Much at Stake in U.S. Supreme Court Online Sales Tax Case

Today, the Supreme Court of the United States (SCOTUS) will hear oral arguments in South Dakota v. Wayfair. Wayfair Inc., Overstock.com and another online retailer challenged a South Dakota law that calls for them to collect South Dakota’s sales tax on their sales to South Dakota residents, even though the companies have no physical operations or physical presence in the state.

The online retailers’ position is supported by precedent. Over 50 years ago in National Bellas Hess Inc. v. Department of Revenue of Illinois (1967), SCOTUS found, based on Commerce Clause protections, that Illinois could not require an out-of-state business to collect its sales tax unless the business had a “physical presence” in Illinois.
This “physical presence” test was affirmed in Quill v. North Dakota (1992) when the Court ruled that North Dakota could not require a mail order company to collect its sales tax, again citing the requirement as an unreasonable burden on interstate commerce. But the Court’s opinion seemed to acknowledge that different circumstances could yield different results.

And much has changed since 1992. Most notably, the internet was only in its infancy then and online retailers were unheard of. The application of Quill to a transaction and industry that barely existed when the opinion was issued has generated growing debate over the last 10 to 15 years. Pressure to overturn Quill has steadily grown as internet sales swallow up a larger market share each year, traditional brick-and-mortar retailers see their profits decline, states see their revenues decline and the “burden” associated with collecting the taxes has been steadily lessened by technological advances.

Congress has the authority to legislatively overturn Quill but countervailing political forces have impeded it from remedying the situation. Consequently, states have legislated an array of their own remedies, in the form of imaginative and constitutionally suspect laws. As part of a concerted effort across the country, advocates for overturning Quill began a campaign designed to present a new basis for testing the Quill holding.

It encouraged states to impose laws they knew would be challenged, in order to get a fresh case before the Supreme Court and give them the opportunity to argue Quill’s legal obsolescence. The laws would purport to establish legal nexus based on the level of sales that online businesses conduct in their state. This concept is referred to as “economic nexus”.

In comes South Dakota – the first state to pass legislation imposing the collection requirement based on a defined economic nexus. If an online seller has more than $100,000 in sales or more than 200 separate sales to South Dakota residents, then that retailer must collect the sales tax in those transactions. The South Dakota law served as the model as a few other states passed nearly identical legislation, including Indiana (in 2017). South Dakota fast-tracked the litigation and here we are with a potential landmark case before SCOTUS.

Will Quill be overturned? It seems very possible. First, the Court took the case which could be interpreted as a recognition that the issue needs to be revisited. Second, three justices have questioned the application of the Quill case. And many stakeholders have presented legal arguments to support and encourage the Court to reach an updated result. Forty amicus curiae (friend-of-the-court) briefs have been filed since the Court decided to hear the case in January.

These include briefs filed on behalf of: various retail business associations, 41 states collectively, the National Governors Association, the National Conference of State Legislatures, the Council of State Governments, the National Association of Counties, the National League of Cities, four U.S. Senators (two Republicans, two Democrats) and the Solicitor General of the United States.

Numerous other organizations filed briefs, including: the Multistate Tax Commission, Streamlined Sales Tax Governing Board and Tax Foundation. One was filed on behalf of “professors of tax law and economics at universities across the United States”. All these can be viewed here. Some taxpayer advocates argued against giving states the authority to require collection. But a majority favor overturning Quill. Typical is the argument of the Solicitor General, stating in its brief:

“In light of internet retailers’ pervasive and continuous virtual presence in the states where their web sites are accessible, the states have ample authority to require those retailers to collect state sales taxes owed by their customers. Quill Corp. v. North Dakota, 504 U.S. 298 (1992), should not be read to bar that result, both because the Quill Court did not and could not anticipate the development of modern e-commerce and because Quill’s analysis was deeply flawed.”

The Tax Foundation, whose brief does not directly support either party, made some important points. It recognizes that the U.S. Constitution’s Commerce Clause prohibits states from unduly burdening or unfairly taxing interstate commerce. But it also recognizes that the current hodge-podge of state laws is untenable. The Tax Foundation maintains that the South Dakota law is constitutional because it minimizes the burden on commerce by adhering to uniform and standard administration. Its brief sums it up saying:

“The Court’s guidance is needed before the states subject interstate commerce to death by a thousand cuts. (And it asks that) the Court reverse the decision of the Court below and uphold the South Dakota statute, but also resolve an almost universal lack of clarity about the proper scope of state sales taxation of out-of-state entities.”

