How the Recent Supreme Court Sales Tax Ruling Will Affect E-Commerce and SaaS Companies

sales tax

About a month ago, a landmark court ruling quietly changed the sales tax landscape for many online retailers and remote software companies. According to the U.S. Supreme Court’s recent decision in South Dakota v. Wayfair, internet retailers can now be required to collect sales tax in states in which they lack a physical presence. In a strongly worded opinion, the Court’s ruling overturns 26 years of precedence, leaving companies to question how, and to what degree, this ruling impacts them.

Historically, states could only mandate companies to collect and remit sales tax on sales made to states where the taxpayer had physical presence (commonly referred to as the Quill physical presence rule). Generally, physical presence was denied as having employees or a physical location, such as an office or warehouse, in that state.

However, in recent years, states began a campaign to override the physical presence standard with a focus on online retailers. States began passing “economic nexus” laws, attempting to redefine or directly contradict the notion of physical presence. Specifically, these laws create sales tax nexus based on certain transactional thresholds.

Many regarded these efforts to tax out-of-state companies as reminiscent of “taxation without representation,” but the states had valid concerns. For example, under the physical presence standard, companies like Wayfair or Amazon had a pricing advantage compared to brick-and-mortar retailers. In a broader sense, technology companies, such as SaaS providers, were notable contributors to lost sales tax revenue — upwards of $33 billion each year.

For Wayfair specifically, at issue was South Dakota’s economic nexus law, which required companies to collect sales tax if it has at least $100,000 in sales or at least 200 transactions with customers in the state. In a 5-4 majority ruling, the Court overruled the  Quill physical presence precedent and deemed South Dakota’s economic nexus as Constitutionally appropriate. The Court reasoned that the state’s law better reflects today’s economy and referred to physical presence rule as “unsound and incorrect.”

What does this mean for technology companies?

Currently, 26 states have either passed or proposed a rule similar or even more aggressive than South Dakota’s economic nexus law — and that list is growing daily.

Considering this new ruling, SaaS companies are especially at risk of seeing a big tax burden. First, due to their cloud accessibility, SaaS companies often have a wider array of sales by state; thus, an elevated risk of expansive nexus. Second, the SaaS pricing model generally breaks out the contract into monthly transactions. Consequently, the common 200+ transaction portion of these economic nexus laws are far easier to meet under the SaaS pricing model. In other words, rather than needing to have 200 customers in a state, SaaS companies may trigger nexus with only 17 customers, perhaps fewer, in the event of other separately invoiced services.

Furthermore, a commonly-held belief in the technology community is the “service” portion of software-as-a-service means that sales tax has little to no significance. However, in conjunction with the Wayfair ruling, a growing number of states now require SaaS companies to collect sales tax on invoices.

Outside of an impending audit, a company’s exit strategy creates another impetus for companies to further evaluate the Wayfair impact. For example, when undergoing an acquisition, sales tax exposure is a frequent issue during due diligence; often requiring sellers to put a portion of the purchase price in a holdback escrow or, at times, cancelling the deal altogether. 

Companies should not take this ruling lightly. In no uncertain terms, Wayfair is a landmark ruling for e-commerce, online or remote sellers, with far-reaching implications. Wayfair alters the sales tax landscape, creating uncertainty for companies at all stages.

Brian Sengson is a tax attorney licensed with the State Bar of Georgia and a Manager of Bennett Thrasher LLP’s State & Local Tax practice.