Economic Nexus Changes & Their Impact on Sales Tax

Portable restroom operators love to get the job done — serve customers, pay employees well, and earn a comfortable living. To accomplish that feat, a tidy portion goes to the government. Sales tax helps educate new generations of leaders and team members and funds police and public employees.

But what happens if you’re asked to pay sales tax on orders from years ago? It can occur, especially if your business is in Wisconsin, for example, and you purchased equipment from an out-of-state manufacturer or distributor. Previously, non-resident companies couldn’t collect sales tax, but a Supreme Court decision changed that.

The South Dakota v. Wayfair ruling impacted retailers, manufacturers, and distributors, including those in the portable sanitation industry like PolyJohn. As a result, many companies conducted in-depth audits to ensure economic nexus compliance across states and jurisdictions. This in-depth article discusses this historic case, the impact on sales tax, and what it means for PROs.

Key Facts: Sales Tax & Economic Nexus Changes

• Legal framework: The U.S. Constitution’s Due Process and Commerce clauses affect sales tax nexus determination.
• Supreme Court decision: South Dakota v. Wayfair established acceptable definitions of economic nexus, expanding sales tax obligations to companies without a physical presence in the state.
• State guidelines: Each state has different registration processes and revenue thresholds. Consequently, some customers may receive bills for unpaid sales tax from previous years.
• Seller obligations: As with all business taxes, sellers must remit tax liabilities and fees to comply with state rules or face interest charges and penalties.

Wrangling the Cross-Border Economies

Early online shoppers may remember the tax-free days. Any store that didn’t have a physical shop in your state couldn’t charge sales tax. Depending on your local and state rates, you could save anywhere from 3% to 10%.

Meanwhile, brick-and-mortar stores met the physical nexus standard, meaning they had to collect and remit sales taxes. Their customers could order similar goods from a non-resident competitor without paying taxes. Of course, local folks transport those products over regional roads, and when thieves steal delivered packages, the local authorities handle it.

Out-of-state distributors and manufacturers couldn’t charge sales tax, either. They were subject to the same restrictions as e-commerce retailers.

For a while, authorities pushed for consumers to self-report their online purchases. After all, the use tax has been around for decades to level the playing field, even before mail-order businesses became popular. However, tracking out-of-state and online purchases for tax time wasn’t a priority for most Americans.

Between 1992 and 2018, the technology-driven economy flourished, blurring state and international borders. Indeed, experts estimate sales tax losses of over $20 billion annually in the years before the South Dakota v. Wayfair decision. Before digging into the court case, let’s look at the fundamental terms.

What Is Sales Tax Nexus?

The definition of “nexus” is a connection between two or more things. For businesses, nexus is a tax-related concept that considers various factors to determine if a company should collect and remit sales tax in a state. An agency can’t levy sales taxes until establishing this association.

State taxation isn’t a new concept; it comes from the U.S. Constitution, specifically the Due Process and Commerce clauses. The Due Process clause requires a sufficient relationship between the state and business, one that is based on explicit or meaningful connections, not arbitrary or random ones. For instance, a U.S. state can’t decide to tax companies simply because its residents access out-of-state websites.

The Commerce Clause requires companies to have a physical presence or substantial economic activity in the state. Before the South Dakota v. Wayfair decision, this clause referred to physical connections, such as owning a business or storing inventory in the state. Since 2018, it also covers economic activities of a certain threshold established by the state.

Physical vs. Economic Nexus

Opportunities abound in modern businesses. PROs can add revenue streams to stay busy during winter or expand into new territory. They can sell branded hats and shirts or earn passive income by partnering with their favorite suppliers.

Modern business models add complexity to tax laws. Government agencies clarify nexus categories to ensure fair tax collection and account for diverse business models and rapidly changing technologies.

Physical Nexus

This concept is the most straightforward. If a company has any physical presence in the state, they have sales tax obligations. However, state guidelines differ. Some count temporary accommodations and road usage of company-owned delivery vehicles as physical nexus.

Physical nexus rules apply to companies that:

• Own or rent brick-and-mortar offices, stores, or warehouses
• Have employees working in the state, even if they work at home
• Own or lease real estate or equipment in the state

Economic Nexus

A business meets economic nexus when its monetary activities reach the state’s threshold for transaction volume or sales revenue. These guidelines vary by state and are further broken into categories for affiliate and marketplace sellers.

Since the 2018 Wayfair decision, most states require companies to collect sales tax once they exceed $100,000 in sales revenue. Some states still mandate organizations to manage sales tax if they’re under the revenue amount but exceed 200 transactions with state customers.

South Dakota v. Wayfair, Inc.

