Practice Development: Sales Tax Economic Nexus Under Wayfair
Any effective advice relating to Wayfair must be both sensible and thorough. As the trusted advisor, you need a methodology for ensuring that you stay up to date with the critical factors and applicable law changes affecting your clients. A plan for reviewing your client's transactions on a monthly, or quarterly basis should also be included.
The first step to advising your clients under the Wayfair ruling is to develop a plan for determining where each one has economic nexus. There are several factors you should consider when developing this plan: 1) the effective date of the Wayfair legislation in each jurisdiction; 2) the lookback period each jurisdiction uses for its economic nexus threshold test; 3) the type of sales used to determine the threshold (gross sales or taxable sales); 4) registration requirements after reaching the threshold; 5) if applicable, the state marketplace facilitator law (map); and, 6) any open amnesty programs.
The initial step is to determine how far back you need to look to provide a thorough and accurate analysis. If this is the first economic nexus analysis that you’re performing for a particular client, we recommend going back to 1/1/2017. Of course, this sounds like a lot of transactional data, but it makes sense when you consider that it’s been nearly two years since the Wayfair decision was handed down on June 21, 2018. At that point in time, certain states had already enacted legislation and put enforcement on hold pending the decision, while other states passed legislation relatively quickly after the decision and established a prior calendar year lookback period. Effectively, any state that passed legislation in 2018 with a prior calendar year lookback period necessitated that threshold tests include transactions dating back to January 1, 2017. And remember, the objective is to ensure that the client taxpayer is not exposed to prior period liabilities
Assuming we go back to January of 2017, you’ll need to gather several particulars from your client. 1) Channels: Which platform(s) does your client sell on? (e.g. Amazon, Walmart, Shopify, Big-Commerce, eBay, etc). 2) How long has your client been using each channel for its sales and distribution? 3) Source systems: What is the general ledger system of record during this time frame? 4) Which source systems have the transactional data needed to do the analysis?
Aggregating this data, then determining who is ultimately responsible for the tax liability will be critical to advising your clients effectively. In some cases, transactional data may be regulated under marketplace facilitator laws, effectively transferring the burden of collecting and remittance from your client to the marketplace facilitator. This same data, however, may be considered as part of gross sales and effectively count towards the economic nexus threshold for omnichannel retailers. It’s important to segregate the transactions that occur through a marketplace facilitator versus your clients’ other channels. The sales that occur via the marketplace facilitator channels will have, in many states, had tax collected and remitted by the facilitator. This reduces the overall tax liability associated with the threshold test of gross sales.
Economic Nexus in Practice
As we will demonstrate in the following scenario, there are multiple outcomes that can occur based on the analysis of the transactional data. Here, we analyzed transaction data starting on 1/1/2017, as we recommended. (In this scenario, if we had only looked at 2019 transaction data, we would have missed the fact that the threshold limits were reached prior to the law going into effect, but within the law’s defined lookback period. This could lead to conflict with the state, or a false registration statement based on an inaccurate “date of first transaction” within that jurisdiction.)
Kentucky (KRS 139.010) defines remote retailers as those with no physical presence in Kentucky. HB 487 requires remote retailers with 200 or more sales (unique invoices) into the state or $100,000 or more in gross receipts from sales into the state to register and collect Kentucky sales and use tax. The transaction and gross receipts thresholds are based on the previous or current calendar year sales. The effective date of the law is July 1, 2018. Kentucky also noted that registrations should be completed with sales and use tax collections beginning by 10/1/2018.
Under this regulation, a taxpayer would need to apply the threshold tests to transactions starting on January 1, 2017, in order to comply with the “previous or current calendar year sales” lookback period, which is based on a 2018 effective date. Carrying this a step further, let’s assume that the transaction data indicated that your client exceeded the threshold of $100K in gross receipts during the 2017 calendar year. Under this scenario, your client should register and begin collecting tax no later than 10/1/2018 to be in compliance. In other words, since your client exceeded a threshold prior to the effective date of the legislation, they must start collecting on the effective date.
Let’s now assume that your client didn’t exceed the threshold of $100K in gross receipts until February 28, 2019. In this case, your client would be required to register by the first day of the next month, or March 1, 2019.
Mississippi’s law (Miss. Code Ann. Section 27-67-4(2)(e)) was technically effective on 12/1/2017, prior to the Wayfair ruling. The state deferred enforcement pending the outcome of Wayfair. However, after the decision, the Department of Revenue made the decision to allow online sellers to begin to collect Mississippi use tax for sales made on or after September 1, 2018, so long as they registered by August 31, 2018.
