TL;DR: The U.S. Supreme Court (SCOTUS) ruled that states can now collect sales tax on online sales even if the business doesn’t have a physical presence in such state. Big retailers like Amazon and Walmart are already collecting sales taxes, so smaller sellers, less prepared to comply, will bear the brunt of this ruling.
Let’s be honest, the sales tax-free bonanza that online businesses and shoppers have been enjoying was going to end eventually.
Last month, in a much-anticipated decision, the Supreme Court ruled on South Dakota v. Wayfair, ending the party for many online retailers that sold their merchandise for many years without collecting sales tax.
What does the SCOTUS decision actually mean for small businesses that sell online?
The short answer is: Small businesses that have a lot of online sales will have some work to do to comply with laws like South Dakota’s, while the smallest businesses will likely be granted exemptions.
A brief history follows below, but if you just want to know what it means for you, skip ahead.
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What’s the deal with sales tax?
For decades, states have sought to levy sales tax on businesses based outside their borders. In order for a state to force a non-resident business to collect its sales tax, however, it had to show that that business had nexus (i.e., a connection) through a physical presence in that state. No nexus? No sales tax.
Over the years, this physical presence requirement has been challenged in court many times. In the 1992 landmark case, Quill Corp. v. North Dakota, the Supreme Court once again ruled that a physical presence was necessary for a state to collect sales tax from a non-resident business.
In the decades that followed, e-commerce exploded from $5.3 billion in sales at the end of 1999 to $123.7 billion the first quarter of 2018—and the Quill ruling meant this boom was largely sales tax-free. This caused two major issues:
1. States lost out on sales tax revenue
A November 2017 study from the US Government Accountability Office found that state and local governments lost out on $8.5 billion to $13.4 billion in revenue from sales tax in that year alone. Many states have been fighting budget deficits for years, making this lost revenue extra painful.
2. Brick-and-mortar sellers were left holding the bag
Speaking of pain, traditional retailers have been collecting sales tax this whole time, putting them at a significant disadvantage; their online competitors were effectively able to sell goods to customers at a discount in the amount of the sales tax.
In June 2018, SCOTUS expanded the reach of online sales tax with the South Dakota v. Wayfair ruling
A challenge to the conclusion in Quill arose in March 2017, when South Dakota passed a law that requires businesses to collect sales tax if they have:
- Over $100,000 of sales annually, or
- Over 200 transactions annually
After the law passed, South Dakota sued four of the biggest online retailers that were not collecting sales tax: Wayfair, Overstock.com, Newegg, and Systemax. Many states began drafting legislation similar to South Dakota’s, and South Dakota v. Wayfair, Inc. found its way before the Supreme Court on April 17, 2018.
South Dakota’s chief arguments against the standard set in Quill Corp. v. North Dakota were:
- States were unfairly missing out on sales tax revenue they were entitled to collect;
- Brick-and-mortar sellers were complying with the law while online sellers were given an unfair advantage;
- The unfair advantage discouraged interstate commerce.
The online sellers’ main arguments were that:
- The law put too large of a burden on businesses;
- Online sellers incurred higher costs in other areas (e.g., shipping), so they were not “unfairly advantaged”;
- Other bills before Congress, like the Marketplace Fairness Act (MFA) and Remote Transactions Parity Act (RTPA), would help change the standard set by the Quill case to level the playing field between online and traditional sellers.
On June 21, 2018, SCOTUS ruled in a 5-4 decision that South Dakota’s law was fine. Essentially it means that sales are sufficient to create nexus—that is, a connection—with a state, and that means a state can collect sales tax from your business if you sell goods there.
Actually, it might not.
The reality for small retailers is far less scary than it seems. Yes, it’s likely that many states will pass laws similar to South Dakota’s requiring tax collection on online sales, but these laws will probably also include a simple threshold that excludes the smallest businesses. Again, South Dakota’s threshold required:
- Only sellers with over $100,000 of sales or 200 transactions have to collect sales tax.
Businesses that fall short of these thresholds won’t have to collect the tax. Most experts expect other states to include similar thresholds.
Phew! Right? But there are a few developments you’ll want to be aware of.
7 things business owners should know about South Dakota’s online sales tax law
1. More states will pass laws similar to South Dakota’s
The Tax Foundation said that some states “may adopt laws that emulate South Dakota’s in every respect,” while others may not follow them so closely. Laws that pursue collecting sales tax more aggressively might get challenged in court. And then a few states may not do anything.
2. So. many. jurisdictions.
Small online retailers that haven’t been collecting sales tax from their customers will have to start, and they will have to find a solution for managing the 18 gazillion sales tax jurisdictions in the US. (OK, maybe not that many, but the tax software company Vertex came up with 10,814 in October 2017, which is nothing to sneeze at.)
3. Tech will be your best friend
Small retailers, especially, will have to rely heavily on technology to keep up. The good news is there are already solutions out there, and at least one person believes Amazon might build a solution for its third-party vendors and charge a commission.
4. Online sellers might have it rough.
Speaking of those businesses that sell on Amazon, the ruling will affect many of them who have not been collecting sales tax. Same goes for sellers on popular online bazaars such as Etsy and eBay.
5. Amazon will be fine.
As for Amazon itself, the company will continue taking over the world because this ruling will not affect them at all. They’ve been collecting sales tax nationwide since April 1, 2017.
6. Not every state is pleased
States without sales tax (e.g., New Hampshire) may pass laws trying to protect the businesses there from having to collect and remit sales tax to other states.
7. Don’t expect much from Congress.
They will NOT pass legislation that would simplify how states tax interstate commerce, certainly not in an election year. I don’t care what anyone says; bills like the MFA and RTPA will continue to go nowhere. The last time a version of MFA passed any house of Congress, for example, was 2013—and neither of the current bills are expected to become law.
How does South Dakota’s online sales tax actually work?
Here’s an oversimplified example. Let’s say you run a bike shop based in Colorado and you sell many bicycles—two per week—through your website to customers in South Dakota. And let’s also assume the average price of those bikes is $500.
- So that’s two bikes per week at $500 a pop, 52 weeks a year.
- That comes to total sales of $52,000 (2 x $500 x 52), which is below the $100,000 threshold.
- Oh, and because you’ve only sold 104 bikes (this example assumes no other sales were made to customers in SD) you’ve fallen below the transactions threshold.
- BOOM, you’re exempt!
Taking this over-simplified example a step further, you could sell 199 bicycles at the average price of $500 each for total sales of $99,500, and you’d still fall below the $100,000 and 200 transaction threshold. Nice!
Now, where things might get complicated is tracking all the sales to customers in each state once more laws like South Dakota’s start popping up. But I have to think that if you’re selling your products online, your e-commerce software should be able to spit out a report that would summarize things like your customers’ geographic locations fairly easily. If not, you might want to consider software that can better help you track your sales.
Anti-tax and business groups might have you believing that this decision will single-handedly crush the innovation and spirit of small retailers across the country, but that’s not necessarily the case.
Like most things in life, things aren’t nearly as bad as they seem. That holds true here. However! Other states may try to pass more aggressive laws than South Dakota’s. Those laws are likely to get challenged while others will pass muster for sticking close to SD’s model. Stay vigilant!