‘Wayfair’ Ruling Continues to Redefine Sales Tax Rules Today
Where and How You Buy a Product Increasingly Matters
If ever a seismic event reshaped the foundation of sales tax policy in the U.S., it would be “Wayfair.” In the landmark South Dakota v. Wayfair, Inc. case, the U.S. Supreme Court struck down the physical presence nexus standard established in the 1992 decision Quill Corp. v. North Dakota. This means states can require certain retailers, with no physical presence, to collect and remit the applicable sales or use tax on sales delivered in locations within their state. Its impact was not simple, and the ripple effects of the Wayfair ruling continue to play out today.
The Wayfair ruling’s most visible impact fell on digital sales. Shoppers who were accustomed to buying goods online and not paying sales tax – unless the goods were shipped from within their states – suddenly found sales tax added to their purchases. Since a large percentage of retail sales had moved online over the years, by the time the Wayfair ruling occurred, states were estimated to be losing $15 billion annually in sales tax revenue. As a result, many states pressured the federal government to enable them to charge sales tax on online purchases. Still, they were hindered by a 1992 Supreme Court ruling that prohibited states from collecting sales taxes from purchases made by their residents from out-of-state vendors that did not have a physical presence within that state. Wayfair essentially reversed that ruling, and many states acted quickly to impose sales tax on internet purchases made by their residents.
Major Change in Sales Tax Landscape
In effect, the Wayfair ruling paved the way for significant changes in the sales tax landscape, many of which have nothing to do with the ruling itself. One such change is in process in Kansas, with the phasing out of sales tax on food bought at the grocery store. Currently taxed at the state’s standard sales tax rate of 6.5% (with cities and counties able to tack on their own additional sales taxes), the state sales tax on groceries will drop to 4% on January 1, 2023, and 2% on January 1, 2024, before disappearing entirely on January 1, 2025.
The phaseout of the sales tax on groceries grew from recognizing that the tax burden on essential goods falls disproportionately on poor and lower-income households. For example, if you spend $400 a month on groceries, you pay $26 in sales tax, whether your take-home pay is $3,750 a month or $11,250 a month. But that tax burden is much more significant as a percentage of disposable income for the person bringing home $3,750.
The phaseout of grocery food sales taxes in Kansas reflects a growing sentiment nationwide that taxation can and should be fair, falling more heavily on higher-income taxpayers. However, this doesn’t apply only to income taxes. Sales taxes are perceived as “regressive” because they are a flat tax, applied equally to all taxpayers regardless of income. While it would be impossible to graduate sales taxes based on purchasers’ income, states can achieve some balance by exempting essential goods and services (like groceries) from sales taxes. Note: the phaseout of sales taxes on food bought at grocery stores in Kansas does not extend to prepared foods.
Tangible v. Non-tangible
On a broader scale, many states are considering or implementing sales taxes on services as well as tangible goods, specifically services that are purchased online. With the seismic shift in the sales tax landscape stemming from the Wayfair ruling, where services and goods are provided or delivered—and how—really matters.
Tangible personal property is the cornerstone of sales tax application. States generally tax anything that can be seen, weighed, measured, felt or touched (except for land or buildings).
Historically, intangible property – such as stocks, bonds, contracts, mortgages, patents, and copyrights – has not been subject to sales tax. However, states are reconsidering this position.
Intangible property can be considered tangible property in the eyes of the state if it is delivered in a tangible means. The waters can be muddied even further as states plan taxing approaches to new technologies, products, and services that are intangible or have intangible qualities. States want a more significant piece of the growing digital and service-based economy.
Recent examples, which may serve as templates for more states to adopt, include:
- Digital goods like e-books, music downloads, and ringtones. Digital sales of these goods have greatly increased while sales of the physical form have experienced a sharp decline. Around two-thirds of states have worked to subject some digital goods to sales tax, but rules across the states are in constant flux.
- Online educational services such as webinars. While most states do not apply sales tax to live online educational services, sales of prerecorded webinars are increasingly subject to sales tax because a recording, even though it is intangible, is a digital product. States that have implemented these sales taxes include Wisconsin and Tennessee.
- Digital advertising and marketing services. The COVID-19 pandemic shifted many business activities to the digital platform and showed the corporate world how much business can get done online. This increased demand for various online services, including digital advertising and marketing. Maryland in 2020 became the first state to subject certain digital products to sales and use tax, including streaming and downloads, and 32 other states quickly followed suit, including Arkansas and Nebraska. (Neither Kansas nor Missouri have joined the crowd – yet.) Many tax policy experts oppose sales taxes on digital advertising due to inconsistency, pointing out that some states that tax digital products do not tax nondigital advertising or marketing services.
The rules around which services are tangible and intangible and under what circumstances they may be taxable are often murky. Understanding the nuances of sales tax classification rules, like the implications of delivery method, allows you to apply sales tax to your products and services accurately.
Small changes to sales and use tax law, such as nexus thresholds, can have a big impact on sales and use tax compliance. Thresholds are based on a remote seller’s sales volume or number of transactions within a certain period. The particulars, including which sales count toward the threshold, vary by state. Unfortunately, thresholds necessitate close monitoring of sales activity since you need to register your business if you cross a threshold — often by the next transaction.
Sales tax rules are changing rapidly, and new interpretations of the Wayfair ruling and other taxation principles are emerging daily.
Sales Tax Client Case Study
The client had no way of evaluating their sales tax liability risk.
Conducted a sales tax risk analysis by state for client offering customized SaaS (software as service) via an online platform.
A Proactive Approach
We provided a summary evaluation of the 18 states where our client had significant sales activity. Our assessment noted if the service is taxable, why, or why not and any relevant thresholds or limitations the client needed to be aware of. Supporting documentation for our findings was also provided.
This enabled our client to proactively establish a working relationship with the states where they needed to collect sales tax. This approach has proven much more cost effective than attempting to establish good standing with these states retroactively, after a backlog of past due returns has accumulated and penalties have been assessed.
Contact your Adams Brown advisor if you would like to review your tax estimates and your application of sales tax, as well as opportunities for tax savings. Most importantly, contact your tax advisor before doing work or sending employees to work in a different state to ensure you understand the implications for both sales and income taxes.