To understand why South Dakota brought the lawsuit against Wayfair and how it ultimately impacted how businesses across the nation charge sales tax, we must explore what led up to the filing of the suit.

Establishing Physical Nexus Precedent

In 1967, the U.S. Supreme Court upheld a lower court ruling on National Bellas Hess, Inc. v. Department of Revenue of Illinois. It stated that states couldn’t require out-of-state sellers to collect sales tax if they didn’t meet physical nexus requirements. Doing so would burden interstate commerce, thereby violating the Commerce Clause of the U.S. Constitution.

With National Bellas Hess as precedent, the Supreme Court reaffirmed the physical nexus requirement in 1992 with its Quill Corp. v. North Dakota decision. In this case, the court ruled that the office supply company couldn’t be forced to pay sales tax since it didn’t have a physical presence in North Dakota.

Rise of the Dot.com Era

Shortly after that, the internet and computers started popping up in homes. Those dial-up days were far from today’s mega speeds. Amazon came online as a bookseller in 1995, followed by Zappos selling shoes. During the 2000s, the internet came alive, with Amazon expanding into product sales. By 2009, Wayfair was a major e-retailer of home furnishings.

These companies sold millions of dollars of products to consumers across all 50 states. Some, including Amazon and Wayfair, even marketed its tax-free status. By highlighting the tax savings price-conscious shoppers could achieve, these online retailers were able to grow rapidly.

Communities Feel the Impact

While e-commerce startups raised millions in venture capital funding to expand further and raked in billions in sales, local economies struggled. Small businesses already have a disadvantage against big box stores, but adding the no sales tax and free shipping leaves them with impossible choices.

In return, local sales tax revenue plummeted. Funds to support workforce development, maintain and improve roads, invest in education, and provide for essential emergency services fell short.

As the recession hit in 2008 and 2009, many families had to make hard decisions. Small businesses closed. More people turned to money-saving options like no sales tax and free shipping for essential household items. This further exacerbated the already troubling state and local tax revenue situation.

Governments Look for Solutions

The strength of Quill’s legal precedent, complexity, and evolving legislative bodies created many challenges. The House and Senate held hearings discussing internet and sales taxes. They spoke with state officials, small business owners, and industry representatives.

Three separate legislative proposals were introduced, with one, the Marketplace Fairness Act, making the most headway. It was presented in 2013, had broad bipartisan support, and gave states tax revenue authority. However, despite multiple attempts, the bill didn’t pass before the 2018 Wayfair decision.

South Dakota Makes Its Move

After unsuccessful proposals, studies, discussions, and hearings, South Dakota Senator Dave Omdahl introduced Senate Bill 106, An Act to Require Certain Remote Sellers to Collect and Remit Sales Tax. On March 1, 2016, the South Dakota Senate passed it with a 31-4 vote. It then moved to the South Dakota House of Representatives, where it was passed on March 11, 2016, with a 60-10 vote. Governor Dennis Daugaard signed it into law on March 22, 2016.

Officially, any business that met the threshold by making 200 transactions or $100,000 in sales in South Dakota had to collect and pay sales tax. As expected, major retailers didn’t comply, citing the Quill precedent. Their non-compliance gave South Dakota a reason to sue them.

The Slow Grind of Justice

The American multi-tiered court system isn’t a binge-watching TV fan’s dream. You can’t find out the ending in a week. The U.S. Constitution shaped the court system’s framework, ensuring checks and balances and separation of powers.

Article III clarifies the Supreme Court as the highest authority but gives Congress the power to create lower federal courts and states the authority to handle state laws through their court systems. These levels provide ample opportunities for review and are meant to prevent one court from becoming too powerful or overreaching while safeguarding individual rights.

And this also means that justice moves slower than in countries where these safeguards are not in place. Attorney General Marty Jackley and the state of South Dakota understood the legal complexities involved and knew they had to follow each step to reach the Supreme Court. He took the case to the courts on May 2, 2016.

Here’s an overview of the steps South Dakota took:

• Trial Court: On May 2, 2016, South Dakota filed the suit against Wayfair, Newegg, and Overstock in the U.S. District Court for the Western District of South Dakota. The court dismissed the case on February 22, 2017, citing Quill.
• Intermediate Appellate Court: On March 13, 2017, South Dakota appealed to the U.S. Court of Appeals for the Eighth Circuit in St. Louis, Missouri. The court reaffirmed the district court’s decision on November 21, 2017.
• Supreme Court: On December 12, 2017, South Dakota petitioned the U.S. Supreme Court to review the lower court’s decision. The court overturned the Quill ruling on June 21, 2018.

