IMPORTANT UPDATE: Since the the original publication of this post (on Dec 16, 2016), the South Dakota law, discussed in detail below, was challenged as unconstitutional. On June 21, 2018, the U.S. Supreme Court held in favor of the state in South Dakota v. Wayfair and overturned the physical presence standard - opening the door for other states to adopt economic nexus rules. The number of states that adopted economic nexus prior to and since the Wayfair decision, has grown exponentially. The post below provides an good overview of economic nexus and the genesis of this trend. For an comprehensive update on which states have adopted economic nexus, see our August 10, 2018 post, "States Follow South Dakota: A By-State Guide on Economic Nexus."
Original Post: There’s a new trend in the world of sales tax nexus; one of states adopting nexus provisions that openly defy the Quill physical presence standard in an effort to require out-of-state internet retailers to collect their state’s sales or use tax. These new “economic nexus” provisions signal that states are tired of waiting for Congress to act, are more than ever willing to take matters into their own hands, and ready to force litigation that could overturn Quill.
But what is economic nexus and why is it such a big deal?
Economic nexus is based on the premise that even if an out-of-state seller has no physical presence in a state, if the out-of-state seller is reaping substantial economic benefits – such as a significant amount of revenue – from sales to in-state customers, then the out-of-state seller is establishing a sufficient enough connection to the taxing state to be subject to the state’s sales and use tax laws. It’s a very big deal because 25 years ago, the U.S. Supreme Court affirmed in Quill vs. North Dakota, that a state could not impose its tax collection requirements on an out-of-state seller unless the seller had a substantial physical presence in the state. And although many states have enacted nexus expanding laws (e.g., Amazon laws), those laws still focus on meeting Quill's physical presence requirement. So something as seemingly minor as engaging unrelated marketing affiliates in the taxing state who passively post web-links on their in-state website that refer visitors to an out-of-state retailer's online store are deemed to be an in-state physical presence of the online retailer.
Alabama Adopts Economic Nexus Regulation
You might say we owe it all to Alabama for kicking off this economic nexus trend, when in October of 2015, Alabama adopted a sales tax regulation imposing its sales and use tax registration, collection and remittance obligations on out-of-state sellers with a substantial economic nexus presence in Alabama.
The Alabama Regulation (Reg. 810-6-2-.90.03), which became effective on January 1, 2016, requires out-of-state sellers who lack an Alabama physical presence but make retail sales of tangible personal property into the state and have a substantial economic presence in Alabama for sales and use tax purposes, to register for a license with the Alabama Department of Revenue and to collect and remit tax. An out-of-state seller is presumed to have a substantial economic nexus with Alabama
- if the seller’s retail sales of tangible personal property sold into the state exceed $250,000 per year based on the previous calendar year’s sales; and,
- the seller conducts one of more of the activities described in Alabama § 40-23-68.
A few of the key activities listed in Alabama § 40-23-68 include maintaining, occupying or using any type of facility on permanent or temporary basis, directly or indirectly, or through a subsidiary or agent; employing or engaging a representative, agent, salesman, canvasser, solicitor or installer to sell, deliver, or take orders for the sale of tangible personal property or taxable services; engaging in substantial and recurring solicitation of orders for tangible personal property if the retailer benefits from banking, financing, debt collection, telecommunication or marketing activities occurring in Alabama or from authorized installation, servicing or repair facilities located in Alabama; soliciting orders for tangible personal property through advertising sent out primarily to Alabama customers or transmitted or distributed over Alabama cable television or through a telecommunication or TV shopping system intended for broadcast to Alabama customers; or distributing catalogs or other advertising matter resulting in orders from Alabama residents.
South Dakota’s Enacts Economic Nexus Law
It didn’t take long for another state to jump on the economic nexus train. On March 22, 2016, South Dakota Governor Daugaard signed economic nexus legislation. S.B. 106, into law. South Dakota’s economic nexus law requires remote sellers that sell tangible personal property, products delivered electronically, or services for delivery into South Dakota, and that meet either one of the following two economic thresholds in either the previous or current calendar year, to collect and remit South Dakota sales tax as if they had a physical presence in the state:
- the seller’s gross revenue from the sale of tangible personal property, any product transferred electronically, or services delivered into South Dakota exceeds $100,000; or,
- the seller sold tangible personal property, any product transferred electronically, or services for delivery into South Dakota in 200 or more separate transactions.
