Thursday, June 21, 2018

Online companies now have obligation to collect sales tax

The U.S. Supreme Court on Thursday held that states can assert nexus for sales and use tax purposes without requiring a seller’s physical presence in the state. The decision in South Dakota v. Wayfair, Inc., et al, No. 17-494 (U.S. 6/21/2018), overturns prior Supreme Court precedent in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), both of which had required retailers to have a physical presence in a state beyond merely shipping goods into a state after an order from an in-state resident before a state could require the seller to collect sales taxes from in-state customers. The Court concluded that each decision was an “incorrect interpretation of the Commerce Clause” (slip op. at 10).


South Dakota, like many other states, imposes a sales tax on the sale of goods in the state and a complementary use tax. Because compliance with the use tax on untaxed purchases from out-of-state vendors is low, South Dakota estimates it loses between $48 million to $58 million a year in sales-and-use-tax revenue from sales to state residents by out-of-state businesses that do not collect sales tax for the state. Because it has no income tax, its sales tax revenue makes up about 60% of the state’s funds each year, so the loss of those funds is substantial (slip op. at 2–3).

To try to counteract the loss of this revenue, in 2016, South Dakota enacted a law, S.B. 106, requiring out-of-state sellers that annually delivered more than $100,000 of goods or services into the state or engaged in 200 or more separate transactions for the delivery of goods or services into the state to collect and remit sales taxes to South Dakota (slip op. at 3). South Dakota’s new law prohibited retroactive application of this requirement and also provided that the law could be stayed until it had been determined to be constitutional.

Because South Dakota’s Legislature was aware that its new law would be unconstitutional unless Quill was overturned, it included a provision for expeditious judicial review if the law was challenged. Therefore, South Dakota filed a declaratory judgment action in state court against Wayfair Inc.,, and Newegg Inc., all large internet merchants that have no employees or real estate in South Dakota and do not collect sales tax for the state. The state also sought an injunction requiring these companies to register for licenses to collect and remit sales taxes as required under the act. The companies moved for summary judgment in state court, arguing that the act is unconstitutional. After the law was declared unconstitutional by South Dakota courts, the Supreme Court granted certiorari.

Supreme Court decision

The Supreme Court’s decision was written by Justice Anthony Kennedy, who in Direct Marketing Ass’n v. Brohl, 135 S. Ct. 1124 (2015), had suggested that it was time to reconsider the Quill decision given economic and technological changes since it was decided in 1992. He was joined by Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel Alito, and Neil Gorsuch. Thomas and Gorsuch filed concurring opinions. Chief Justice John Roberts wrote a dissenting opinion, joined by Justices Stephen Breyer, Sonia Sotomayor, and Elena Kagan.

In deciding to overrule Quill and Bellas Hess, the Supreme Court found that the rule in Quill banning sales tax collection when businesses lack “physical presence” in a state was an incorrect interpretation of the Commerce Clause. The Court criticized the Quill decision on several grounds. First, the physical presence rule is not a necessary interpretation of the “closely related” nexus requirement from Complete Auto Transit v. Brady, 430 U.S. 274 (1977). Second, the Court found that Quill creates, rather than resolves market distortions, calling it a “judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services” to a state’s residents (slip op. at 13). Third, the Court found that Quill imposes “arbitrary, formalistic” distinctions that run counter to the Court’s modern precedents under the Commerce Clause (slip op. at 10). For example, a business that holds a few items of inventory in a state would be required to collect sales tax in the state under Quill, while an online retailer with pervasive sales in the state would not, a distinction that the Court said, “simply makes no sense” (slip op. at 14).

With regards to stare decisis, the doctrine that court precedent generally must be followed, the Court found that the doctrine does not justify the prohibition of a valid exercise of the states’ sovereign power, and, if a prior decision did so, the Court must be vigilant to correct its error, and that the Court should not ask Congress to fix an error of the Court’s making.

