Various interpretations of the recent Wayfair decision from the U.S. Supreme Court has led to confusion about its impact for online sellers and consumers. TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation hopes to clear up that confusion with this Q&A.
Were internet purchases exempt from sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. before this decision?
Internet purchases were not exempt from tax, but in many cases it looked that way to consumers. Internet sellers typically only had to collect a state’s sales tax from buyers if the company had property or employees in a state. As of 2018, state sales taxes are collected on about half of e-commerce.
It is worth noting that consumers technically owe use tax to their resident state on purchases where they did not pay sales tax. Sales taxes, which exist in 41 states, apply to most purchases of retail goods within the state. The seller has the responsibility to collect the tax and forward the money to the state. Each state with a sales tax also has a use tax at an identical rate, to be paid by the buyer in cases where a seller doesn’t collect the tax.
I thought states were prohibited by law from taxing the internet?
Yes, Congress has prohibited states from taxing internet access in a law known as the Internet Tax Freedom Act (ITFA). That law is not changed by this decision and isn’t directly related to whether states can tax e-commerce. ITFA only applies to what you pay to connect to the internet. So long as states pass e-commerce laws that apply equally to other forms of commerce, they would not conflict with ITFA.
When will we start to notice the effects of this decision?
Some states will move quickly to enact laws resembling South Dakota’s to collect sales tax on internet purchases. Other states would need to make significant changes to their sales tax system to be able to collect, particularly large states that have resisted joining other states in adopting more uniform, simplified sales tax laws. Some states, such as New Hampshire, will likely never pass a sales tax.
Another question will be whether Congress acts. Congress has pending bills (Remote Transactions Parity Act, or RTPA, and Marketplace Fairness Act, or MFA) that would specify what simplifications a state must make to be able to require online sellers to collect taxes. Such a law would be compatible with the Court’s ruling, providing more protections for sellers and consumers. But some have opposed the passage of those bills, claiming it would tax the internet.
What was wrong with only giving states tax authority over businesses with a physical presence? What is the “Wayfair test” now?
The property or employees rule, or physical presence rule, dates to 1967’s Bellas Hess case, where the Supreme Court held that Illinois could not require an out-of-state catalog company to collect sales tax. The idea was that sales tax is so complex to collect that forcing out-of-state sellers to do so put impermissible burdens on interstate commerce. That ruling was reaffirmed by the Court in 1992’s Quill case, with some misgivings over whether it was the correct rule.
Between 1992 and 2018, several factors undermined the physical presence rule. E-commerce emerged and grew sharply, resulting in some online sellers not collecting sales tax despite widespread directed sales and activity in a state. Technological advances reduced the cost of collecting sales taxes, including platforms created by some of the e-commerce websites. Finally, the physical presence rule proved to be an ineffective restraint on state tax power. Even before the Wayfair ruling, 31 states required tax collection in minimal cases of physical presence in a state, such as with airport stopovers by employees, contracts with in-state advertisers or placing website cookies on computers within the state. It is noteworthy that none of the nine justices in Wayfair, nor either of the parties in the case, asserted that the physical presence rule is the correct rule.
The new question for judges evaluating a state tax, instead of asking whether a seller’s presence in the state is sufficiently physical, is asking whether the state tax discriminates against interstate commerce. If complying with a state’s tax system is sufficiently burdensome on an interstate seller, it is unconstitutional, regardless of the level of the seller’s physical presence in the state.
Will this decision hurt e-commerce? Will my online purchases be more expensive now? Should I alter my shopping behavior? How does this decision impact small businesses versus big retailers?
E-commerce will now have to collect the same sales tax collected by all other retailers. As e-commerce’s strengths over brick-and-mortar are more about convenience, wider selection, and lower costs, it’s unlikely this decision will hurt large e-commerce firms. As sales tax collection on e-commerce grew from almost zero to half of all sales, e-commerce has continued to grow sharply.
A valid concern, however, is the ability of small e-commerce sellers to collect sales taxes in a simple way. The Court praised South Dakota’s provision of compliance software and simplified state rules. For instance, South Dakota gives immunity from auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. to sellers who encounter errors made by sales tax software programs. It is likely that large e-commerce platforms will provide sales tax compliance services for their sellers. Congress could also pass RTPA, which provides additional protections such as limiting interstate audits, requiring states to pay for integrating sales tax collection software within sellers’ systems, and setting a sales threshold exempting smaller businesses from having to comply with too many rules.
Does this decision give states carte blanche to raise taxes?
No. The Court carefully evaluated South Dakota’s law, noting six features showing it was “designed to prevent discrimination against or undue burdens upon interstate commerce.” These six features are (1) a safe harbor excluding those who sell only limited amounts in South Dakota; (2) no retroactive tax collection; (3) single, state-level administration of sales taxes; (4) a simplified tax rate structure; (5) uniform definitions and other rules; and (6) access to software provided by the state, with immunity for those who rely on it. A state that attempts to collect sales taxes on e-commerce without these provisions will almost certainly face a legal challenge, with challengers of such laws able to point to the rationale in the Wayfair ruling as guidance of what’s permissible.
How will this affect my state? What’s next for states? For Congress? For the courts?
Within 48 hours of the decision, legislators from nearly every state contacted the Tax Foundation to ask what changes they should make to their sales tax to be able to collect tax on internet purchases. Some states may adopt laws that emulate South Dakota’s in every respect. Other states may adopt laws that adopt only some of the features, and that would likely be subject to further litigation. Some states may not act until their next regular legislative session, while others may never act.
Congress may act to establish a minimum standard for states that wish to collect sales tax on interstate sales. A federal standard would create certainty for sellers and consumers and ensure that every state meets certain simplification guidelines. Until then, we’ll likely see more states seek the same authority as South Dakota, with some encountering legal challenges.
Is my state going to receive a ton of revenue?
The Government Accountability Office (GAO) estimates uncollected e-commerce revenue nationwide to be about $8 billion to $13 billion. In no state would this be more than a small percent of current overall tax collections. The revenue would likely grow faster than most other revenue sources, however, due to the strong growth of the e-commerce sector.
What will the landscape look like in one to two years because of this decision, versus 10 years from now?
If states simplify their tax systems as set out by Wayfair, there will likely be only small changes in the e-commerce landscape. Sellers may need to monitor their new compliance requirements and seek a new software solution, but these costs can be minimized if states provide the necessary simplifications and protections. However, if some states ignore the features of the South Dakota law in crafting their own laws, and put crushing burdens on interstate sellers, there will be more litigation and a higher potential for action by Congress.
The Tax Foundation will be working with states to include seller protections in their laws and will help challenge laws that ignore the Wayfair rules, and educating policymakers on the value of congressional action to codify seller protections in federal law.