Sales Tax Compliance in a Post-Wayfair World
For decades, sales tax compliance was relatively straightforward: If your business didn’t have a physical presence in a state, you generally didn’t have to collect that state’s sales tax.
The advent of e-commerce blurred a lot of lines, however, and that included taxation. This came to a head in 2018 with the Supreme Court’s decision in South Dakota v. Wayfair, Inc. The ruling fundamentally reshaped how states enforce sales tax laws, and how businesses must think about compliance. Today, even small and midsize companies with no offices, employees or property outside their home state may have multi-state sales tax obligations.
If you sell products, or even certain services, across state lines, understanding economic nexus and avoiding common compliance pitfalls is essential to protecting your bottom line.
What Happened in South Dakota v. Wayfair?
South Dakota v. Wayfair, Inc. effectively overturned a 1992 Supreme Court ruling in Quill v. North Dakota that a state could only require a retailer to collect sales and/or use taxes if that retailer had a certain level of physical connection with a state.
E-commerce began to swell in the years following Quill, and states understood they were losing increasingly more tax revenue to online interstate commerce. Several states tried to create laws to combat Quill; South Dakota’s law required “remote sellers” to collect sales taxes on goods and services delivered into South Dakota, then remit them to the state. Online furniture retailer Wayfair challenged this the law in a case that eventually reached the Supreme Court, which upheld South Dakota’s law, opening the gates for other states to establish and enforce their own rules governing online retailers and sales taxes.
Broadly, the court held that states can require out-of-state sellers to collect sales tax based on “economic nexus,” meaning a sufficient level of economic activity in the state, even without physical presence.
Following the decision, nearly every state with a sales tax enacted economic nexus laws. While each state’s thresholds vary, many adopted standards similar to South Dakota’s:
- $100,000 in annual sales into the state, or
- 200 separate transactions into the state
Once a business exceeds a state’s threshold, it is generally required to register, collect, file and remit sales tax there.
Importantly, states are increasingly moving away from number of transactions as a threshold and instead leaning on dollar amount of annual sales.
What Is Economic Nexus?
Economic nexus refers to the connection between a business and a state based solely on the volume or value of sales into that state.
You don’t need an office, a warehouse, employees or inventory. You simply need enough sales activity.
Importantly, nexus is evaluated state by state. A company might have economic nexus in five states but not in the other 45.
This is particularly relevant for:
- E-commerce businesses
- Remote service providers
- Software-as-a-services (SaaS) and digital product companies
- Wholesalers and manufacturers selling direct to customers
- Businesses that expanded online during the pandemic
If your business model changed over the last several years, including adding online sales, subscription models, or remote fulfillment, your sales tax footprint may have changed, too.
Common Sales Tax Compliance Issues
Navigating multistate tax compliance is, as you’d imagine, a little complex. Here are some of the most common mistakes small and midsize businesses make:
1. Not Monitoring Thresholds in Real Time
Many businesses don’t actively track state-by-state sales totals. By the time they realize they’ve crossed a threshold, they might already have uncollected tax liability.
Because economic nexus is often triggered midyear, proactive monitoring is essential.
2. Assuming Marketplace Facilitators Cover Everything
Major platforms such as Amazon, Etsy and Shopify often collect and remit sales tax on behalf of sellers under “marketplace facilitator” laws. However:
- Not all sales channels qualify.
- Direct website sales may still create obligations.
- Some states still require registration even if tax is collected by the marketplace.
Relying blindly on marketplace collection can leave gaps.
3. Misclassifying Products or Services
Sales taxability varies widely by state. For example:
- SaaS may be taxable in one state and exempt in another.
- Further complicating matters, some cities might tax SaaS even if the state does not.
- Professional services may be taxable depending on how they’re structured.
- Digital goods have inconsistent treatment nationwide.
Incorrect product tax codes can lead to under- or over-collection.
4. Failing to Register Promptly
Once you exceed a state’s threshold, you generally must register for sales/use tax permits and begin collecting taxes. Collecting without registration, or failing to collect when required, can create compliance issues.
5. Ignoring Use Tax Obligations
Businesses also have use tax responsibilities on out-of-state purchases when vendors do not charge sales tax. In multistate environments, use tax compliance is often overlooked.
How to More Effectively Manage Multistate Sales Tax
Sales tax compliance can feel overwhelming, but it becomes manageable with a structured approach:
- Conduct a nexus study. Start with a comprehensive review of gross sales by state, number of transactions by state, inventory locations, employees or contractors by state and affiliate relationships.This establishes where you currently have exposure.
- Implement ongoing monitoring. Set up systems to track thresholds monthly or quarterly. Many accounting platforms and tax software tools can automate reporting and alerts. Monitoring should be part of your regular financial review, not something you check once a year.
- Automate where appropriate. Sales tax automation tools can, among other things, calculate correct rates by jurisdiction, apply proper taxability rules, generate state-specific reports, and assist with filing and remittance. Automation doesn’t completely eliminate responsibility, but it can significantly reduce human error.
- Document taxability decisions. If you determine a product or service is exempt in a state, document the reasoning and supporting statutes. This could be extremely valuable in the event of an audit.
- Proactively address historical exposure. If you discover past noncompliance, voluntary disclosure agreements (VDAs) may limit penalties and lookback periods. Conversely, ignoring the issue can increase risk over time.
The Cost of Getting It Wrong
Sales tax is considered a “trust-fund tax,” though that doesn’t quite mean what the name might suggest. A trust-fund tax is any tax collected and held on behalf of another government entity. Until that tax is remitted to the entity, it’s said to be held “in trust.”
If a sales tax isn’t properly remitted, states can access back taxes, penalties and interest. And because the business is liable for payment of the trust, management of (and others responsible for payment who are employed by) limited liability companies may be held personally reliable in some cases.
For growing companies, unresolved sales tax exposure can also derail financing, investment or M&A transactions. Buyers and lenders routinely scrutinize indirect tax compliance during due diligence.
Need Help Navigating Multistate Sales Tax?
Sales tax compliance has grown more complex in the post-Wayfair landscape. Monitoring economic nexus thresholds, managing multistate registrations, and ensuring accurate reporting require careful oversight and planning.
McManamon & Co. is an accounting, tax, fraud, forensic and consulting firm that serves small and midsize businesses. Our experienced tax team can help you evaluate your multistate sales tax exposure, conduct nexus studies, improve compliance processes, and address historical risk, while our outsourced CFO services can help you stay on top of your state tax obligations.
Call McManamon at 440.892.8900 or contact us online today to learn how we can help you manage your sales tax obligations strategically and proactively.
Tags: compliance, McManamon, sales tax, sales taxes, small business taxes, tax compliance, taxes | Posted in McManamon & Co., taxes