In the last two decades, the rapid rise of online sales has upended the retail industry, providing shoppers with an unprecedented variety of options — and posing problems both for brick-and-mortar retailers and the governments that depend on them for sales tax revenue.
According to the trade publication Internet Retailer, in 2018 the internet accounted for an astonishing 15 percent of worldwide retail sales. In the U.S., the volume of e-commerce rose by more than 15 percent in that year alone. And until fairly recently, the tax due on much of this commerce went uncollected. State and local governments, which rely heavily on sales and use taxes, saw the growth of untaxed online sales as a serious and growing problem for vital public programs as well as local retailers, who faced an uneven playing field.
On June 21, 2018, the U.S. Supreme Court addressed this threat, ruling in South Dakota v. Wayfair (PDF) that states can require many out-of-state sellers — sometimes called “remote sellers” — to collect sales tax on purchases made by their residents. The decision overturned decades of precedent.
It’s a complex issue that raises questions about how states should proceed. Texas is establishing its policies now and, while much has been decided, some specifics are still pending.
Forty-five states and the District of Columbia impose sales and use taxes. In Texas, the general sales and use tax brought in more than $31.9 billion in fiscal 2018, about 57 percent of state tax revenue in that year.
Generally speaking, the sales tax is imposed on the sale of property or services in a state, while the use tax is a complementary tax imposed on the sale of property or services that are subsequently used in a state if its sales tax has not been paid.
Sales and use tax collections are fairly simple when a buyer and seller are in the same state. But the issue has been murkier for sales across state lines. A 1977 Supreme Court decision, Complete Auto Transit, Inc. v. Brady, established that the obligation to collect a sales tax could be imposed on a seller only if a “substantial nexus” — a clear connection, such as a brick-and-mortar store — existed between the seller and the taxing entity.
According to the 1992 decision in Quill Corp. v. North Dakota, the state of North Dakota couldn’t require a company to collect tax on its mail-order sales because it lacked a physical presence in that state. This “physical presence” test was the guiding legal standard for years, but grew problematic as e-commerce became common. Online purchasing from remote sellers began to cut dramatically into both sales tax revenues and the sales of in-state businesses, who, unlike remote sellers, were required to collect sales taxes.
Many states responded to Quill with laws asserting nexus over out-of-state sellers, based on new business models and their relationships with entities located in those states. For example, an out-of-state seller might have “affiliate” nexus based on the in-state presence of another entity under common ownership. Texas had affiliate nexus in law before the Quill decision, and most recently updated its statute in 2012.
The business model of Amazon, the world’s dominant online vendor, has had a significant impact on state efforts to collect sales taxes on internet purchases. In 2010, the Texas Comptroller’s office asked Amazon to pay $269 million in back taxes on sales to Texas purchasers, basing nexus on a warehouse it had built in the state. The company initially resisted, but its growing nationwide physical presence led it to begin collecting sales taxes in some states in 2011 (and in Texas in 2012). Today, the company collects taxes on purchases made directly from Amazon in all states with sales and use taxes.
Taxes on purchases made on rapidly growing online marketplaces, however, typically have gone uncollected. These marketplaces allow third parties to sell and ship to consumers. Amazon hosts the biggest by far in terms of sales volume; some 2.5 million sellers around the world used its platform to make $175 billion in sales in 2018.
Other large marketplace websites include eBay (25 million sellers), Etsy (1.2 million sellers) and Walmart (21,800 sellers). Many independent sellers now rely solely on these marketplaces for the visibility and sales, fulfillment and shipping infrastructure they provide.
In 2016, South Dakota challenged the physical presence test with a law requiring remote sellers to collect and remit sales tax based on an “economic nexus” established by the annual delivery of more than $100,000 of goods or services into the state, or by 200 or more separate transactions in a single year for the delivery of such goods or services. Some vendors sued, led by online retailer Wayfair LLC.
In 2018’s South Dakota v. Wayfair decision, a 5-4 majority of the U.S. Supreme Court overturned the Quill standard and upheld South Dakota’s law, asserting that “physical presence is not necessary to create a substantial nexus.” The court further said that the growth of e-commerce since Quill had distorted markets and created an uneven playing field among sellers.
