, from assessments, penalties and liens to collection agencies and referral for criminal action.

Wayfair fallout

In the past six years, with some variation especially in thresholds involving numbers of transactions (we’ll talk about that in a sec), every state with a sales tax has instituted economic nexus laws. States generally set economic nexus triggers based on in-state sales numbers, revenue or both: $100,000 or 200 transactions in the prior 12 months in Minnesota, for instance, or $500,000 and 100 transactions over the previous four sales tax quarters in New York. Alabama’s threshold, on the other hand, is only $250,000 per year in sales in the state; Colorado’s is greater than $100,000 in sales.

In just 72 months, widespread economic nexus has managed to become ceaselessly confusing to sellers who inadvertently incur penalties.

Some states’ sales/use tax laws, for instance, don’t impose a filing requirement if a seller is not making “retail sales of tangible personal property.” Other states take the opposite approach. In some states, third-party marketplace facilitators such as Amazon must collect and remit sales and use taxes – which, due to such facilitators often being partially unfamiliar with the goods or services being sold, could result in under-collected tax. Technology is another example of an industry risky when it comes to taxable products and services, especially Software as a Service (SaaS). Sold by annual subscription, SaaS would need relatively few customers accumulated during a monthly sales cycle in a state to top the annual threshold.

Not all changes work against sellers. Colorado, for instance, used to also require or 200 or more separate transactions in the state, but has since joined South Dakota, California, Iowa, Louisiana, Maine, Massachusetts, North Dakota, Washington and Wisconsin in eliminating transaction-based thresholds.

Transaction thresholds may be on the way out in many states, as critics have said they bring in little tax revenue relative to the costs of enforcement and put a hard burden on smaller remote sellers.

Nothing stays the same in sales tax, and certainly not in the wake of Wayfair.

If you think your business may be impacted by sales tax developments, contact TaxConnex to learn how we can become your outsourced sales tax department.