The South Dakota v. Wayfair, Inc
, which overturned the physical presence requirement for state sales and use tax purposes, is shifting the balance around corporate taxation in the United States. There is a high possibility that we will see a trend toward more robust transaction taxes and increasingly aggressive state and local enforcement, with a hodgepodge of exemptions and credits to navigate.
As the effects of Wayfair
kick in, companies will need to re-evaluate their long-term strategy for taxation and refocus their resources around critical risks. They will also need to strategically evaluate opportunities and potential exposures around state taxes moving forward.
In the past and now
Historically, companies have focused the bulk of their tax function efforts on their federal income tax posture as U.S. federal income tax rates were among the highest in the world. The Tax Cuts and Jobs Act of 2017 changed that with its 40% reduction in the top federal C corporation tax rate, making rates far more competitive on a global scale.
In contrast, state corporate income tax rates (ranging in the aggregate from 5% to 10%) have not been reduced, so from a tax-rates perspective alone, state taxation has become more important as a result of federal tax reform. Wayfair
has amplified the importance of state taxation by putting sales and use tax front and center. Wayfair
, along with the intricate state tax implications of federal tax reform, has raised the possibility that companies may have more exposure around state tax than around federal. This shift could change the composition of company tax departments over time and result in a more even split between federal and state tax resources.
Companies need to come up with a proactive plan that supports their growth strategy, ensures their state taxation compliance and preserves their profit margins.
“As many companies evaluate their state taxes after federal tax reform and
Wayfair, they may be paying more in cash taxes on the state side than on the federal side, which is an important change moving forward.” -- Mark Arrigo, national managing partner and practice leader, State and Local Tax Services
No time like the present
States may seize on the ruling as a means to address their budget deficits. As the Tax Foundation
reported, “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.” This points to states trying to budget through above-the-line channels, mainly sales and property taxes.
States may get creative in enforcing Wayfair
because of the amount of revenue that may be raised across the board from sales and use tax. One example is New Jersey, which has been active this year in passing legislation in response to federal tax changes and Wayfair
. The state had discussed raising its sales tax rate to address budgetary concerns, but chose not to do so based on the expectation that, with Wayfair
, a move to economic nexus, along with the adoption of complementary rules governing marketplace providers, would bring in more revenue from sales tax even without a rate rise.
Other states are taking action on the legislative and administrative front around Wayfair
. As several economists have predicted, Wayfair
could mean billions in additional revenue annually for states.
“Since sales tax is not your tax, getting
Wayfair wrong is going to negatively impact your margins, and it could be several years down the road before you realize that you’re doing something wrong.” – Kevin Herzberg, partner and Central Florida practice leader, State and Local Tax Services
5 action steps companies should take to respond to Wayfair
Companies need to be proactive around Wayfair by identifying and setting in place strategic considerations for their businesses.
A challenging path forward
- The first step is to figure out where they are conducting their business and need to file from a sales and use tax perspective. This step includes identifying the documentation they need to support filings.
- The second step involves coming up with their own systems to track and update their responsibility in each state where they conduct business. States will have varying approaches to implementation.
- Step three relates to exemption certificates, which allow companies to justify not claiming and remitting sales and use tax. Companies will need to get a razor-sharp understanding of their resale and exemption certificates and documentation, which will be difficult given the variety of filing requirements from state to state.
- A fourth, and critical, step is using technology to their advantage. Companies should assess their current infrastructure and where they fall short in order to make the appropriate technology investments for compliance and remittance. Technology upgrades and investments, as overseen by an electronic certificate manager, could help mitigate these challenges.
- The fifth step is to monitor the taxing authorities that collect tax on your company, important knowledge that can help preserve profit margins. Some states will be more aggressive in collecting sales tax, and organizations need to be cognizant of all the players.
The full implications of the Wayfair
ruling and its ripple effects for companies will unfold over the coming months. There are many unknowns, including the effect of Wayfair
on inbound foreign sales and whether future congressional action will set standards for a variety of state nexus requirements.
What is certain today is that companies will need to closely follow activity at the state level; assess their tax technology and determine whether they are capable of providing information to multiple states; have adequate internal controls so that they can manage liability in a rapidly changing environment; and have the right talent to handle the very difficult decisions that are coming their way.
Mark R. Arrigo
National Managing Partner and Practice Leader, State and Local Tax Services
: +1 678 515 2320
Partner, State and Local Tax, National Wayfair Leader
: +1 813 204 5101