In 2018, a court case decided by the U.S. Supreme Court (South Dakota v. Wayfair) created a paradigm shift in how businesses are exposed to state tax filing requirements, leading to more companies exposed to state tax implications.
SCOTUS ruled that states are no longer held to the threshold of physical presence to require an out-of-state business to collect sales tax. Formerly, a state could not impose state tax collection, registration, or tax liability reporting requirements unless an out-of-state business had physical presence in their state: property or employees. However, after Wayfair most states adopted ‘economic nexus presence’ as their substantial connection requirement for businesses generating revenue from sales in their state. The general rule for economic nexus presence is if a business generates over $100,000 in revenue or 200 transactions, they’ve created substantial presence in that state meeting those thresholds. But, in addition to sales tax collection, a business may have income/franchise tax liabilities that may have been formerly protected from paying under Constitutional Law P.L. 86-2721. There’s still a little grey area regarding whether the Wayfair case negates these protections for income taxes, however, states have enacted these economic nexus standard laws that may subject all business types to these liabilities. But, formerly, protections from tax liability only applied to businesses selling tangible products, soliciting, and delivering to a customer.
So, if you’re a service provider business, your exposure to tax liabilities is greater simply for the type of business you are. Some states charge a sales tax for your service, some do not. But you’re most certainly liable for income/franchise taxes if the state charges those taxes. For the small business owner, a reprieve is available, even though you’re responsible for taxes, as states are lenient to you if your revenue generated in the state is under the economic nexus threshold.
Often businesses fail to realize, sales tax collection and remittance is not the only tax obligation they have when gaining revenue in a state. Physical presence formerly allowed coverage protection only for businesses selling tangible products to a resident customer, and their only activity in the state was soliciting the business from out of state, then shipping it to them via common carrier (i.e., Fedex). The threshold protection under P.L. 86-272 was never for sales of service or selling tangible products while having employees or property in the state you do business.
So, what are the consequences for non-compliance?
Hazards of Non-Compliance:
- You will expose your business to state audits and assessments. Penalties and interest can reach substantial amounts, especially for a business with multi-state activities.
- Outstanding tax liabilities pose a challenge for future expansion. Hopefully, your goal as a business is to grow and expand. And what if you’re offered the greatest merger/acquisition deal of a lifetime? Or you’ve grown so much that you want a physical store in the state you’re generating the highest revenue? Lack of compliance can be huge impediments to your business growth.
- States will more likely hold your business, or the marketplace facilitator you use, rather than customers accountable for unpaid taxes. Usually, the consumer of the product or service purchased is responsible for sales tax because they are the end-user of the purchase. And as a seller, you will generally not be able to go back and collect the uncollected tax from your customers (it’s not a good look for your business, and once a customer pays for something good luck asking for more).
We offer free evaluation of your business activity to determine if you need a full analysis of your state tax exposure for sales tax and income/franchise taxes. Schedule an appointment with us soon!
Footnotes
1) P.L. 86-272 prevented states from imposing income taxes on businesses whose only activities in the state are restricted to the “mere solicitation” of sales of tangible personal property. So the law applies to; 1) net income taxes. it does not apply to gross receipts or franchise taxes; 2) Sales of tangible personal property. Sales of services and digital products are typically not covered; 3) limited to “mere solicitation” Wisconsin Dept. of Revenue v. William Wrigley, Jr. Co., 505 U.S. 214(1992)