The Court noted that the Quill rule actually discouraged interstate commerce by creating incentives to avoid economic activities in many states. The Court continued: “When the day-to-day functions of marketing and distribution in the modern economy are considered, it is all the more evident that the physical presence rule is artificial in its entirety” (slip op. at 14).

The Court also rejected arguments that the physical presence test aids interstate commerce by preventing states from imposing burdensome taxes or tax collection obligations on small or startup businesses. The Court concluded that South Dakota’s tax collection plan was designed to avoid burdening small businesses and that there would be other means of protecting these businesses than upholding Quill (slip op. at 22).

Finally, the Court stated that in the absence of Quill and Bellas Hess, the first prong of the Complete Auto test simply asks whether the tax applies to an activity with a substantial nexus with the taxing state, and in South Dakota’s case, the nexus is clearly sufficient, because the South Dakota sales tax act applies only to sellers who engage in a significant quantity of business in the state, and Wayfair,, and Newegg are large, national companies that undoubtedly maintain an extensive virtual presence.

Therefore, the judgment of the South Dakota Supreme Court invalidating South Dakota’s out-of-state sales tax collection requirement was vacated and remanded for “further proceedings not inconsistent with this opinion,” i.e., it allows South Dakota’s law to be put into effect by lifting the state’s injunction (slip op. at 24).

In his dissenting opinion, Roberts argued that, although he agreed that Bellas Hess was wrongly decided and that the enormous growth in internet commerce in the interim years has changed the economy greatly, Congress was the correct branch of government to establish tax rules for this new economy. He also took issue with the majority’s conclusion that the burden on small businesses would be minimal.

Looking forward

Congress may now decide to move ahead with legislation on this issue to provide a national standard for online sales and use tax collection, such as the Remote Transactions Parity Act or Marketplace Fairness Act, or a proposal by Rep. Bob Goodlatte, R-Va., that would make the sales tax a business obligation rather than a consumer obligation. Under that proposal, sales tax would be collected based on the tax rate where the company is located but would be remitted to the jurisdiction where the customer is located. The AICPA has submitted comments on the Marketplace Fairness Act, noting some concerns and suggested improvements if Congress decides to proceed with such a bill.

Last week, the AICPA testified and submitted written comments opposing the Multistate Tax Commission’s model sales-and-use-tax notice and reporting statute. The AICPA urged the MTC and its member states to not adopt the draft model statute because it is contrary to good tax policy, has many costs and few benefits, and will lead to further complications and burdens on customers, sellers, marketplace facilitators, and referrers, as well as the state.

Thanks to Sally P. Schreiber who is a JofA senior editor for this concise reporting..

Wednesday, June 20, 2018

Tax planning for the new Trump tax law

Form 1040, U.S. Individual Income Tax Return, is one of the most important documents that CPAs who do tax work will encounter. In addition to providing a view of the current tax situation, the form also provides insights into planning opportunities, and CPAs may want to make a Form 1040 review one of the first steps in a new client engagement.
“The 1040 always tells us a lot about the personality of a client,” said Alpa Patel, CPA, tax partner in the Atlanta office of Charlotte, N.C.-based DHG. “It gives a lot of insight into the individual and their preferences.”
For instance, in one case, Patel and her colleagues noted that a client had Schedule C income but was not contributing to a SEP IRA. After pointing this out, the CPAs helped the client set up the account and take advantage of the above-the-line deduction.
Speaking at the AICPA ENGAGE 2018 conference on Tuesday in Las Vegas, Patel and her colleague Tara Thomas, CPA, senior tax manager at DHG, highlighted some of the ways CPAs can use clients’ tax filings to uncover planning strategies, including:

Stacking charitable contributions

When reviewing a tax return, pay special attention to any itemized deductions, especially those for charitable donations. Given the changes made by P.L. 115-97, known as the Tax Cuts and Jobs Act, clients will likely need to rethink their giving strategies.
The new standard deduction of $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for all other individuals means that many clients will no longer itemize deductions, Patel said.
That presents challenges for charitably minded clients, who may not be able to realize the same benefit for their gifts as before. Depending on the client’s charitable goals, you might recommend a strategy known as stacking or bunching deductions, Patel said.
For example, instead of making five $10,000 donations in five consecutive years — which, when combined with other deductions, may not push the donor over the standard deduction threshold — clients can “stack” $50,000 worth of gifts into one year.
“It’s the tax-smart way of giving,” Patel said.