But here are some interesting tidbits about South Dakota’s economic nexus law. Written right into the economic nexus bill was extensive language justifying why South Dakota's legislature was compelled to enact an economic nexus law. These reasons included that the state’s inability to effectively collect sales or use tax from out-of-state sellers has seriously eroded the state’s sales tax base, lead to significant revenue shortages and harm to the state due to critical funding shortages for government services. Also since South Dakota, a state with no income tax, relies heavily on sales and use tax revenues to fund government services the loss of sales tax revenue is particularly significant. The legislation also cited that an economic nexus law was justified since remote sellers who make a substantial number of deliveries into or have large South Dakota gross revenues benefit extensively from the state’s market as well as its infrastructure, yet many remote sellers actively market sales as “tax-free or no sales tax transactions.”
Also key in the South Dakota legislation was its explicit intention to bring about a Quill challenge. On this point the legislation includes expedited judicial procedures so that a legal challenge can be expeditiously reviewed, including language that would allow any appeal to go directly to the state’s Supreme Court.
Even though South Dakota’s economic nexus law had an effective date of May 1, 2016 – the law is yet to take effect. You see, the law also provides that the filing of a declaratory judgment action by the state would operate as an injunction while the case is pending and thus prohibit the state or any local taxing jurisdiction, from enforcing the sales tax remittance obligations against any non-compliant taxpayer. Just days before the May 1st effective date, the South Dakota Department of Revenue filed a suit against four large remote retailers (more on this in a bit) which triggered an injunction against the enforcement of the economic nexus law.
Tennessee Adopts Economic Nexus Regulation
Not to be left behind, on October 3rd, the Tennessee Department of Revenue adopted a final economic nexus regulation, adding one state willing to boldly defy Quill into the mix. Tennessee’s economic nexus Regulation, Rule 1320-06-01-.129, also referred to as Rule 129, states that an out-of-state dealer (Tennessee’s term for a retailer) is deemed to have substantial nexus with Tennessee if the dealer;
- engages in the regular or systematic solicitation of Tennessee consumers through any means; and
- makes sales exceeding $500,000 to Tennessee consumers during the previous 12-month period.
Tennessee’s economic nexus regulation is scheduled to go into effect on effective January 1, 2017 and requires out-of-state dealers that meet this economic threshold to register with the Tennessee Department of Revenue (TN DOR) for sales and use tax purposes by March 1, 2017, and to begin collecting and remitting tax to the Department by July 1, 2017. However, despite the January 1st effective date, the regulation will expire if it not approved by the Tennessee legislation by July 1, 2017.
Will Economic Nexus for Sales Tax be the Demise of Quill?
I mentioned above, that even prior to the May 1, 2016 effective date of its economic nexus law, South Dakota filed a suit against four large online retailers. These retailers, Newegg Inc., Overstock.com Inc., Systemax Inc., and Wayfair LLC, had been notified by the Department of their requirement to register by April 25th – but failed to comply, which triggered South Dakota’s suit against them. Two industry organizations, the American Catalog Mailers Association's Board, and NetChoice, also filed a suit challenging the constitutionality of South Dakota’s economic nexus law. Legal action has also developed in Alabama. In an effort to enforce its economic nexus regulation (and also spark a legal challenge), the Alabama Department of Revenue issued an assessment against Newegg Inc. for Alabama sellers use tax, plus penalties and interest for the months of January and February of 2016. On June 8, 2016, Newegg appealed the assessment to the Alabama Tax Tribunal, arguing that since Newegg does not have a physical presence in Alabama, the Department’s assessment was not valid and that Alabama’s economic nexus regulation is not only unconstitutional, but in conflict with Alabama’s sales and use tax statute.
