Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...
By Tripp Baltz
So where are the lawsuits?
In the first several weeks after the U.S. Supreme Court’s groundbreaking ruling in South Dakota v. Wayfair, many tax experts and practitioners predicted states that failed to live up to the guidance contained within the ruling would be hauled into court by remote sellers and the trade associations that represent them.
Nearly eight months later, no suit has been filed against a state asserting its remote sales tax authority, even though several states have set up remote sales tax systems departing substantially from the South Dakota model at the core of the ruling. But, tax experts say, the likelihood of litigation is still high, especially in states with complicated compliance rules or with an isolated retailer who wants to test the law—possibly in the last half of the year.
The risk of being sued may be higher for certain states—namely Colorado and Louisiana—whose sales and use tax systems are highly complex, due in part to constitutionally independent home rule cities and counties that could make it burdensome for remote sellers to comply with local sales tax rules.
Requirements that remote sellers collect and remit sales taxes based on sales into a state have gone into effect in about 30 states and Washington, D.C. The millions of dollars those states have started collecting aren’t at risk of having to be refunded—even in the event of an adverse court ruling against a state, sources said.
“It’s much more likely a state would identify a remote seller who’s not collecting, issue an assessment against that seller, which the seller would then challenge in court, and if the assessment got dismissed, no refund would be issued because the seller never paid anything to the state,” Richard Cram, director of the national nexus program at the Multistate Tax Commission, told Bloomberg Tax.
The lack of litigation means there hasn’t yet been a legal test of the three features the court identified about South Dakota’s tax system that appear to prevent it from being an undue burden on interstate commerce. The majority in the 5-4 ruling didn’t declare South Dakota’s economic nexus approach—a tax connection based on the amount of business done in the state—to be constitutional. However, the court did toss out the physical presence standard it affirmed in 1992 in Quill Corp. v. North Dakota.
First, South Dakota’s law has a small business safe harbor exempting vendors who conduct a limited amount of business in the state. Only those with more than $100,000 in in-state sales or with more than 200 transactions into the state in a year are subject to collecting the tax. Second, the law ensures no retroactive application of the obligation to remit the sales tax. And third, South Dakota is a member of the Streamlined Sales and Use Tax Agreement, a program under which sellers collect tax voluntarily and remit it to the 24 state participants. The SSUTA is designed to impart uniformity and simplicity in tax administration and compliance.
The dearth of lawsuits so far could have several explanations, sources said.
For starters, it’s early in the game. E-commerce companies are giving states a chance to get their post-Wayfair tax regimes up and going, Cram said. “The states haven’t started enforcement yet,” he said. “Certainly businesses will be much more likely to sue if they are faced with a state coming after them.”
Second, a legal challenge probably won’t come until a company can argue it has been “substantially financially harmed” by compliance or enforcement Darcy Kooiker, a principal with Ryan LLC, told Bloomberg Tax.
“The perfect test case might come later when some small remote seller gets tagged for sales tax and it causes them to go into bankruptcy or go out of business,” she said. “States will have to ask, ‘Really? Is this what we want to do? Put a small seller out of business?’ Nobody’s been hurt bad enough financially yet to cause it to rise to a level of a court case, but there’s going to be a challenge somewhere by somebody.”
Perhaps the most likely “somewhere” is a state with a highly arcane tax system replete with multiple, separate authority local sales tax jurisdictions like Colorado or Louisiana, both of which have strong constitutional home rule counties and municipalities.
Colorado’s system in particular is very complex, and at present it would probably run afoul of the commerce clause as having an undue burden on out-of-state businesses, Phil Horwitz, state and local tax director at Moss Adams LLP in Denver, told Bloomberg Tax. Horwitz, former director of tax policy in the Colorado Department of Revenue, said the state’s tax system doesn’t come close to meeting the principles of simplification laid out in Wayfair.
“Colorado presents such challenges for a remote vendor,” he said. “It has really failed to come to terms with having a filing system for remote vendors.” Currently vendors don’t have to comply with the state’s remote sales and local sourcing rules until a grace period ends May 31.
Another risk for Colorado is that the state is asserting its remote sales tax authority post-Wayfair by administrative rule rather than by an action of the state legislature. That could be an overreach of the department’s authority, Nikki Dobay, senior tax counsel at the Council On State Taxation, told Bloomberg Tax.
“We believe there has to be some sort of legislation,” Dobay said. “You can’t cure the problems with just regulation. That’s going to be the first level of litigation, is whether or not the department has the authority.”
On the other hand, it might not be worth it to a vendor to sue a state because sales tax is an indirect tax, and “it’s other people’s money you’re defending,” Horwitz told Bloomberg Tax. “It would be so easy to fix in virtually every state. So even if you win, it’s likely to just be a short-lived victory. There’s not really an incentive, just because you have a chance at overturning another state’s law.”
Beside Colorado, several states have asserted their remote sales tax authority via rule, with many citing legislation empowering them to do so. Dobay said many state laws will need to be modernized post-Wayfair.
New York issued guidance with its response to Wayfair in mid-January, basing its authority to do so on a nearly 30-year-old tax law. The guidance said the obligation to remit and collect taxes applies to tangible personal property, making no reference to sales of software, services, or other intangibles.
For now, bigger companies are keeping the litigation arrow in their quiver, focusing instead on getting into compliance with new or renewed remote sales tax requirements in the states.
“This whole movement was never really about the small companies with a $300 liability in a state. It was always about the big sellers,” Susan Bittick, principal with Ryan LLC in Sacramento, told Bloomberg Tax. “Big retailers, as much as 20 years ago, lacked the capacity to calculate all the rates, exemptions, and tax laws,” she said. “We’ve moved the needle an unbelievable amount from 20 years ago.”
As far as litigation, “we’ll have to wait and see—you never know what the fact pattern will be in these home rule states,” she said. “Most of them don’t want further litigation—they just want to get the vendors to collect and remit for them so they can get the money in the door. They don’t want to be the next one to see their name in one of these lawsuits.”
Richard Pomp, the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law and an authority on state and local taxation, said there would be ample opportunities for sellers to sue states over their Wayfair-inspired remote sales regimes, but the litigation would focus on narrow, practical issues particular to each state program. Few, if any, lawsuits, would challenge the breadth of a state program by asserting an undue burden on interstate commerce, he said.
But Pomp said the vast majority of the litigation would involve definitions, eligibility for exemptions, thresholds for having a business presence in a state, and tax administration issues. Not all of these disputes, however, will be worth the cost of a lawsuit and those considerations will only come to light after states begin issuing assessments to noncomplying sellers.
“You’ve got a lot of gray areas to litigate,” Pomp said. “Will it be worth it to anyone to litigate? That’s always the question. How much is on the table? What’s it going to cost to litigate?”
—With assistance from Michael J. Bologna.
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