As anyone who follows tax news is by now likely aware, on June 21, 2018, the United States Supreme Court issued a landmark ruling, South Dakota v. Wayfair, Inc. (2018), which increased states’ powers to collect sales tax from online merchants, such as Newegg, even without the physical, brick-and-mortar presence historically required to establish economic nexus (and in turn, trigger sales tax collection requirements). The ultimate consequences of Wayfair are yet to crystallize, as various states still in the process of evaluating their existing sales tax laws and requirements for Nexus. However, one fact is clear: the decision has drawn considerable attention from various government agencies tasked with the administration of sales tax laws, such as the California Department of Tax and Fee Administration (CDTFA). Translation? We can likely expect to see an increased number of sales tax audits as the California government takes measures to enforce compliance with the ruling. If you’re a small business owner, make sure you’re prepared by working with an experienced California sales tax audit lawyer.
Our California tax audit attorneys have discussed June’s Supreme Court Wayfair ruling in two previous articles, which are available here and here. For the unfamiliar, here is a brief overview of the ruling and its significance:
For over 20 years, a case known as Quill Corporation v. North Dakota (1992) established a precedent that effectively disallowed states from forcing retailers to collect and remit sales tax if they lacked a “physical presence” in the state: for example, online retailers. This ruling stood on a foundation established even earlier through National Bellas Hess v. Illinois Department of Revenue (1967), in which the Supreme Court issued a similar decision. (Since Bellas Hess obviously predates the birth of e-commerce, the ruling pertained, at the time, to mail order distributors.)
The California Department of Tax and Fee Administration (CDTFA) is taking the position under Quill that if Amazon kept third party seller inventory in California warehouses (with or without the knowledge of the third-party seller) that is enough nexus to force the out of state third party seller to collect and remit sales tax on good sold in California. They are offering leniency if you cooperate with an audit in that they will only examine the past three years of California Sales tax and forgo penalties and ½ of the applicable interest if you meet the terms of this program. If you offer them any type of resistance they are threatening to audit 8 tax years and assess all available penalties and interest. Our office may be able to secure preferential treatment under the first option above if you bring us in immediate and let us negotiate on your behalf. We have also seen the CDTFA request Amazon reporting that shows the first date inventory was kept in California on behalf of a third-party seller and assessed all tax years from that date forward.
Wayfair is legally and economically important because it overturns these longstanding rulings, effectively stripping away any protection that online retailers once had against the burden – already familiar to brick-and-mortar businesses – of ensuring continual compliance with sales tax and economic nexus laws. Justice Anthony Kennedy (who retired just a month after Wayfair), writing the majority opinion for the Court, called the pre-Wayfair Quill decision, “as first formulated and as applied today… an incorrect interpretation of the [U.S. Constitution’s] Commerce Clause,” which allows Congress to “regulate commerce with foreign nations, and among the… states.”
The Wayfair decision applies a radically new interpretation, which each state, notwithstanding those which do not impose sales tax, is now working to assess and codify through sales tax statutes. Unsurprisingly, different states have had differing responses to the ruling. For example, starting December 1, 2018, the state of Connecticut will begin requiring online merchants to comply once they have both (1) surpassed a $250,000 gross revenue threshold, and (2) made at least 200 separate transactions during the prior calendar year. Other states, like New Hampshire, have gone in the opposite direction by resisting the ruling, with Governor Chris Sununu stating, “If you try to come into our state and force our businesses to collect a sales tax in a manner that violates our laws or the United States Constitution, you will be in for the fight of your life.”
While New Hampshire is gearing up to challenge Wayfair, California – which imposed some of the nation’s most rigorous tax and business regulations, even prior to the ruling – is taking a different approach, likely using the ruling as grounds to intensify already-aggressive sales tax enforcement efforts. After all, as a July 2018 article published in the Sacramento Bee pointed out, “Last fall, more than 2,500 online retailers with out-of-state addresses received letters from California’s Department of Tax and Fee Administration informing them that they appeared to owe sales tax here.”
The CDTFA is a relatively new organization, formed in 2017 through the passage of the California Taxpayer Transparency and Fairness Act. Today, the CDTFA administers many of the tax duties that were once performed by the Board of Equalization (BOE) – including confirming whether businesses (and individual taxpayers) are in compliance with California’s sales and use tax requirements. To quote the CDTFA website directly, “Retailers engaged in business in California must register with the… CDTFA and pay the state’s sales tax, which applies to all retail sales of goods and merchandise except those sales specifically exempted by law.” The CDTFA website also supplies taxpayers with a list of downloadable sales and use tax forms, such as CDTFA-401-A (State, Local, and District Sales and Use Tax Return) and CDTFA-531 (Schedule B – Detailed Allocation by County of Sales and Use Tax Transactions).
If the CDTFA detects discrepancies, omissions, or other anomalies on your sales tax forms – or if you have the unfortunate luck to be randomly selected by computer software – it is only a matter of time before your business will be chosen to undergo a sales tax audit. For example, a sales tax audit may be triggered by failure to report sales tax, filing sales taxes late, having an audit in your history, or even working with a business that has been audited.
In light of the Wayfair decision, which brings innumerable taxpayers (such as eBay and Etsy sellers) into its scope, sales tax audits are likely to spike in coming years – especially as California and other states iron out the details that are presently in the process of being clarified. Unfortunately, that can only mean one thing for business owners and online merchants: increased financial danger. If a sales tax audit reveals or confirms noncompliance with the new laws, you can be heavily penalized, and potentially, even criminally investigated for tax fraud.
If you are a small business owner or online seller with questions about complying with the changing state sales tax laws – or if you need help getting ready for an audit – turn to the Tax Law Office of David W. Klasing for assistance. We have helped numerous taxpayers settle complex sales and use tax controversies and are well-versed in the nuances of this evolving area of California tax law. For a reduced-rate consultation, contact the Tax Law Office of David W. Klasing online or call our law offices today at (800) 681-1295.
Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices San Bernardino, Santa Barbara, Panorama City, Oxnard, San Diego, Bakersfield, San Jose, San Francisco, Oakland and Sacramento.
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