A U.S. Supreme Court ruling last week involving the state of South Dakota vs Wayfair (an online furniture retailer) opens the door for states to impose sales taxes on online retailers located outside their borders.
This will have wide-reaching effects on small businesses and consumers. Here’s what you need to know:
Who benefits?
- State governments. States will be able to collect hundreds of millions of additional tax revenue from purchases made at Amazon, Overstock and other online retailers.
- Brick-and-mortar stores. Physical stores that are collecting sales taxes will no longer be at a price disadvantage with online competition that hadn't been.
Who loses?
- Online businesses. Not only will online sellers likely have to raise their effective prices to pay the state taxes, they now may have to contend with a complex patchwork of state and local tax jurisdictions.
- Consumers. Consumers that had been enjoying lower taxes on online purchases are likely to have to pay more after this ruling.
- Small businesses. Trying to keep track of 50 different sets of sales tax rules and complying with this ever-changing rate environment will be difficult.
Some background
The federal standard in place since the 1990s was that states could only impose taxes on businesses that had a physical presence within their borders. Many states tried get around this by imposing “use taxes” on consumers who made purchases from out-of-state retailers. But use taxes proved hard to enforce and have been widely ignored by taxpayers.
In the recent Supreme Court ruling, South Dakota successfully challenged the physical presence standard in favor of “economic presence,” allowing states to require businesses to collect these taxes even if they are located elsewhere.
The small business dilemma
This ruling may be concerning to small business owners who have customers outside their home state. The risk is that small businesses may now have to register and comply with complex tax filings in all 50 states, and maybe even thousands of local jurisdictions as well. But keep in mind that:
- The ruling is based on South Dakota’s simplified tax structure, which collects only at the state level, avoiding the complexity of local tax compliance.
- South Dakota has a compliance threshold that exempts small businesses with less than either $100,000 in sales or 200 transactions of products or services delivered into the state.
- Further events may follow:
- State governments will have to put their collection systems in place, which will take time. Some will first need to pass new laws authorizing the taxation of online transactions using the economic versus physical presence standard.
- Congress may feel compelled to act with legislation simplifying the tax jurisdiction of state and local governments.
There’s no doubt the Supreme Court ruling has caused the ground to shift for any businesses selling outside their state, and the total effect of the changes is still unknown. Call if you have any questions about this or other tax matters.
As always, feel free to pass this Tip along to friends, and reach out if you need help with your personal tax and finance situation.