The outcome of this case, 50 years in the making, will have a significant impact on many people. States and local governments care about this case because there is around $20 billion of state tax revenues at stake. (Estimates range from $13 billion to $26 billion and the number will only get larger as time goes by.) Indiana’s share would probably be in the $200 million range, so the state’s budget makers care.

Brick-and mortar retail businesses in Indiana care because they must compete with online retailers and having to charge their customers the 7% Indiana sales tax puts them at a price disadvantage to the online sellers who don’t collect it. Indiana businesses that sell online to customers in other states care because they must comply with the expanding spectrum of varying state laws. Taxpayers should care because they are legally already obligated to pay use tax on their online purchase, whether they presently do or not, and because dwindling/unrealized revenues can spur tax increases elsewhere.

SCOTUS hearings are not broadcast. However, a recording of the oral argument will be made available the Friday following the hearing.

The Court’s decision will be made sometime before the end of June when its current term expires.

Tech Talk: Making Progress at the Statehouse

An Indiana General Assembly analysis at the midway point of the session is always a bit tricky. We can tell you the current status of legislation, but with the caution that more negotiations, compromises and refinements are on the way.

Clarifying the tax status of software as a service (SaaS) is among the high-priority items. Bill Waltz, our tax policy expert, shares this insightful update:

Bill Waltz

As is often the case, the House and the Senate each have their own ideas on how best to address big issues. That is the current circumstance regarding the taxability of software utilized as the means of providing a service. Obtaining greater clarity on this subject is a priority of the Chamber and the Governor.

Senate Bill 257 embodies the efforts of the administration to clarify tax law in this arena. It was largely formulated by the Department of Revenue (DOR) and the Office of Management and Budget to serve as guidance for what is taxable and what is not. The bill is basically a codification of recent DOR rulings interpreting and applying its own information bulletin, which outlines a complicated set of factors and tests. The legislation is focused on what constitutes a retail transaction (sale) of a tangible good.

Essentially, the position of DOR is to tax the sale of prewritten off-the-shelf type software, including such software even if it is downloaded or accessed over the internet. But if it is customized software or software utilized in connection with what is primarily a service to a customer, it is omitted from the new statute and deemed not taxable.

The determinations in gray areas will remain fact sensitive, but the language is intended to make it clearer that software services are not taxable. The statutory provisions should operate to make people in the SaaS industry more comfortable in concluding that they do not need to collect sales tax, unless they are engaged in a transaction that falls squarely into the retail product sale category as set out in the legislation.

On the other hand, HB 1316 takes a different approach. It uses similar language as is in SB 257 but adds several unique twists to the picture. First, it creates a new lesser rate for prewritten off-the-shelf type of software – with the apparent objective of identifying and monitoring the tax revenues associated with these transactions. It excludes transactions where the software is acquired by a business to perform its core business purpose. This business-to-business exemption component is of course a very positive thing and should be embraced. Finally, it looks to the long term potential of sales involving software as the industry continues to expand, plus creates a trigger reducing the standard sales tax rate for when total collections exceed $250 million (a threshold so high that it is hardly foreseeable in the near future.)

Perhaps it makes the most sense to combine the good pieces of these competing bills to produce the best end result. The Chamber sees much merit in doing all that is possible to clarify the state of the law regarding SaaS as is addressed in the Senate bill. This is needed and would be a positive step. But while unique aspects of the House bill present some real concerns, it also includes the most solid of tax principles – don’t tax business inputs. Exempting business-to-business transactions would prove a terrific encouragement to the SaaS industry to conduct their businesses in Indiana.

In the second half of the session, the Chamber will be leading the charge to resolve the SaaS clarification issue to the fullest extent possible.

A variety of other tech policy priorities are still in play. Here is a brief summary.

What’s Up With Federal Tax Reform

Is anything really happening? Yes.
Will something eventually get passed? Probably.

A group of key individuals who dubbed themselves the “Big 6” has been meeting for a few months and more intently in recent weeks. They include two members each from the administration (Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn), Senate (Majority Leader Mitch McConnell and Finance Committee Chair Orrin Hatch) and House (Speaker Paul Ryan and Ways and Means Chair Kevin Brady.)

Are they motivated to find common ground? Certainly. Is there a consensus? Not yet. Right now, they don’t even agree on whether, or to what extent, the legislation must be revenue neutral.

