Are nonprofits that sell goods liable for state sales tax, like for-profit businesses? And does the answer change if sales are made via the Internet? Nonprofits may indeed owe state sales tax for their sales, depending on their specific activities and extent of available state nonprofit exemptions. In the wake of the U.S. Supreme Court’s June 2018 South Dakota v. Wayfair, Inc. decision, such liability may include online sales – for both businesses and nonprofits. This is huge news for giant retailers like Wayfair and Amazon, but what does it mean for nonprofit sellers?
The Legal Landscape of State Sales Tax Liability
As a general proposition, states uniformly impose sales tax liability on retail sales. Such tax liability is technically owed by consumers who purchase goods, but business vendors are legally responsible for collecting and remitting the taxes to state Departments of Revenue. Within the nonprofit context, the taxability of retail sales is highly state-specific. For example, under Illinois law, nonprofits must collect taxes on retail sales except for non-commercial transaction like sales to members, internal school or hospital sales, and occasional sales primarily for fundraising purposes. Other states similarly exempt occasional sales or sales occurring for a very limited time period (e.g., Ohio – exempt if less than six days of sales per year). For further background on nonprofit state sales tax liability, see our blog post here.
Notably, this sales tax liability is different from sales tax liability that nonprofits may owe on their retail purchases. The focus here is on their sales.
Selling Across State Laws – Physically and Virtually
The question for our modern, online times is whether the location of the sales transaction makes any difference. In other words, do sellers owe sales tax liability for only sales made physically within their state (and subject to state-specific nonprofit seller exemptions)? Or are sellers liable for sales taxes in other states where their purchasers are located? If the latter is true, then sellers could face legal obligations to state Departments of Revenue across the country, with daunting registration and payment requirements for smaller retailers.
The U.S. Supreme Court’s June 2018 decision in South Dakota v. Wayfair, Inc. answers this question affirmatively for multi-state sales tax liability – so long as the state has safeguards in place exempting smaller retailers. Wayfair thus reversed course from the Court’s prior 1992 decision in Quill Corp. v. North Dakota, effectively recognizing that internet sales have so drastically changed the legal landscape as to warrant a new multi-state sales tax approach.
The Wayfair Decision
The case involved a challenge by Wayfair and two other large-scale internet retailers to a South Dakota statute requiring out-of-state retailers to collect and remit sales taxes in the event that a retailer: 1) sells more than $100,000 worth of merchandise in the state; or, 2) engages in 200 or more separate transactions in South Dakota. The statute thus provided two significant tax threshold, to screen out smaller retailers (or those with relatively minimal sales there) for which sales tax liability could be a relatively significant burden in proportion to their sales activity. Wayfair and the other large retailers each met the minimum sales and transaction requirements, but they did not collect sales tax because they had no employees, real estate, or physical business locations in South Dakota.
A retailer’s physical presence within a particular state has long been constitutionally required, in order for it to be liable for collection and remittance of sales tax. Before Wayfair, any physical presence was enough to justify tax, no matter how small the organization’s operations. In like fashion, the lack of physical presence was enough to avoid tax, no matter how high the sales volume in the subject state.
Through its Wayfair decision, the Supreme Court moved away from this constitutional framework. Perhaps in keeping with more recent economic realities, the Court ruled that “presence” in a particular state need no longer be a physical, brick-and-mortar building, but it can also be defined as purely virtual contacts through internet sales. As the Court determined, this legal approach ends the “arbitrary advantage” existing in favor of online retailers. As the Court further observed, justice and equity support businesses which “avail themselves of the states’ benefits to bear an equal share of the burden of tax collection.” The Court acknowledged the potentially significant resulting tax compliance burdens, but such implications “cannot justify retaining this artificial, anachronistic rule that deprives States of vast revenues from major businesses.”
