New software tools could help states collect sales tax revenues on all products purchased online thanks to a Supreme Court ruling. The change will generate billions in new revenue.
There are about 12,000 sales taxes in the nation. And thanks to the Supreme Court decision in the 2018 case, South Dakota v. Wayfair Inc., businesses that sell products outside of their home state now have a greater responsibility to keep up with all of those different taxes.
“It’s a lot of legal burden on businesses given that there is no single oversight agency which provides clear guidelines of what to do,” said Lucy Dadayan, senior research associate for the Urban-Brookings Tax Policy Center.
Before the Supreme Court ruling, businesses only had to collect sales tax for out-of-state sales if they had a physical presence in the state where the purchase was made. That changed radically when SCOTUS removed the physical-presence requirement, and states established rules around the collection of remote online sales taxes in order to capitalize on the case’s implications.
“States have moved faster on this fiscal policy issue than almost any I’ve ever seen,” said John Hicks, former executive director of the National Association of State Budget Officers and the current state budget director for Kentucky.
Of the 45 states that collect sales tax, Florida and Missouri are the only two that have not passed legislation requiring remote sellers to collect sales tax, but both are considering bills. These laws are known as “economic nexus” regulations. The idea is that if a business passes a threshold of total number of sales made or of total money made from sales in a state, it must collect sales tax.
These economic-presence thresholds differ by state, but they follow the spirit of the Supreme Court decision in an attempt to reduce the burden on small businesses. In the landmark case involving South Dakota, the state set its threshold at more than 200 individual shipments or more than $100,000 in total sales. Other states have followed this lead, according to an Urban Institute report.
Many states also passed regulations that require marketplace vendors like Amazon to collect sales taxes on behalf of their smaller sellers. These laws “really put the burden on the entities who already have the infrastructure and technology and capability to figure out the sales tax in your town versus my town and correctly calculate and in essence facilitate the payment,” said Hicks.
In a 2017 audit, the Government Accountability Office estimated that states and local areas could receive anywhere from $8 billion to $13 billion in additional revenue if they collected taxes from remote sellers.
Hicks cited a lower national estimate of $6 billion. “We’ve been trying to at least track the estimates that were made, the estimates that states used in their budget process,” he said. “Roughly it reflected another two percent increase in their sales tax revenues. That isn’t massive, but the sales tax is 30 percent of states’ general fund revenue,” said Hicks. “So, it’s the second largest type of tax receipt, second to personal income taxes. A two percent increase in your second highest revenue stream is a notable item.”
However, Dadayan claims it’s too early to say anything about the revenue impact. “It’s not really substantial,” she said. “We think it’s going to take some time for the states to figure out the final rules related to the administration and thresholds and everything, and it’s going to take time for businesses to figure out how do they comply. Maybe in a year or so we will start seeing more substantial growth in sales tax, all things equal of course.”
Before the South Dakota v. Wayfair Inc. decision, a remote seller with something as large as a warehouse or as small as a computer in a state could be expected to collect sales tax according to the laws of that state. The collection challenges included the manual process of calculating different tax rates and the potential for sudden changes to the sales tax definitions of local areas.
“You’ve got thousands and thousands of cities with a sales tax in the United States who have the ability to change their boundaries,” said Scott Peterson, the former sales tax director of the South Dakota Department of Tax Revenue. “And every time they change that boundary, someone’s tax obligation changes. Either a retailer’s business gets sucked into the city and they now have to start charging the city sales tax, or a neighborhood gets sucked inside the city and every consumer inside that neighborhood is now subject to the city sales tax.”
The Streamlined Sales and Use Tax Agreement (SST) was created during the 2000s to help reduce the burden of tax compliance for remote sellers. Peterson, the first executive director of the SST Governing Board, said the goal of SST was to get the cost of tax compliance to zero. As part of this effort, the board developed a public-private partnership called the Certified Service Provider (CSP).
The CSP program involves a software company providing tax administration services to a seller, with SST member states covering the bill for the automated tax services.
“Sales tax is a very rote process,” said Peterson, who now serves as director of governmental affairs for Avalara, one of five CSPs. “It’s extraordinarily suited for automation. So retailers were naturally moving toward automation anyway, and this [Supreme Court decision] gives them another reason to move even quicker, because now they have an obligation to collect sales tax, which is very complicated if you aren’t automating it, and those streamlined states will pay for it.”
But if a retailer sells products in the wrong state, so to speak, they’ll have to foot the bill for CSP tax services. To date, 24 states are SST members. The fact that 26 states aren’t participating SST members presents a challenge for businesses, according to Peterson.
Verenda Smith, deputy director of the Federation of Tax Administrators, said marketplace laws passed by states after the Wayfair decision took some business away from CSPs. Marketplaces that collect taxes for sellers give smaller businesses a new way to interface with the tax agency.
“The CSPs have responded by doubling down on their sales effort, by pushing the idea that states really do need to address the burden by using this service and by paying for it,” Smith said.
Although some states may not be interested in bearing the cost associated with being an SST member, there are benefits that might offset the price. Peterson said the Wayfair decision opened up the market for CSP software given the “thousands of sellers today that are collecting that didn’t have to collect before.” Without the aid of a marketplace or automation, this new context could lead to businesses making mathematical errors, given the complexity of sales taxes across the United States.
“While there’s a lot of things that are pretty standard, normal or almost completely normal around the country, if all you know about sales tax is the California sales tax system, you won’t even recognize the New Mexico sales tax system,” Peterson said. “You won’t even see it as the same tax, they are so different from each other. And you’re going to make mistakes.”
According to Smith, the SST contract essentially states that if any mistakes occur while using CSP software, the business is not held liable.
In any case, the potential for miscalculations carries implications. Peterson said department of revenue offices have no idea whether a given retailer is collecting the right amount of taxes without an audit. In states that administer local sales taxes, this could mean that cities may not receive the tax revenue they’re entitled to.
“The department of revenue has no choice but to distribute the money the way the retailer said they collected it, notwithstanding how poor a job the retailer may have done collecting it,” Peterson said.
The solution to the auditing challenge is using a CSP-generated transaction list to ensure that every purchase included the right amount of sales tax, according to Peterson. Regardless of whether a state decides to pay for CSP services, rely on the marketplace model or take another path, the reconfigured landscape of sales tax collection raises important questions about how states and local areas can fully benefit from the Wayfair decision.
This article was originally published by Governing, Government Technology's sister publication.