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Question: I work as a legal secretary by day, but by night, I sell my own crafts online. Because I’m around lawyers all day, I heard about a case called South Dakota v. Wayfair, which I’ve read up on. It basically says states can now charge tax on purchases that someone makes out of state — and I sell most of my stuff to people in other states. Can you explain this to me? Despite what I’ve read, it still makes little sense to me. And is there anything I can do to avoid these taxes?
— Jo in Nevada
Yes, it’s complicated. Yes, there’s something you can do. Let’s break it down.
Last year, the Supreme Court announced in a 5-4 ruling that states have the right to levy sales taxes on online retailers who do not have a physical presence in the state. This landmark ruling was called South Dakota v. Wayfair, Inc.
Not to get too technical — OK, maybe just a little — but that decision overturned Quill Corp v. North Dakota from way back in 1992. That decision limited the ability to hold retailers liable for sales tax to only retailers who had a physical presence in the state itself.
Hi, I’m Jacob Dayan, CEO, and Co-founder of Community Tax. And this is “Taxing Questions.” When you think of the words “technology” and “taxes,” you usually think of online calculators or chat boxes that can help you properly fill out your annual tax returns. But technology is also affecting merchants who sell their products online and whether they need to charge their customers state sales taxes – even if those merchants aren’t located there.
For years, that answer was no. And it came from non-other than the Supreme Court way back in 1992. But last year the Supreme Court essentially changed its mind in a case called “South Dakota vs. Wayfair” it ruled that states can charge sales tax on merchants who sell to their residents only online. So, of course, other states have been altering their own laws, so they can earn some extra revenue. You might ask what that means to both merchants and customers? Check out my analysis on Debt.com. And if you have tax questions of your own, hit me up there.
The new precedent set by the Court will have far-reaching impacts on the way sales tax is enforced nationwide. What will the new Supreme Court ruling mean to online businesses that may be on the hook to pay a ton of sales tax?
In light of the ever-changing landscape of commerce, perhaps for many, this ruling makes sense. Selling goods and services has evolved over time (like all things) with technology. Sales tax was a relatively simple concept when local shops and businesses made up the majority of retailers. It became more complex as stores grew into national and global chains. But with the emerging popularity and convenience of online retailers in the last 10 years, states were really feeling the pain from lack of sales tax revenue.
States like South Dakota, with no income tax, heavily rely on sales tax revenue. The online retail boom was seriously eroding the coffers, making it a revenue emergency on the state level, as Justice Kennedy states in his opinion.
The opinion further discusses that the Quill ruling essentially created a sales tax loophole that robbed states of the ability to charge sales taxes — but also created larger issues of unfair marketplace advantage. Kennedy’s opinion claims that online retailers were able to avoid the sales tax burden thereby being able to offer “de facto lower prices.”
Perhaps a key summary of the Court’s reasoning to overturn its own precedent is best explained in Justice Kennedy’s own words…
Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court’s precedents. This Court should not prevent States from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the State.
Now that the physical presence precedent has been overturned, it is extremely important for business selling online to pay attention to all legislative movement regarding taxation to be imposed by the states. The best-case scenario is that states will be forced to streamline their sales tax requirements, and the Court’s ruling does make clear that state sales taxes imposed on commerce should not discriminate against out-of-state sellers, and it should not place an undue burden on interstate commerce. But it did not lay out explicitly how the states should execute on this new law.
In South Dakota, there is a “safe harbor rule” exempting out-of-state business from being charged sales tax on less than $100,000 in revenue or less than 200 transactions. Therefore, it is a safe bet for businesses to expect state legislation that will align sales tax laws with something similar to the South Dakota law as it has been upheld by the highest Court in the land.
Although there is still a high degree of uncertainty on how online and interstate business are supposed to comply with all sales tax jurisdictions they sell to, one thing that is certain is that its unlikely consumers will choose paying sales tax at a brick-and-mortar store of the convenience of shopping online even if that comes with sales tax too. At the end of the day, sellers pass sales taxes on to consumers so additional business cost of the ruling should be limited to hiring tax professionals to ensure the business remains compliant with its sales tax obligations nationwide.
Jacob Dayan is co-founder of Community Tax LLC, a full-service tax company helping customers nationwide with tax resolution, tax preparation, bookkeeping, and accounting.
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