States began to draft new legislation and new administrative rules almost immediately in the decision’s wake. As of July 1, 2019, 36 states have adopted remote sales tax collection laws and regulations based on economic nexus, while 33 have required marketplaces to collect sales tax on their sellers’ behalf. Details vary considerably; Exhibit 1 highlights those of the six most populous states and Texas’ neighboring states.
|State||Effective Date||Remote Seller Threshold|
|California||April 1, 2019||$500,000|
|Florida — No remote sales tax law|
|Illinois||Oct. 1, 2018||$100,000 or 200 transactions|
|Louisiana||No later than July 1, 2020||$100,000 or 200 transactions|
|New Mexico||July 1, 2019||$100,000|
|New York||Effective “immediately” after Wayfair ruling||$500,000 and 100 separate transactions|
|Oklahoma||Nov. 1, 2019||$100,000 in previous year|
|Pennsylvania||July 1, 2019||$100,000 in previous year|
|Texas||Oct. 1, 2019||$500,000 in previous year|
Source: Federation of Tax Administrators
Before the 2019 legislative session, the Comptroller’s office amended its rule related to seller and purchaser responsibilities for sales and use taxes in response to the Wayfair ruling. The rule amendment created a “safe harbor” for remote sellers with limited sales in Texas; the agency will not enforce sales tax permitting and collection obligations on remote sellers whose total Texas revenue in the preceding 12 calendar months is less than $500,000.
To give sellers affected by the amended rule adequate time to prepare for their collection and reporting obligations, the rule now provides that remote sellers’ permitting and collection responsibilities will begin on Oct. 1, 2019.
“We weighed the burden of tax collection on small vendors, the amount of potential tax revenue to be collected on the sales and the interests of in-state vendors in a level playing field, to reach what we hope is the right threshold amount,” says Associate Deputy Comptroller Karey Barton.
These rule amendments apply only to remote sellers. In general, a remote seller cannot have a physical presence or activities in the state other than the solicitation of sales to Texas customers by remote means.
In addition to the rule changes, the Comptroller’s office worked with the Legislature and many stakeholders to pass two new bills during the 2019 session that amend Texas law in response to Wayfair. At this writing, the agency is updating its rules to implement these new laws as of Oct. 1, 2019.
House Bill (HB) 1525 is Texas’ marketplace statute, amending the Tax Code’s definitions of “seller” and “retailer” to include marketplace providers that directly or indirectly process sales or payments for third-party sellers. The marketplace provider certifies to third-party sellers that it will collect Texas taxes; the provider then assumes the seller’s tax collection obligation. The third-party seller therefore is relieved of tax collection responsibility and has no liability to the state unless it provides incorrect or insufficient information to the marketplace provider.
“The marketplace providers were very forthcoming and worked with us to get to the right result,” says Barton.
And the hard work paid off. According to Barton, “Texas has gotten kudos on our marketplace legislation for being simple and not overreaching.” Representatives of Amazon and eBay have praised its straightforward language.
The other Wayfair bill passed this session, HB 2153, amends the Texas Tax Code to allow remote sellers to collect a single local tax in lieu of the different taxes imposed by cities, counties and special taxing jurisdictions at each shipping destination. This measure, too, was designed to avoid undue burdens on small business.
The legislation authorizes the Comptroller to set the single tax rate annually, based on an average of local rates across the state. The Comptroller has set the initial rate at 1.75 percent, bringing the combined state and local tax rate for remote sales to 8 percent. Remote sellers either can collect the 8 percent statewide rate or charge the actual combined state and local sales tax rate imposed at the delivery destination, but must choose one or the other for all sales. This legislation offers a simple solution to sellers that could find it difficult to keep up with the wide variation among local tax rates.
“One of the more complicated aspects of our system is the differences among local sales tax rates,” says Barton. “But Texas is lucky because the state actually administers that tax, not local jurisdictions. Money will come into a pool and be distributed based on total local sales taxes collected.”
The marketplace law is expected to bring in an additional $300 million to Texas each year, while taxes collected by other remote sellers should generate an additional $200 million annually.
The responses of the Legislature and Comptroller’s office to Wayfair are intended to level the playing field between in-state and remote sellers, while avoiding excessive burdens on the business community — points stressed in the Supreme Court’s decision. To that end, Texas policymakers have consulted other states and as many stakeholders as possible, including the Comptroller’s taxpayer advisory group, the Texas Retailers Association, the Texas Taxpayers and Research Association and businesses including Amazon, Etsy, eBay and Walmart.
Differences among state tax laws and the sheer number of remote sellers mean that states must work together with taxpayers to bring order and predictability to sales tax collection.
The Comptroller’s office will continue to develop best practices in conjunction with the Multistate Tax Commission (MTC), an intergovernmental state tax agency, and monitor other efforts at uniformity, such as the Streamlined Sales Tax Project (SSTP), a tax simplification agreement among 24 states. The SSTP website offers sellers an easy way to register and collect taxes among member states, and while Texas isn’t a member of the SSTP, the Comptroller’s office has considered using its registration portal.
Barton sums up the overall process as “a marathon, not a sprint,” and emphasizes that state policymakers remain open to new ideas and concerns. “We want to be fair and take careful, deliberate approaches to this,” he says. “We’ve been preaching to our sister states: let’s think it through, minimize the impact on businesses as much as possible and create as level a playing field as we can get.” FN