But they all seem to recognize that they need to do something – failure to coalesce is not in anyone’s interest. So what have they agreed on so far? The border-adjustment tax is out. Some method for allowing the repatriation of overseas earnings (at a one-time low-rate tax) is in. The corporate rate must drop to 25% or less (depending on how many deductions and breaks they can eliminate.) They appear to be embracing a way to allow small businesses to immediately deduct investments in new equipment and facilities, i.e. “full expensing.” On the individual income side, a collapsing of the brackets and lowering of rates (no details.)

Possible tradeoffs or “pay-fors” in tax circles: eliminating some business interest deductions, eliminating the state and local tax (SALT) deductions and capping the mortgage interest deduction. These are yet unsettled issues. But listen and watch closely to the SALT discussions going forward; there is a lot of money and a lot of political (with a small p) interest in this item. It is more a geographic than partisan issue because taking the SALT deduction away will have a significant negative impact on people (constituents of Republicans and Democrats) in states that have high state and local taxes. This item could have a big bearing on the entire effort and whether we get true reform or temporary tax cuts.

Tax cuts are the easy part for these folks. The hard part is finding ways to pay for reductions. The last true tax reform was in 1986, 31 years ago, and it required a lot of time and bipartisan buy-in. The Big 6 are all Republicans and they are anxious to get something done. They could mimic the Bush tax cuts of 2002 and 2003, passed through the reconciliation process, which means whatever they do expires after 10 years. Somewhat ironically, most of those Bush cuts were only made permanent as part of the Obama budget deal of 2012.

To recap the status of tax reform: Much remains up in the air.

Small Business Tax Rankings Released

The “Small Business Tax Index 2017: Best to Worst State Tax Systems for Entrepreneurship and Small Business” ranks the 50 states according to the costs of their tax systems for entrepreneurship and small business.

View an interactive U.S. map of “Small Business Tax Index 2017” results.

Raymond J. Keating, chief economist for the Small Business & Entrepreneurship (SBE) Council and author of the report, said: “While there is much discussion in Congress and the Trump administration about making the federal tax system more competitive, these issues obviously reach down to state and local levels as well. That’s the focus of SBE Council’s ‘Small Business Tax Index 2017.’ Specifically, which states are among the least burdensome in terms of taxes, and which inflict the weightiest burdens on small businesses?”

The SBE Council pulls together 26 different tax measures, and combines those into one tax score that allows the 50 states to be compared and ranked. Among the taxes included are income, capital gains, property, death, unemployment, and various consumption-based taxes, including state gas and diesel levies.

According to the “Small Business Tax Index 2017,” the 10 best state tax systems are: 1) Nevada, 2) Texas, 3) South Dakota, 4) Wyoming, 5) Washington, 6) Florida, 7) Alabama, 8) Ohio, 9) North Carolina, and 10) Colorado.

The bottom 10 include: 41) Connecticut, 42) Oregon, 43) New York, 44) Vermont, 45) Hawaii, 46) Iowa, 47) Minnesota, 48) Maine, 49) New Jersey, and 50) California.

Since last year’s report, several states have made significant tax changes.

Five states – Arizona, Indiana, New Hampshire, New Mexico, and North Carolina – have improved their tax climates by reducing their personal or corporate income tax rates. Other states – such as New Mexico and Tennessee – have scheduled changes that will improve their tax climates for entrepreneurship, business and investment in coming years. Unfortunately, all of the news is not good. Kansas, Maine and New York have made tax changes that are negatives.

Indiana Climbs in Small Business Policy Index

Indiana ranks seventh in the Small Business & Entrepreneurship Council’s 2017 Small Business Policy Index (up from 10th in last year’s ranking).

This is the SBE Council’s 21st annual look at how public policies in the 50 states affect entrepreneurship, small businesses and the economy. The report ranks the 50 states according to 55 different policy measures, including a tax, regulatory and government spending measurements.

According to the report, the most entrepreneur-friendly states under the “Small Business Policy Index 2017” are Nevada, Texas, South Dakota, Wyoming, Florida, Washington, Indiana, Arizona, Alabama, and Ohio. In contrast, the policy environments that rank at the bottom include Rhode Island, Oregon, Iowa, Connecticut, Maine, Hawaii, Vermont, Minnesota, New York, New Jersey, and California.