Making sure clients’ investments are tax-efficient

Another reason to scour the tax return is to figure out whether the client’s investments provide the best after-tax return. For example, if a client is projected to be in the 0% capital gains bracket, Patel and her clients look for opportunities to sell appreciated investments in order to maximize the bracket.
Additionally, some clients might benefit from municipal bonds. “You might get a lower return, but [once] you factor in the taxes, you’ll get a higher after-tax return,” Patel said.

Determining whether they have the right type of 401(k)

A tax return can also tell you whether a client has been investing in a traditional or a Roth 401(k). This is the first step in evaluating the optimal 401(k) strategy.
Retirement savers like the Roth version of the 401(k) because it allows them to invest after-tax money in exchange for tax-free growth and withdrawals. However, high earners need to weigh the desire for tax-free retirement income against their current tax liability. A traditional 401(k) would allow them to deduct substantial sums.
“Generally speaking, in retirement you’ll likely pay lower tax if you’re in the highest tax bracket today,” Patel said. “And while people want their money to grow tax-free, they’re paying a lot of tax now when they could really use the deduction.”
Patel also recommended that CPAs perform an analysis on the rate of return of their clients’ portfolios. Clients with a high risk tolerance (and therefore a potential for higher returns) might still fare better with a Roth, given that type of portfolio’s potential higher returns, despite the present tax hit.

Reducing taxable retirement income

A Form 1040 also outlines the sources of income that are available for clients in retirement. In the years leading up to retirement, clients should plan to minimize taxable retirement income.
First, anyone with a nondeductible individual retirement account needs to keep track of its basis to avoid having 100% of the distribution becoming fully taxable in error.
“A portion of the distribution from the nondeductible IRA would be tax-free because they have basis,” Patel noted. “This is often overlooked.”
Additionally, CPAs should anticipate how much of their clients’ Social Security will be taxable. Those who are at least age 70½ must start taking required minimum distributions from most retirement accounts, but that additional income could trigger higher taxes on Social Security, rendering up to 85% of it taxable, a situation often referred to as the “tax torpedo.”
Structuring withdrawals differently in the years leading up to age 70½ could minimize those taxes, Patel said. Taking more withdrawals from traditional retirement accounts early could lessen the amount of Social Security income that’s taxable.
Thanks to Iliana Polyak, a Massachurssets Free Lance reporter for assembling much of this information.

Sec 179 allowed property for 2017 tax reporting years

FS-2018-9, April 2018

The Tax Cuts and Jobs Act, signed Dec. 22, 2017, changed some laws regarding depreciation deductions.

Businesses can immediately expense more under the new law

A taxpayer may elect to expense the cost of any section 179 property and deduct it in the year the property is placed in service. The new law increased the maximum deduction from $500,000 to $1 million. It also increased the phase-out threshold from $2 million to $2.5 million.

The new law also expands the definition of section 179 property to allow the taxpayer to elect to include the following improvements made to nonresidential real property after the date when the property was first placed in service:

  • Qualified improvement property, which means any improvement to a building’s interior. Improvements do not qualify if they are attributable to:
    • the enlargement of the building,
    • any elevator or escalator or
    • the internal structural framework of the building.
  • Roofs, HVAC, fire protection systems, alarm systems and security systems.

These changes apply to property placed in service in taxable years beginning after Dec. 31, 2017.