When South Dakota brought the case to the Supreme Court, they introduced detailed information about Wayfair’s sales. In 2017, Wayfair generated about $4.7 billion in net revenue from its e-commerce platform. Of this, online sales in South Dakota accounted for roughly $10 million. Its sales tax rate was 4.5%, meaning that in 2017 alone, Wayfair should have collected and remitted about $450,000 to South Dakota.

Wayfair (Defendant) Arguments

Wayfair argued that determining tax policy wasn’t the court’s duty. The defendants claimed that requiring online businesses to collect sales tax was unconstitutional and an administrative burden, infringed on state sovereignty, harmed small and mid-sized companies, and could create an unfair playing field.

South Dakota (Plaintiff) Arguments

South Dakota refuted these concerns by pointing out its legislative action and fair sales threshold ($100,000 in sales or 200 transactions), which the defendants refused to comply with. The attorneys discussed how small businesses were negatively affected, specifically that remote sellers not paying tax competitively disadvantaged small companies. The attorneys also gave examples of previous cases where the Supreme Court ruled to modernize federal tax policies based on state lawsuits.

The Supreme Court Ruling

The Supreme Court heard oral arguments from both sides on April 17, 2018 (about one hour total), and the court decided the case on June 21, 2018. The 5-4 ruling in favor of South Dakota overturned the precedents set by Quill and National Bellas Hess.

Justice Anthony Kennedy delivered the opinion of the Court. He explained how the framers of the Constitution designed the Commerce Clause “to prevent States from engaging in economic discrimination so they would not divide into isolated, separable units.” Kennedy also noted that in 1992, when Quill was decided, “less than 2% of Americans had internet access,” whereas today it’s “about 89%.” Consequently, “The internet’s prevalence and power have changed the dynamics of the national economy.”

Kennedy refers to Wayfair’s marketing while discussing the solvency of state and local governments. He points out that Wayfair shows images of beautiful homes in peaceful neighborhoods while encouraging tax evasion, using Wayfair’s wording: “One of the best things about buying through Wayfair is that we do not have to charge sales tax.”

Then, Kennedy adds:

• “State taxes fund the police and fire departments that protect the homes containing their customers’ furniture and ensure goods are safely delivered; maintain the public roads and municipal services that allow communication with and access to customers; support the “sound local banking institutions to support credit transactions [and] courts to ensure collection of the purchase price.”

Chief Justice John Roberts and Justices Stephen G. Breyer, Sonia Sotomayor, and Elena Kagan wrote dissents discussing concerns about overruling legal precedents, the impact on small businesses, and potential administrative burdens.

Post-Wayfair: Immediate State Action

State legislative bodies prepared policy changes before the final decision, enabling them to act swiftly after the ruling. In 2018, 23 states updated or passed legislation, including Wisconsin, Tennessee, Indiana, and Illinois. Some went into effect immediately, whereas others began in 2019. Since then, nearly all states that charge sales tax have enacted economic nexus policies.

As for Wayfair, Newegg, and Overstock, South Dakota pursued legal action to collect back taxes owed from the initial filing date. The three companies negotiated separately with South Dakota to reach settlement agreements.

Impacts on Manufacturers and Distributors

While the interstate laws are geared toward online retailers, manufacturers and distributors were also impacted. Equipment dealers often maintain a few locations and ship their products nationally. Whereas online retailers had e-commerce software to track the thousands of tax laws between jurisdictions so shoppers could place online orders swiftly, many large equipment sales occur over the phone or face-to-face.

Consequently, companies like PolyJohn needed to review their sales and tax practices to ensure they aligned with new state rules and evolving tax policies. Many negotiated with states to receive a grace period while they assessed their technologies and evaluated sales to determine which states to register with.

Embracing Change with Transparency

PolyJohn was able to arrange an extension with the Wisconsin Department of Revenue. This delay ensured that clients were not unduly impacted and received accurate, detailed transaction histories. It also provided PolyJohn with time to implement the essential systems effectively.

The company recently communicated with customers to help them understand how the tax policy affects their previous purchases and affirm PolyJohn’s commitment to minimizing disruption in the future. While all businesses must maintain compliance, they empathize with customers’ frustrations over complex tax law changes and increasing prices. Companies like PolyJohn want to listen to you and work with you on solutions.

States like Arizona, Massachusetts, New Jersey, and Ohio are among those where companies may start receiving tax bills as a result of becoming compliant. The rest of the states are sure to follow before long.

Commitment to Customer Service

Tax burdens and economic uncertainty are challenges that all portable restroom operators face. Yet, all-sized businesses can achieve goals and access opportunities by fostering relationships with suppliers and customers, developing processes, maintaining healthy profit margins, and getting involved in their communities.

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