Mississippi stated, “Online sellers seeking to determine whether they meet or exceed the $250,000 small seller exception should make this determination based on their total sales into this state in the prior twelve-month period. A total sales measure means and includes all sales into this state, both those that are wholesale and those that are taxable under the Mississippi sales and use tax statutes. Total sales also include any sales that are subject to any exemption provided by the Mississippi sales tax statutes”.
Here, looking back at the prior twelve-month period would require you to look at your client’s transaction data starting on 9/1/2017. In this scenario, let’s assume your client didn’t hit the gross sales threshold of $250K until 4/1/2018. Following the Mississippi guidance, your client should have registered by 8/31/2018 to relieve the burden of the prior exposure. If your client did not register by that date, the lookback period would effectively start with transactions dating back to the original effective date, which is 12/1/2017.
Washington is another interesting use case since it has changed its laws numerous times post-Wayfair. Starting Jan. 1, 2020, remote sellers must register to report B&O tax and to collect and remit applicable sales tax if they exceed $100K in combined gross receipts in the current or prior year. Washington defines a remote seller as a business with no physical presence in Washington that makes retail sales to Washington purchasers and does not meet the definition of a marketplace facilitator. However, you must also consider laws in place dating back to July 1, 2017, that could impact your client (i.e. Marketplace Fairness Act)
Looking back to 2017, let’s assume the $100K threshold was surpassed by your client on February 1, 2017, which means they exceeded the threshold prior to the legislative effect. In this case, your client would be subject to the Wayfair effective date of 10/1/2018, and the registration requirement would have been 11/1/2018.
As can be seen from the previous examples, it would be extremely difficult for businesses to track economic nexus laws and their proximity to the corresponding threshold test(s) in each state as part of their daily operating duties. This undertaking would be made even more difficult when you consider the fact that many states require businesses to start collecting sales tax on the very next transaction after their threshold has been met. The enforcement of Wayfair requires the CPA community at large to develop and deliver competency in multi-state sales and use tax. And as the trusted advisor, you have an opportunity to reduce the compliance risk, exposure, and stress for your clients.
While our commentary up to this point has been focused on the economic nexus factors outlined in the Wayfair decision, you should still consider physical presence factors before deciding the best course of action for your client. Many companies won’t have physical presence factors to consider, but if your client is selling via Amazon FBA, third-party logistics (3PL), or stores inventory in third-party locations, there may be additional associated compliance risks. Other common factors to consider for physical presence are employee locations, office locations, etc.
After the economic nexus analysis is completed, you must decide whether to register or prepare VDA’s for your client. Each of the example scenarios we went through above requires considerable thought as to the appropriate way forward. Your client taxpayer has several choices that should be considered: 1) standard registration; 2) voluntary disclosure agreement; or 3) amnesty programs.
You might be asking yourself: Wouldn’t it be appropriate to just proceed with registration? Not necessarily. While it may seem intuitive, and most businesses will want to register immediately, it may be prudent to begin by applying for the VDA program.
Using the standard registration process is usually the best option when your client taxpayer is operating under a timeline within the guidelines set out in each jurisdiction. If your client hits the economic threshold in Kentucky, they’ll need to register by the 1st day of the next month. The timeline in Mississippi for registration is the very next transaction. Washington requires registration by the 1st day of the month after 30 days. As you can see, each state has a different registration grace period and very strict timelines for a standard (timely) registration. If there is no prior period exposure or risk of liability, the standard registration process is the best course.
Voluntary Disclosure Agreement (VDA)
If your client has a prior period liability or exposed transactions from exceeding economic nexus thresholds, we recommend applying for a voluntary disclosure agreement (VDA). The VDA limits your client’s past-due tax liability to a limited number of prior tax years (the lookback period). Generally, your client will receive a complete or partial waiver of penalties and the state’s agreement not to assess tax and interest prior to those tax years. The VDA also eliminates the risk of state audit prior to the lookback period. The VDA process protects your client from discovery by the state once the application for voluntary disclosure is received, and their identity will not be disclosed to the state until the VDA is completed.
As is readily apparent from this detailed analysis, you, the trusted advisor, must be prepared to apply a vast array of economic nexus rules, lookback periods, transaction summations, counts, registration timelines, marketplace facilitator implications, and calculated exposure amounts to properly protect your taxpayer client and minimize their overall risk. Using the LumaTax solution, you never have to worry about tracking all of these varying parameters to deliver this advisory service efficiently and effectively.