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Analysis

'Wayfair'—potential income tax nexus ramifications

Multistate Tax alert | June 28, 2018

This tax alert addresses the potential implications of the Court’s overturning 'Quill’s' physical presence requirement relative to other state and local taxes, notably income tax.

Overview

On June 21, 2018, the US Supreme Court decided what is arguably the most important state tax case of the last 25 years in Wayfair et. al.1 In a 5–4 split decision, the majority overruled the brightest of state tax bright-line rules in overturning the sales/use tax nexus standard of physical presence previously established in National Bellas Hess (1967)2 and later upheld in Quill (1992).3

For further information on the Wayfair decision and the potential implications for remote sellers overall, please see our US Supreme Court overturns Quill’s physical presence standard tax alert. For further information on the potential state tax implications of Wayfair for non-US companies with US customers, please see our State tax implications of Wayfair for non-US companies with US customers tax alert.

Income tax nexus implications of 'Wayfair'

While Wayfair will have a significant impact on sales and use tax collection obligations, the decision may also impact nexus positions taxpayers have taken with regard to other taxes, notably income tax.

Since the Court’s decision in Complete Auto (1977),4 a taxpayer’s activity must have a substantial nexus with the taxing state to support the imposition of the tax. In Quill, the Court drew a distinction between nexus required to satisfy the Due Process Clause versus nexus required to satisfy the Commerce Clause, providing the Commerce Clause's “substantial-nexus requirement is not, like due process' minimum contacts requirement, a proxy for notice, but rather a means for limiting state burdens on interstate commerce.”5

Under the Quill analysis “a corporation may have the ‘minimum contacts' with a taxing state as required by the Due Process Clause, and yet lack the ‘substantial nexus' with the state as required by the Commerce Clause.”6

Quill overruled the due process nexus holding of Bellas Hess but not the Commerce Clause holding, “grounding the physical presence rule in Complete Auto’s requirement that a tax has a ‘substantial nexus’ with the activity being taxed.”7 However, the Court in Wayfair has now clearly established that “[p]hysical presence is not necessary to create a substantial nexus.”8

Whether physical presence is necessary for the imposition of income taxes has been the subject of uncertainty for the last several decades as well. In 1993 the South Carolina Supreme Court held that physical presence was not required for the imposition of income tax and that Quill’s physical presence standard was limited to only sales and use tax.9 To date, however, the Supreme Court has not granted certiorari in any such case pertaining to economic nexus. In recent years, a number of states have enacted so-called “factor-based” economic presence nexus standards for income or gross receipts-type taxes.10

For example, Alabama law provides, effective for tax years beginning after December 31, 2014, that factor-based presence nexus standards exist for business activity for purposes of business privilege tax, income taxes, and financial institution excise taxes if any of the following thresholds are exceeded during the tax period: (1) $50,000 of property; (2) $50,000 of payroll; (3) $500,000 of sales; or (4) 25 percent of total property, total payroll, or total sales.11

In light of the Court’s unequivocal statement in Wayfair that physical presence is not a necessary element for “substantial nexus,” and the Court’s review and approval of South Dakota’s economic nexus sales tax statute, taxpayers will need to revisit positions they may have taken regarding both sales/use taxes and other taxes and the need for physical presence in order the establish substantial nexus.

While the facts at issue in Wayfair involved a statute with prospective application, potential retroactive application and enforcement to the effective date of a state’s applicable income tax nexus statute or rule are possible. This landmark decision will also receive careful consideration by other states which may seek to enforce or adopt economic factor-based presence nexus provisions in light of the Wayfair decision.

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Public Law 86-272 considerations should not be overlooked

The Wayfair decision does not overrule P.L. 86-272 in the state income tax setting. While certain states have adopted sales-based nexus provisions for income tax purposes, P.L. 86-272 remains in force and prohibits states from levying a net income tax upon an out of state company if the company’s activities in a state are limited to the solicitation of orders for the sale of tangible personal property and the orders are approved and filled from outside the state. More specifically, P.L. 86-272 states “a person shall not be considered to have engaged in business activities within a state during any taxable year merely by reason of sales in such state.”12

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Financial statement implications

Companies should evaluate the impact of the decision on their existing tax positions involving nexus (i.e., with respect to income taxes, as well as sales/use tax) and consider what impact, if any, the decision has on both their contingent liabilities and liabilities for unrecognized tax benefits.

Because the decision discussed in this tax alert was rendered on June 21, 2018, any impact of this decision on income taxes should be accounted for in the financial reporting period including June 21, 2018.

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Contacts:

If you have any questions regarding the sales and use tax implications of this important decision, please contact any of the following Deloitte Tax LLP professionals:

Valerie C. Dickerson, partner, WNT-MTS, Deloitte Tax LLP, Washington DC, +1 202 220 2693

Michael J. Bryan, managing director, WNT-MTS, Deloitte Tax LLP, Philadelphia, +1 215 977 7564

Kenneth Jewell, managing director, WNT-MTS, Deloitte Tax LLP, Parsippany, +1 973 602 4309

David Vistica, managing director, WNT-MTS, Deloitte Tax LLP, Washington DC, +1 202 370 2268

Alexis Morrison-Howe, senior manager, WNT-MTS, Deloitte Tax LLP, Boston, +1 617 437 2345

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Multistate Tax alert archive

The Multistate Tax alert archive includes external tax alerts issued by Deloitte Tax LLP's Multistate Tax practice during the last three years. These external alerts highlight selected developments involving state tax legislative, judicial, and administrative matters. The alerts provide a brief summary of specific multistate developments relevant to taxpayers, tax professionals, and other interested persons.

View the list of archived Multistate Tax alerts.

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References

1 South Dakota v. Wayfair, Inc., et al., No. 17-494 (June 21, 2018) 585 US. A copy of the decision is available here.

2 National Bellas Hess, Inc. v. Department of Revenue, 386 US 753 (1967).

3 Quill Corp. v. North Dakota, 504 US 298 (1992).

4 Complete Auto Transit Inc. v. Brady, 430 US 274 (1977).

5 Quill Corp. v. North Dakota, 504 US 298, 313 (1992).

6 Id.

7 Wayfair, US Supreme Court, Dkt. 17–494, (6/21/2018).

8 Id.

9 Geoffrey, Inc. v. South Carolina Tax Comm'n, 313 SC 15 (1993), cert. denied, 510 US 992 (1993).

10 States with statutes or promulgated administrative rules that apply a factor or sales-based nexus rule for income (or gross receipts) tax purposes currently include Alabama, California, Colorado, Connecticut, New York State, Ohio (Commercial Activity Tax), Tennessee, and Washington (Business & Occupation Tax).

11 Act 505 (H.B. 49), First Special Session, Laws 2015.

12 15 U.S.C. § 381(c).

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