South Dakota v. Wayfair, decided by the U.S. Supreme Court on June 21, 2018, is arguably the most significant state and local tax (SALT) decision of the past several decades. The Wayfair court overturned 50 years of precedent and upended what had been a bright-line physical presence sales/use tax nexus standard that had been established in National Bellas Hess, Inc. v. Department of Revenue and upheld in Quill Corp. v. North Dakota. Wayfair undoubtedly has a significant impact on sales tax, however, the decision also has a significant impact on retroactive and prospective nexus positions regarding other state taxes, including income tax.
Impact on Income Tax
Unlike sales/use tax nexus, the question of whether physical presence was necessary for the imposition of a state income tax has been the subject of uncertainty. In light of the Wayfair conclusion that physical presence is not required to establish constitutional nexus, taxpayers need to now revisit positions they may have taken regarding the need for physical presence in order to establish income tax nexus as well as sales/use tax nexus.
Economic nexus and market-based sourcing can trigger retroactive and current income tax nexus. For example, in Q2 2018, Wells Fargo recorded an estimated $481 million net discrete income tax expense primarily related to state income taxes and driven by the Wayfair decision. Although Wayfair dealt with the prospective application of sales/use tax, retroactive income tax application is possible. If a return is never filed, the statute of limitations does not run, and a state can go back to collect taxes from the date that the business had the requisite economic nexus in that particular state.
It is important to note that the Wayfair decision does not overrule Public Law (P.L.) 86-272, and it must still be considered with regards to assessing income tax nexus for companies selling tangible personal property.
Qualification
The following taxpayers will see an impact to their income tax under Wayfair:
In addition, taxpayers with significant throwback may have a corresponding refund opportunity related to the application of Wayfair nexus.
Financial Considerations and Timing
Taxpayers should evaluate the impact of the decision on their existing tax positions involving nexus (income tax and sales/use tax) and consider how their contingent liabilities and liabilities for unrecognized tax benefits are impacted.
In addition, it is important to understand that the impact to taxpayers is immediate. Any financial statement impact of this decision should have been accounted for during the second quarter of 2018. There may also be refund opportunities to those taxpayers with significant throwback sales in any state.
If your business has not already performed a Wayfair nexus study and threshold analysis, we strongly recommend you do so immediately to evaluate your prior-period physical presence nexus, review the potential liabilities, lookback period, penalties and more, and determine the most beneficial next steps.
To evaluate the state tax impacts of Wayfair as it relates to your specific tax situation, or to request a Wayfair nexus analysis, contact: Alex Thacher or Malcolm Ellerbe, CPA.
February 09, 2019
