Can the states utilize the taxman to cure its ills

 

Many states including my home state of Illinois, do not allow out-of-state retailers to ship to in-state customers. Problematically for these states enforcing these laws are tough and sometimes close to impossible. States try different methods to stop out-of-state retailers from shipping to in-state customers, but the states really lack a strong deterrence for stopping these shipments.

However, the U.S. Supreme may have handed the states a real powerful tool for enforcing these shipment bans. In the recent U.S. Supreme Court decision in Wayfair, the Supreme Court overturned its precedent that the Commerce Clause restricted a state from imposing a sales tax unless a business had a physical presence in the state. South Dakota v. Wayfair, Inc., No. 17-494 (S. Ct. June 21, 2018)

Previously, a state could not impose a sales tax on an out-of-state retailer without a physical presence in the state. Now, based on the new ruling, a state could impose a sales tax liability on an out-of-state retailer whose activity is limited to shipping wine into the state. The possibility now exist for an out-of-state retailer to be involved in tax avoidance and be charged with tax evasion.

Today, I will look at how Wayfair changes the whole enforcement landscape and whether it will act as a powerful tool for the states to enforce their laws.

 

The Present state of state laws and their ineffectiveness

States tried many methods to deter out-of-state retailers from shipping into the state. Whether any of the these methods worked is debatable and if they worked, they were often times effective after an out-of-state retailer already violated the state specific laws.

So the goal for the states is an up front deterrence that keeps out-of-state retailers from making shipments in the first place.

To use Illinois as an example, Illinois attempted to deter illegal out-of-state shipments of wine by making it a Class 4 felony to ship 45 liters or more of wine into the state. Further, a person, regardless of the amount shipped, that was issued a cease and desist letter to discontinue shipping into Illinois and failed to do so and continued shipping, could be subject to a Class 4 felony.

The first aforementioned violation generally does not apply to out-of-state retailers shipping wine into the state. This generally deals with a party that smuggles large quantities of liquor into Illinois from a border state. There is no case that I know of where an out-of-state retailer was charged with a Class 4 Felony for shipping wine into the state.

The second aforementioned violation is the one most relevant to out-of-state retailers shipping into Illinois. The state sends these letters out after it notices that an out-of-state retailer shipped into Illinois. It is difficult to discern the effect of cease and desist letters have on an out-of-state retailer.

However, what is obvious is that Illinois laws did not stop the initial action of shipping wine into the state illegally.

 

Does the state have the holy grail that will stop out-of-state retailers from shipping wine in?

With the present laws clearly not deterring out-of-state retailers from shipping into the state, does the recent decision in Wayfair allow the states to go after out-of-state retailers for tax evasion and provide the states with an effective deterrence mechanism?

On the surface it might seem so, Wayfair overturned the requirement that a state can only impose a sales tax liability on a company with a physical presence in the state. The Court held  that the physical presence test for sales and use tax nexus was unsound and incorrect.

So what results, does the state start going after out-of-state retailers for tax evasion and does the threat of tax evasion deter the out-of state retailers from shipping into the state? Remember it was tax evasion that brought down Chicago’s most famous criminal Al Capone, and it is being charged with tax evasion that puts the fear of God into average citizens.

In other words, could the states find their holy grail that keeps out-of-state retailers from shipping into the state?

 

The states’ ammunition is not as powerful as it seems

Although the Court overruled the physical presence standard for sale tax nexus, it did not provide the state with unlimited power to tax any sales activity whatsoever.

The Court took the view that to impose a sales tax there must be substantial nexus between the businesses activity and the state. In Wayfair the Court held that $100,000 worth of sales and more than 200 separate transactions constituted sufficient nexus based on both economic and virtual contacts.

Based on the facts in Wayfair, Illinois enacted an economic nexus rule which requires an out-of-state retailer to remit sales tax, if it makes sales of tangible personal property to Illinois customers and there are at least 200 separate sales transactions or $100,000 of gross receipts from sales to Illinois customers.[1]

So what is the answer to the question, will this new development in the law and these new state statutes act as a deterrence for retailers and prevent them from illegally shipping into the states?

Well for the states they could hold the stick of tax evasion over any out-of state retailer’s head. However, this stick is very soft unless the out-of-state retailer’s activity is significant in the state.

States may make pronouncements that retailers illegally shipping wine into the state will be subject to tax evasion charges.

But this is a case where the bark is much worse than the bite. Under Illinois law, only an out-of-stae retailer with significant activity should be sanctioned.

I assume the other states which do not allow out-of-state retailers to ship into the state, will also develop a minimum nexus standard threshold.

In the end, with the physical presence defense no longer available, the state has greater power to tax these out-of-state retailers, it has another bullet to use against them, however, because the out-of-state retailers activity needs to be significant and many won’t meet this threshold, the bullet is there but the color may not be silver.

 

 

[1] https://www.natlawreview.com/article/illinois-budget-bill-makes-few-tax-changes-except-adoption-economic-nexus-standard

2 thoughts on “Can the states utilize the taxman to cure its ills”

  1. Hi Sean, As ever I appreciate your post. You’re definitely right that the Wayfair decision opens up a lot more opportunity for states to tax remote sellers. However, you overlook the fact that most states that allow the direct-to-consumer shipping of alcohol (even those that allow out-of-state retailer do it) already require those shippers to collect and remit sales taxes. While nexus rules would typically prevent this, states get away with this by requiring DtC shippers to get a license in order to ship, and then condition getting that license on the winery or retailer first “voluntarily” accepting a sales/use tax liability in the state. There are a few states that don’t require this, where the Wayfair decision will have an impact on DtC shippers. But for the most part, DtC shippers (who are admittedly mostly wine producers, but in about 10 states can also be retailers) are ahead of the game when it comes to dealing with interstate sales/use tax collection and remittance.

    1. Thanks Alex for the comment. Yes, you are 100% correct that the license is what creates the ability to tax. With the license, the retailer consents to the taxing jurisdiction. Technically, they don’t have to consent to taxation based on no physical presence. But since registering with the state is a precondition for shipping into the state, I think they do so, and the alternative for small retailers to challenge the law is probably not worth it.
      In states like Illinois that don’t issue a license to retailers, they could utilize Wayfair as a way to go after businesses via tax evasion. However, this state charge should only be valid if the substantial nexus requirements are met.

      Thanks again, great comment

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