Upholding the South Dakota statute as constitutional, the Court determined that the requisite “presence” was satisfied by the retailers’ “substantial nexus” (or contacts) with the state of South Dakota including virtual presence, sales volume, transaction volume, and other factors, in addition to physical presence. In so ruling, the Court favorably noted the minimum financial and transactional tax thresholds for lower-activity retailers, as key elements of the statute’s constitutionality. Correspondingly, the Court’s decision thus avoided the question of whether states can impose sales tax on retailers who make any online sales to state residents regardless of the sales volume. Rather, the Court approved South Dakota’s lawful ability to impose the responsibility of sales tax collection and remittance on retailers that meet specified sales and transaction thresholds.
What Does Wayfair Mean for Nonprofit Sellers?
The South Dakota legislature did a careful and impressive job in crafting its sales tax legislation, with the expectation of a constitutional challenge and judicial scrutiny. Will other states follow suit and enact similar legislation? That may be quite likely, particularly given the potential availability of new tax revenue streams and the political pressure from in-state “brick and mortar” retailers to level the overall retail sales playing field. Notably, the Court in Wayfair observed that 41 states, two territories and the District of Columbia advocated rejecting the prior physical presence rule per Quill, thereby indicating widespread governmental readiness to impose sales taxes widely on online sellers.
What does this legal change mean for nonprofits that engage in retail sales? Such activity may be minimal (as it generally should be for continued tax-exempt status), but nonetheless appropriate for careful attention and follow-through.
First, nonprofit leaders should check on their sales activity and any applicable state law exemptions. Is your nonprofit selling goods? If so, has the nonprofit registered with the state Department of Revenue, or does an exemption apply? Examples and exemptions vary widely, so a careful legal evaluation is essential.
Second, is the nonprofit’s sales activity carried out via the internet and/or over state lines? If so, a nonprofit should keep in mind the following points. Until Wayfair, only sales activity to purchasers located in a state as the nonprofit have been taxable. Post-Wayfair, nonprofits’ sales to purchasers in South Dakota may be subject to sales tax liability, if such sales meet the specified volume thresholds. In addition, the determination of whether purchasers are in the same state as the nonprofit depends on where the nonprofit is physically located, and that may include the nonprofit’s home office, locations where it carries out program activities, and other places where the nonprofit has significant physical connections (e.g., multiple conferences, donor relations, etc.)
Third, nonprofits may need to register with one or more state Departments of Revenue, and in some states they may need to file registrations to do business, which likely will add compliance burdens. Complying with various complex state tax systems may require considerable adjustments in operations and tracking technology, and as well as possibly service firms to assist nonprofits in implementing updated tax collection processes. For many nonprofits, it may be sufficient to identify state-specific sales activity, determine where a nonprofit is sufficiently present in a particular state, evaluate whether any nonprofit exemption applies, and then register, collect, and pay state sales tax in the limited states of applicable liability.
Fourth, nonprofits may need to revisit – or consider anew – their multi-state charitable registrations. This area is markedly different from state sales tax liability, because it involves consumer protection policing of fundraising activity by state Attorneys General. Nevertheless, it involves a similar type of legal analysis, with a state-by-state determination of the nonprofit’s activity in each state, the applicability of potential exemptions (financial thresholds, religious, other), registration requirements, and ongoing compliance. Notably, the threshold for triggering a nonprofit’s charitable solicitation registration obligations is generally lower than for triggering state sales tax liability. But both involve the sometimes headache-inducing evaluations of state-by-state legal patchworks for registration and ongoing regulatory compliance.
Acting Now – and Waiting
Many nonprofits never engage in retail sales, so Wayfair is of no import to them. Other nonprofits keep their retail sales within local spheres with applicable sales tax exemptions, so again Wayfair is inconsequential. But for nonprofits that sell goods over the Internet, or within states with no nonprofit exemption, the tax man surely cometh. And Wayfair just may pave the way for additional tax liability. Prudent nonprofit leaders thus should check on their sales tax liability compliance now. In addition, they should monitor what states will follow South Dakota’s lead in imposing retail sales tax liability on out-of-state retail sellers – hopefully with an ample low-volume threshold to exempt their own nonprofit!
