Tax Compliance Headaches as Localities Wade into Wayfair

September 2019

By Eric Fader

This article was originally published by Law360 on September 9, 2019.

Remote sellers nationwide are wrestling with sales and use tax compliance obligations in light of the U.S. Supreme Court’s South Dakota v. Wayfair Inc. decision. While the potential for remote sellers to be exposed now to state-level sales and use taxes has received a fair amount of coverage, where the dilemma really takes hold is whether to register for locally administered sales and use taxes.

The Wayfair decision, which lifted the in-state physical presence requirement for states’ power to impose sales and use taxes, is now 14-months old. Nearly all states that impose general sales and use taxes have revised their laws to impose a use tax collection responsibility on remote sellers. South Dakota’s sales and use tax laws are styled to “reduce administrative and compliance costs,” so said the U.S. Supreme Court; however, that’s not true with every state.

Some local taxes are administered not by the state but instead by local municipalities and counties with their own local ordinances, separate tax forms, and audits that may be conducted by third-party contingency-fee firms. States that have locally administered general sales and use taxes include Alabama, Alaska, Colorado and Louisiana. In addition, the city of Chicago administers a use tax, as well as a personal property lease transaction tax (lease tax) that applies to software-as-a-service.[1]

These locally administered sales and use tax and lease tax rates can exceed some state sales tax rates. Alaska has no state-level sales tax, but the top local sales tax rate is 7.85%, and top local use tax rate is 6%. In Colorado, the state sales and use tax rate is 2.9%, but Winter Park is a home rule city with a locally administered sales tax rate of 7%. Chicago’s lease tax rate is 9% but is only 5.25% for certain SaaS transactions.

The sheer number of taxing jurisdictions in Alaska, Alabama, Colorado and Louisiana that impose locally administered sales and use taxes is staggering. Louisiana has more than 60 parishes that are taxing authorities.[2] In Alabama, there are 73 towns/cities that self-administer various sales and use taxes, rental taxes or lodging taxes, coupled with 12 counties that are self-administered.[3] Colorado has 70 home rule cities for which the state does not collect local sales taxes.[4]

Here’s some good news: Chicago has not been imposing its lease tax on remote companies.[5] Likewise, various Alaska cities and boroughs have not approved economic nexus. But, this is changing.

Nome, Alaska, just approved an ordinance requiring remote sellers to collect the city’s sales tax effective Sept. 1, 2019.[6] Remote sellers making sales of property, digital products or services delivered to Nome customers may be covered by the ordinance’s safe harbor of $100,000 of gross revenue and 100 transactions with customers in the state (not just Nome). But, the challenge now — one that is aided by automation — is keeping tabs on which locality with locally administered sales and use taxes has adopted economic nexus, including the applicable safe harbor provisions.

To help simplify local tax administration, Alabama allows remote sellers to file use tax returns with the state only at a fixed sales and use tax rate. Alabama’s simplified sellers use tax rate is a flat rate of 8%. But, in some jurisdictions in Alabama, a sale by a brick-and-mortar retailer may be subject to a 5% sales tax. So, some Alabama customers may be charged a higher tax rate when purchasing goods shipped from a remote seller than from their local retailer. The U.S. Supreme Court has held this type of tax rate system impermissibly discriminates against interstate commerce in violation of the commerce clause.[7] To protect from such a challenge, Alabama allows customers to file a refund or credit for such incrementally higher taxes.[8] However, refund claims may be filed only once per year.

It is not just locally administered sales and use taxes that may present constitutional issues. The Illinois General Assembly recently revised its sales and use tax regime to require remote sellers to determine the applicable sales and use tax rate based on destination sourcing (state and local tax rate), rather than administering the state’s use tax rate only.[9] This new sourcing regime for remote retailers is effective July 1, 2020.

However, Illinois’ sourcing rules have not changed for retailers with a physical presence in Illinois. As such, an Illinois customer may pay only 6.25% use tax from a seller located in an Illinois city with no local sales tax, but if the seller is a remote retailer and the customer is in East Dundee, Illinois, the tax rate required to be paid is 11.5%. Unlike Alabama, there is no provision for the customer to seek a refund or credit. The question then is whether the regime will be challenged as unconstitutional as impermissible discrimination on interstate commerce.
 

Benefits of Safe Harbor Provisions Don’t Offset Compliance Hurdles

More than half of the states’ remote seller laws mirror South Dakota’s safe harbor provision — that is, remote sellers escape a use tax collection responsibility if they derive gross revenue of less than $100,000 and have fewer than 200 transactions with customers in the destination state (a growing trend, however, is to drop the transaction count safe harbor, which is good for remote sellers of low-value items).

A recent newsworthy development is the Kansas Department of Revenue’s decision to require all remote sellers to collect and remit use taxes. Kansas now is the only state enforcing an economic nexus standard that does not have a safe harbor provision. Kansas’ position calls into question: How far can states push the envelope before their laws create an undue burden on interstate commerce and violate the commerce clause?

While Kansas’ imposition statute, which reaches the fullest extent permitted under federal law, may not be facially invalid, it certainly could present a colorable “as applied” challenge. The question, though, is will the department issue assessments against such small remote sellers and, if so, will any such seller contest the assessment?

In sum, the Wayfair decision has prompted a wave of state tax legislation and administrative guidance with states enacting economic nexus with varying safe harbor provisions. These state-level safe harbor provisions are in flux as states revise their gross revenue thresholds — some are increasing the threshold (e.g., California, New York and Oklahoma), others are decreasing it over time (Arizona), and various states are either removing the transaction volume safe harbor (California, Iowa, Massachusetts, North Dakota, and Washington) or putting one in place (Ohio).

With all the moving parts, for those remote sellers that want to be in full compliance, there’s a full-time job to be had for monitoring locally administered sales and use tax laws. There are many ordinances to follow. And some of these laws, either on their face or as applied, may be unconstitutional as creating an undue burden on interstate commerce or imposing an impermissible discrimination on interstate commerce. Some may have hope that Congress will step in to create a nationwide safe harbor for small businesses, with tax administration only for state-administered sales and use taxes. But, that’s extraordinarily doubtful in this author’s opinion.

Sales tax automation and software are your cure for going crazy over sales tax compliance. The world of indirect tax automation is quickly expanding to help companies manage all the complexities of the tax compliance issues described above. Automation simplifies the management of the ever-changing sales tax rates and exemption certificate management that needs to be applied to each transaction. This allows tax professionals to focus on the important issue of identifying those transactions that may now create economic nexus in new states.

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[1] See Chicago Department of Finance Personal Property Lease Transaction Tax Ruling #1 (June 9, 2015); Informational Bulletin: Nonpossessory Computer Leases (Nov. 2015) (“the Lease Tax applies to any usage of remote computing or software, including but not limited to SaaS, IaaS, and PaaS…”).
[2] https://secure.salestaxonline.com/lookup/lookup.aspx.
[3] See https://revenue.alabama.gov/wp-content/uploads/2017/09/address.pdf.
[4] See https://www.colorado.gov/pacific/sites/default/files/DR1002.pdf.
[5] Per the City’s Deputy Corporation Counsel, Weston Hanscom, at a Chicago Bar Association state tax committee meeting held December 19, 2018.
[6] See https://www.nomealaska.org/egov/documents/1567113279_7822.pdf (approved August 26, 2019), as reported by Law360 on Aug. 27, 2019.
[7] See Assoc. Industries of Missouri v. Lohman, 511 U.S. 641 (1994).
[8] Ala. Code § 40-23-196.
[9] See Illinois P.A. 101-0031 (SB 690) (signed into law June 28, 2019).