US Sales Tax in E-commerce: Post Wayfair Era

US e-commerce companies paved the way for modern online and cross-border trade. While US companies, such as Amazon or eBay, have entirely changed the everyday shopping habits of consumers, Chinese companies, like Alibaba, which was among the early pioneers of e-commerce expansion, and not Temu, continue to disrupt the e-commerce industry.

The increase in online transactions and the creation of a nearly borderless shopping environment have led to the establishment of a new legal standard for sales tax compliance, known as economic nexus. In 2018, the US Supreme Court published a landmark decision in the South Dakota v. Wayfair Inc. case, commonly referred to as the Wayfair ruling, which reshaped the rules of the game for e-commerce businesses, online sellers, and consumers.

Background: Sales Tax Before Wayfair

Before the Wayfair ruling, US sales tax compliance was primarily governed by the 1992 Supreme Court decision in Quill Corp. v. North Dakota (the Quill ruling). The Supreme Court of North Dakota ruled that a state cannot require a retailer to collect and remit sales tax unless it has a substantial nexus, that is, a physical presence in that state. Typically, physical presence means that businesses have an office, warehouse, or employees in the state.

The decision had far-reaching consequences and contributed to creating an ideal environment for the development and growth of the e-commerce industry. With this rule in place, online retailers had the opportunity to sell goods to consumers across the US in states where they did not have a physical presence, without having to collect and remit local sales taxes. The liability was on the consumers to report and pay use tax for purchases from out-of-state sellers.

Consequently, this contributed to a growing tax revenue shortfall for states and an uneven playing field for brick-and-mortar retailers who were obligated to collect tax while their online competitors were not. By 2017, the discrepancy had become so large that it could no longer be ignored, prompting South Dakota to challenge the physical presence requirement through litigation against Wayfair, Inc., Overstock.com, and Newegg, the three largest online retailers with no physical presence in the state at the time.

Wayfair: A New Chapter in E-commerce Sales Tax

On June 21, 2018, the U.S. Supreme Court issued its final decision in South Dakota v. Wayfair Inc., overturning the Quill ruling. By doing so, the Supreme Court significantly altered the sales and use tax rules, allowing states to require remote or out-of-state e-commerce businesses with a substantial economic presence, rather than a physical one, to collect and remit sales tax.

The reasons behind this historical decision can be found in several conclusions outlined in the Wayfair ruling. The Supreme Court concluded that the physical presence rule established by the Quill ruling was entirely outdated and artificial when applied to the realities of modern e-commerce and the digital economy. 

This was supported by data showing that in 1992, mail-order sales in the US totaled USD 180 billion, whereas in 2017, e-commerce retail sales alone totaled nearly USD 453.5 billion. Additionally, the Supreme Court determined that states were losing between USD 694 million and USD 3 billion per year in sales tax revenues as a result of the physical presence rule.

The Wayfair ruling upheld South Dakota’s economic nexus law, which required out-of-state sellers to collect sales tax if they had more than USD 100,000 in sales or 200 separate transactions in the state during the calendar year. Other US states followed South Dakota's example and began passing or enforcing similar laws, rapidly reshaping the tax compliance obligations for the e-commerce industry.

Implications for E-commerce Businesses

The most immediate effect of the Supreme Court's decision was the proliferation of state-level economic nexus laws. Each US state adopted and implemented its thresholds, rules, and enforcement mechanisms, creating a patchwork of compliance obligations that required new systems, processes, and, in many cases, professional guidance.

The implications of economic nexus rules may be viewed from different angles, depending on the type of seller or facilitator involved. 

Remote or Out-of-State Sellers

Remote or out-of-state businesses are those that do not have a physical presence in a state but sell goods and services to consumers within that state. As a direct consequence of a Wayfair ruling, these businesses must now closely monitor their sales volume in each state to determine whether they exceed economic nexus thresholds. 

While many US states adopted South Dakota’s USD 100,000 and 200 transaction standard, others have significantly different thresholds. Some states have higher total sales thresholds set at USD 200,000 or USD 500,000, while others do not have a transaction threshold.

Sellers that exceed these thresholds must register for, collect appropriate state-wide and local sales taxes, comply with tax return filing requirements, and remit collected taxes. Meeting these requirements might be especially challenging for small and mid-sized sellers, who are now facing new administrative burdens. Those who were once required to only deal with sales tax in their home state may now find themselves managing compliance in dozens of jurisdictions, each with unique tax rates, rules on exempt items, and filing requirements.

Online Marketplace Sellers

While remote or out-of-state sellers typically offer and sell their goods and services through their websites, online stores, or similar channels, online marketplace sellers primarily use the services of online marketplaces, such as Amazon, eBay, or Etsy, to make sales. Rules for online marketplace sellers depend on whether they make sales exclusively through online marketplaces or also sell through other channels. 

Under the influence of the economic nexus rules, most US states have enacted marketplace facilitator laws that place the obligation to collect and remit sales tax not on the individual seller but on the marketplace platform itself. Therefore, if the online marketplace seller makes sales only through an online marketplace, the marketplace facilitator or operator is typically liable for collecting, reporting, and remitting sales tax.

However, suppose the online marketplace sellers make sales through online marketplaces and other channels. In that case, they are responsible for charging, collecting, and remitting sales tax on sales made outside of online marketplaces. In contrast, a marketplace facilitator is responsible for collecting and remitting tax for sales made through the marketplace.

Marketplace Facilitators

Marketplace facilitators are defined as platforms that enable third-party sellers to offer and sell goods and services to consumers. More specifically, they facilitate sales for marketplace sellers through marketplaces and, directly or indirectly, through any agreement or arrangement with third parties, collect payments from consumers, and transmit them to the marketplace sellers.

These platforms have arguably been the most impacted group post-Wayfair. Considering the power and the scale at which they operate, states decided to shift the burden of sales tax compliance onto these platforms, requiring them to collect and remit sales tax on behalf of third-party sellers once certain thresholds are met.

Therefore, in addition to collecting, reporting, and remitting sales tax on their sales, marketplace facilitators must also do so for the sales that they facilitate. Depending on the state, they must either submit a single tax return for all sales or file separate tax returns for their sales and facilitated sales.

Conclusion

The Wayfair ruling marks a fundamental turning point in the regulation of the e-commerce industry and how state Tax Authorities treat e-commerce businesses. By establishing a new economic requirement for sales tax purposes, the Supreme Court acknowledged the evolving nature of the economy. Moreover, it leveled the tax playing field between traditional and digital retailers.

However, this evolution in the regulatory framework came with a cost, such as increased complexity and compliance burdens for remote and marketplace sellers and facilitators. The post-Wayfair era is one of adaptation, where the rules significantly vary from one US state to another, require constant monitoring, and are still considered a maturing regulatory environment.

Source: Supreme Court of the United States - South Dakota v Wayfair, Inc., Supreme Court of North Dakota - Quill Corp. v. North Dakota, VATabout - US – Challenges for Tax Compliance of the Foreign E-Commerce Providers, VATabout - South Dakota Sales and Use Tax Guide for Retailers & E-Commerce Sellers, Washington Department of Revenue, Vermont Department of Taxes, Maurer School of Law: Indiana University - Taxing E-Commerce in the Post-Wayfair World, VATabout - Americas Tax Guides and Resources