Taxes and Public Finance: A Very Early Look at What We Are Following

We have yet to see the complete list of bills that have been introduced, and no bills having primarily to do with tax have yet been heard in committee. But of those that are available for viewing and assigned to committee, quite a few are worthy of note. They may or may not ultimately get a hearing, so it cannot be said that they are moving. Nevertheless, these bills are ones to keep an eye on.

Two measures will undoubtedly move through to the end of session – albeit with the expected/unexpected twists and turns. House Bill 1001 on the budget currently contains the Holcomb administration’s spending proposals – that is until the Ways and Means Committee has its way with it. Accompanying it will be HB 1002, the measure for long-term transportation funding (see Mark Lawrance’s infrastructure story).

There are the usual sales tax exemption and sales tax holiday bills, which historically have not been favored by the budget makers: HB 1063, HB 1111 and SB 53. There are many dealing with property tax assessment and property tax appeals, which could get some attention: HB 1046, HB 1056, HB 1105, HB 1198, HB 1229, HB 1299, SB 292, SB 331, SB 350 and SB 415. Meanwhile, SB 449 addresses how personal property tax audits can be funded; SB 308 would take heavy equipment that is rented off the property tax rolls and puts an excise tax on the rentals; HB 1247 creates a minimum property tax fee; and SB 342 revisits tax increment financing.

On the local tax front, HB 1129 keeps up the ongoing work on local option income (LOIT) taxes while HB 1096 grants broad authority to locals to adopt food and beverage taxes.

Interestingly, and unnecessarily, HB 1160 seeks a further study of the Tax Court (on top of the review conducted by the Supreme Court just last year.) Tax attorneys will be interested in SB 440 as it gets into some procedural issues.

This is just a small sampling of what has been filed. Once bills involving tax matters begin to make their way through the committees, we will report on those that are of consequence to the business community.

Smaller State Revenue Collections Continue: How Will It Impact 2017 Legislative Session?

Each December the state budget makers receive a revenue forecast prepared by group of very knowledgeable and conscientious fiscal analysts, economists and academics. The group considers economic predictions, uses elaborate models and applies involved equations to generate what has proven to be remarkably accurate predictions of how much the state will collect in taxes over the next two years. Every other year, including this year, their numbers serve as the basis for building the state’s biennium budget. While lawmakers will debate how the projected revenues should be spent, Indiana is fortunate that lawmakers accept the consensus of these experts and do not debate how much money there is to spend – as is the case in many other states.

Forecasters project that Indiana will take in $31.5 billion in FY2018 and FY2019. This is around a billion dollars more than what was projected for the last biennium. However, as good as the predictions have been historically, FY2017 estimates turned out to be off the mark by $378 million. Low gas prices were a major contributor to the inaccuracy. Unexpectedly cheap gas meant less sales tax on those less expensive fill-ups.

When coupled with generally weaker sales tax collections, the FY2017 (ending in July) collections are now expected to be about 2.5% less than earlier projections. That money will have to be made up in the first year of the biennium, from the projected 2.9% year-over-year (FY2018 over FY2017) growth. Fortunately, the forecasters see a little better growth, 3.9%, in the second year of the biennium (FY2019). The bottom line is that the money available to cover growing expenses and new funding desires will be very modest, somewhere around $1 billion – that’s only about 3% more money for the entire two-year period. And essentially it all comes in the second year, so look for budget makers in the 2017 legislative session to be very frugal in FY2018 and then build in some increases in FY2019.

Economic uncertainty, sluggish sales tax collections, further diminishing gaming revenues and other factors will all put additional pressure on the budget process. As these things play out, the forecasters could shift their numbers a little more before they update their two-year projections in mid-April, just a couple of weeks before the budget has to be passed by the General Assembly.

Trump Tax Plan 2.0

19145168Republican presidential candidate Donald Trump recently announced revisions to his tax plan. And it has already been broken down and analyzed by the Tax Foundation. Individuals would be subject to just three possible rates: 12% for up to $37,500 in income; 15% for up to $112,500; and, 33% for over $112,500 (all double for married couples.) The top capital gains rate would be 20%. It would also increase the standard deduction to $15,000 (currently at $6,300.) Carried interest would be taxed as ordinary income. And there are other changes including a new childcare cost deduction.

As for business taxes, the plan reduces the corporate rate from 35% to 15%. It has a lesser rate of 10% for repatriated foreign profits. But on the negative side for manufacturers, it takes away the Section 199 domestic production activities deduction. The research credit is left intact. Unfortunately, it is not clear that the reduced corporate 15% rate will be applicable to business pass-through income (stay tuned on that.)