While states normally don't want their tax laws challenged as being unconstitutional, a legal challenge with the hopes that Quill will be overturned is exactly what Alabama and South Dakota want. incidentally, Alabama's Commissioner of Revenue, Julie Magee, has not been shy about voicing her wish that Quill will be overturned and her hope that Alabama's economic nexus regulation will pave the way. As Commissioner Magee stated in her June 15th press release "ADOR believes that the actions it has taken to require remote sellers to collect and remit Alabama tax will provide a proper case to the U.S. Supreme Court to consider the significant changes in the retail economy and in technology and to grant relief to the states from Quill's harsh effects."
In July of 2011, I authored my first blog post for SalesTaxSupport.com. In that post, “Amazon Laws: The New Normal? Internet Sales Tax Law Update,” I explained what in 2011, was a growing trend - states enacting so called Amazon Laws, what these nexus expanding laws hoped to achieve, the various types of Amazon Laws and why more and more states were embracing them. I also wrote, “As I closely follow developments in the internet sales tax area, I’ve often found myself …. wondering whether ‘Amazon Laws’ are the ‘new normal’ - the expected approach to be taken by states that seek to tax internet sales.” Amazon Laws did indeed become the “new normal” as one state after another enacted nexus expanding legislation that redefines a physical presence in order to meet the Quill requirement.
Will economic nexus become the “new normal” for determining whether an out-of-state seller has nexus for sales tax purposes? States have already adopted an economic nexus standard for sales tax either through regulation or law. A delayed economic nexus law has also been enacted in Vermont and is being considered in Rhode Island. (See August 15, 2017 update below for additional states that have enacted economic nexus legislation in 2017)
Despite the fact that applying an economic nexus standard for sales tax nexus clearly violates Quill, the trend will likely continue - especially since it’s almost certain that federal remote seller legislation will not be enacted this year. Which means it will be back to square one when the next U.S. Congress convenes in January of 2017.
Yep, I predict, economic nexus will be the “new normal” -- and quite possibly the demise of Quill.
August 15, 2017 UPDATE: As predicted, 2017 has seen a flurry of sales tax economic nexus activity - with at least 15 states proposing economic nexus bills and several being enacted. As of August 15th, five more states have enacted economic nexus legislation modeled off of South Dakota's law. Those states include:
- Indiana (HB 1129, enacted 4/28/2017), Indiana sales > $100,000 or 200+ Indiana transactions.
- Maine (LD 1405, enacted 7/21/2017), Maine sales > $100,000 or 200+ Maine transactions.
- North Dakota (SB 2298, enacted 4/10/2017), North Dakota sales > $100,000 or 200+ North Dakota transactions.
- Rhode Island (HB 5175, enacted 8/30/2017), Rhode Island sales > $100,000 or 200+ Rhode Island transactions.
- Wyoming (HB 119, enacted 3/6/2017), Wyoming sales > $100,000 or 200+ Wyoming transactions.
Also, on April 3, 2017, Massachusetts also adopted an economomic nexus bright-line rule through administrative guidance (see my 4/10/2017 blog post, "Massachusetts Expands Sales Tax Nexus Policy for Internet Vendors" in the Massachusetts Tax blog section). The Massachusetts administration guidance was revoked and replaced with a Proposed Regulation. Massachusetts sales > $100,000 and 100+ Massachusetts transactions.
August 10, 2018 UPDATE: As noted at the beginning of this post, On June 21, 2018, the U.S. Supreme Court held in favor of the state in South Dakota v. Wayfair and overturned the physical presence standard - opening the door for other states to adopt economic nexus rules. For an comprehensive update on which states have adopted economic nexus, see our August 10, 2018 post, "States Follow South Dakota: A By-State Guide on Economic Nexus."
Interested in a by-state summary of Amazon and/or Economic Nexus type legislation? See my 5/23/2017 by-state update of which states have adopted Amazon type legislation (click-through, related party/affiliate nexus), notification & reporting – and/or economic nexus.
Other recent “Internet Tax / E-Commerce” posts by Sylvia F. Dion, CPA:
- States Follow South Dakota: A By-State Guide on Economic Nexus
- With Wayfair Decided, Is a Federal Solution Still Needed?
- Amazon and Other "Nexus Expanding" Laws - By State Summary
- Economic Nexus: The “New Normal” or the Demise of Quill?
- Remote Transactions Parity Act: Comparing RTPA to MFA