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Current Trends in Income Tax and Sales Tax Nexus

In 2018, the U.S. Supreme Court issued a ruling that inexorably altered the trajectory of nexus laws across the country. This court case overturned precedent that had been held for decades, forcing many businesses to file tax returns in new states or risk accumulating steep non-filing or underpayment penalties. As you meet with your clients this year, talk to them about their multistate activity. The new compliance requirements they’re facing may feel overwhelming, but they are manageable.

The Lead Up to South Dakota v. Wayfair

In 2016, South Dakota passed Senate Bill 106 that gave them permission to impose sales tax laws on out-of-state retailers who made sales to South Dakotan residents. This law stated that a business generates sales tax nexus in South Dakota when the business makes either (1) over $100,000 in sales or (2) 200 separate transactions within South Dakota. Although this state law was sound, it was in opposition of national precedent that had been established almost 25 years prior.

In the 1992 U.S. Supreme Court Case Quill Corp v. North Dakota, the Court determined that states could not enforce sales tax filing and collection responsibilities on out-of-state businesses unless those businesses had a physical connection to the state. This ruling was an attempt to protect interstate commerce. The courts implied that a law that required out-of-state retailers to file sales tax returns would impose too much of a burden on retailers and discourage them from operating across state lines.

The doctrine established under Quill held firm for the next two decades. It was used in court case after court case to protect remote retailers from sales tax collection duties. As the internet only made interstate commerce simpler, states were losing sales tax revenue to out-of-state sellers. South Dakota’s Senate Bill 106 was an attempt to kill the precedent set in Quill. Although it was not the first law of its kind, it was the first that made its way to the Supreme Court.

In the court case South Dakota v. Wayfair, South Dakota attempted to enforce their new laws against the online retailer Wayfair. The Court ruled in favor of South Dakota. By stating that South Dakota’s Senate Bill 106 was defensible, the Courts overturned the long-held precedent set under Quill. No longer was physical presence required for a business to establish nexus with a jurisdiction. A business may be liable for sales taxes if they establish an economic connection as defined by that state’s tax laws.

The Aftermath of South Dakota v. Wayfair

The South Dakota v. Wayfair decision was monumental for states and businesses across the country. While the Wayfair decision itself did nothing to change state laws, it gave states the opportunity to set economic nexus doctrines. And states seized that opportunity.

In the years since the Wayfair case, almost every single state has passed a law that asserts an economic nexus doctrine for sales taxes. Most states mimicked South Dakota’s doctrine established in Senate Bill 106, but others established their own activity thresholds.

These new laws will affect many businesses, especially online retailers. These businesses may now be liable in almost all 50 states for sales taxes. The taxes themselves are not imposed on retailers, but retailers with nexus are expected to collect and remit sales taxes on sales made within those states. These new compliance requirements can be extraordinarily burdensome, especially to small or medium sized businesses that file sales tax returns in-house.

What can make these law changes so difficult is that states tend to apply steep penalties to businesses who fail to collect and remit sales taxes properly. It can be difficult for businesses to understand the laws and meet compliance requirements in dozens of states at once. With almost no lead time or buffer, your clients can easily get overwhelmed with their new filing responsibilities.

What About Income Tax Nexus?

The trend toward economic nexus doctrines does not stop at sales taxes. States are beginning to draft new income tax laws that outline when economic activity generates income tax nexus for a remote business. Although some states have had income tax economic nexus doctrines for decades, the Wayfair ruling was a signal that the courts were more open to broadening the concept of nexus, and states have begun to make some changes in the years since Wayfair.

  • Massachusetts ruled in October 2019 that a business establishes excise tax nexus with their state when they make annual sales within Massachusetts that exceed $500,000 or conduct certain activities (like solicitation) with 100+ residents of the state.
  • In September 2019, Pennsylvania stated that even without physical presence, a corporation will have income tax nexus if they have annual gross receipts sourced to Pennsylvania that exceed $500,000.
  • In July 2019, Hawaii imposed an economic nexus doctrine that says remote businesses will be liable for state income taxes if they engage in 200 or more transactions or have gross income of $100,000 or more in Hawaii.
  • In December 2019, Texas amended its franchise tax laws to adopt a new economic nexus threshold. For reports due in 2020 and all franchise tax reports thereafter, remote businesses will have nexus with the state if they generate $500,000 or more annual receipts attributable to Texas.

We anticipate more states will adopt clear-cut economic nexus thresholds for income tax, excise tax, activity tax, and gross receipt tax purposes soon.

Help Your Clients with Their Filing Responsibilities by Using Tax Planning Software

State trends clearly show that economic nexus laws are on the rise. Are your clients prepared? When you meet with them this year, talk to them about their interstate activity. If your clients sell online or perform services for businesses and individuals in other states, they should be concerned about economic nexus. You can help them determine filing deficiencies – if they have any – by performing a nexus study.

When you perform a nexus study, you will look at your client’s business activity and research whether those activities make them liable for taxes in other states. You can perform nexus studies for sales tax purposes, income tax purposes, or both. This information can be illuminating to you and your clients. They may not realize how their business activity has exposed them to new filing responsibilities.

Armed with this information, you can help them manage those new filing requirements. If your clients are liable in a lot of new states all at once, you can help them establish a timeline for coming into compliance. Some states have amnesty programs or voluntary disclosure programs that can make the process a bit easier for your clients. Many of these programs reduce or eliminate penalties for program participants, so take advantage of these when you can.

Another great way you can help your clients is to mentally prepare them for the new tax outlays. This is where a good tax planning software can come in handy. Corvee tax planning software has the power to calculate how these new tax liabilities will affect your clients’ financial position this year and years into the future. Our software can help you give your clients the information they need to make better strategic decisions.

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