The estate and gift tax would be eliminated. However, the inheritors would eventually have to pay on the full gain realized when they sell the asset, without the benefit of a stepped-up basis.

What about the impact on revenues and our federal debt? Well, the new plan is better in that regard than the original. The static evaluation is that it will reduce revenues (increase the debt) somewhere between $4.4 trillion and $5.9 trillion (depending on the unspecified details) over 10 years; that is roughly half of the estimate of the plan he first outlined. The dynamic analysis, factoring in economic growth improvement associated with tax cuts, lessen the overall impact, but those numbers are inherently more speculative.

See the complete analysis and full breakdown from the Tax Foundation.

Clinton vs. Trump? A Taxing Decision in November

Now that the election process is to the point where the presidential nominees of the two major parties appear clear, it’s a good time to start considering their various tax plans. Although things can change, details will have to be determined and Congress will have its say, below are some of the current proposals from the two presumptive candidates.

Individual Income Tax
Donald Trump proposes just four brackets; Hillary Clinton proposes eight brackets.

trump clinton tax

Deductions
Clinton caps itemized deductions at 28% of the deduction. Trump phases out all deductions except for the charitable deduction and the mortgage interest deduction.

The Alternative Minimum Tax (AMT)
Clinton creates a new minimum 30% rate on individuals earning over $1 million, while Trump eliminates the AMT.

Corporate Income Tax
Trump lowers the top corporate rate to 15%; Clinton has no specific proposal at this time.

Estate Tax
Clinton increases the top estate tax rate to 45% and lowers the estate tax exclusion to $3.5 million. Trump eliminates the estate tax.

Effect of Plans on the Deficit
And as a final note, you may also want to consider how these proposals will likely impact our federal deficit. Trump’s plan is projected to increase the deficit by $9.5 trillion over the next 10 years; Clinton’s is estimated to reduce the deficit by $1.2 trillion over that same period of time.

Corporate Tax Reform Would Benefit Nation, Workers

Abstract View of Urban Scene and Skyscrapers

Lawmakers and candidates on all sides of the political spectrum acknowledge reforming America’s corporate tax rate is overdue. President Obama has even suggested reducing the rate from 35% to 28%. Writing for Reason, Veronique de Rugy of the Mercatus Center sums up the necessity for this, concluding it’s an optimal way to benefit both businesses and the workforce:

Even such high-tax nations as France have lower rates. However, the real competition comes from Canada (26.1 percent), Denmark (25 percent), the United Kingdom (20 percent) and the many countries, such as Ireland (12.5 percent), with rates below 20 percent. Moreover, competition is intensifying. Last June, the U.K. announced that it would cut its rate from 20 percent to 18 percent in the next five years. It’s now saying that it will lower the rate even further, to 17 percent. These reductions are the final stage of drastic cuts implemented since 2007, when the country’s companies faced a 30 percent tax rate. That’s a second wave of reduction since the rate was as high as 54 percent in the 1980s.

Now contrast this with the United States. In the 1980s, policymakers responded to the pressure put on by many countries lowering their corporate rates by decreasing America’s rate from 49.7 percent to 33 percent. However, since then, the U.S. has fallen asleep on the switch (and even raised the rate by 1 percentage point in the 1990s) and is now widely out of sync with internal competition. In 2015, the average corporate rate for countries in the Organisation for Economic Co-operation and Development was 25 percent, down from 48 percent in the early 1980s.

As if that were not enough competition for American companies, the U.S. government burdens them with another layer by taxing them on a worldwide basis. In that system, income from American companies is subject to U.S. taxes whether it’s earned in Seattle, Paris or Singapore. By contrast, most wealthy countries don’t tax foreign business income; about half of OECD nations have “territorial” systems that tax firms only on domestic income. In other words, U.S. exporters face a much less competitive tax system than most of their biggest competitors…

Not everyone would like to reduce taxes on corporations, but everyone should. The data show that most of the corporate tax burden is actually shifted to workers, who end up shouldering the tax in the form of lower wages. With the U.K. taking further measures to reduce its burden on corporations, boosting its workers’ wages and inflicting yet another blow to U.S. competitiveness, Congress should do what’s right by reforming the corporate tax. It may be the one bipartisan issue out there. All we need is leadership.