The Wayfair decision — Can sales tax break a deal?
October 23, 2018
By Martha Sullivan, CPA, CVA/ABV, CM&AA, CEPA
Partner, Succession Planning Practice Leader
Martha leads HK’s succession and exit planning services division and is a regular contributor to Wisconsin’s InBusiness digital magazine.
The value of a business is in the eyes of the beholder — the buyer. It reflects the perception of how much reward she or he will get for the risk that they are taking on. Tax exposure is certainly a risk every buyer should understand and analyze because it can be significant. On June 21, the Supreme Court upped the ante related to tax risk, particularly sales tax risk.
In the court’s South Dakota v. Wayfair Inc. decision, the justices threw away the old rules on what obligation a merchant has to collect and remit sales tax in any given state.
As background, under the Supreme Court’s 1992 Quill Corp v. North Dakota case, the litmus test for sales tax was whether the merchant had a physical presence in a state. As a merchant, you had to have a store, warehouse/goods, employees, and other situations in which your people or property stepped into the state to do business. If you did any of these types of activities, you were considered to have “nexus” in that state. Currently, 45 states collect state-level sales tax with rates ranging from 2.9 percent (Colorado) to 7.25 percent (California). Many states also have local sales tax at the county and/or municipal level. The merchant’s physical presence, not the customers’ location, has been the guidepost for state and local sales tax requirements since 1992.
Physical nexus was logical then. In Quill, there was no way to know how retail commerce would evolve from 1992 to today. Public access to the World Wide Web was less than a year old at that time. Today, almost all retailers have a website to broaden their sales beyond their physical footprint. By selling online, merchants extend their economic reach. The concept of economic reach drives the Wayfair decision.
At least 30 states have enacted internet sales tax laws given the growth in e-commerce. If you sell into one of these states, you likely have click-through or economic nexus. You’re expected to charge, collect, and remit such sales tax to that state. However, even with such laws on their books, enforcement could be contentious because of the Quill precedent. Wayfair resets the table. There’s no longer a question of whether these states’ laws are enforceable based on legal theory and precedence.
Online retailers have been wrestling to navigate sales tax compliance for quite a while. There’s no uniformity among the states’ laws. Thresholds on revenue and/or the number of transactions that trigger a liability vary by state. Wayfair doesn’t address uniformity. In oversimplified terms, it only says the rules have changed and that states can go for it — and the states are going for it. At the beginning of October, 10 more state internet sales tax laws went into effect. It wouldn’t surprise me if eventually all the sales tax states update their laws to cover all online retail commerce.
So, what does this have to do with the sale of a business and risk in the deal?
Consider this scenario: A business we’ll call iSellStuff.com sells exclusively through its website. iSellStuff is physically located in a single state but has a nationwide customer base. About 5 percent of its $10 million in sales is in its home state — the only state in which it currently collects and remits sales tax. Under Quill, this was all that was theoretically needed. Under Wayfair, not so much.
Pre-Wayfair, iSellStuff had an annual sales tax liability of about $25,000. Since it charged the customer for sales tax and then paid that to the state, iSellStuff complied and the money didn’t come out of its pocket. Under Wayfair, assuming all sales were in states that have an internet sales tax, that exposure goes to $500,000, a difference of $475,000 per year. The owner of iSellStuff doesn’t read this blog and isn’t aware that he’s operating in a new world. He continues only collecting and remitting sales tax from his home-state customers.
Three years from now, he strikes a deal to sell the company for $5 million. In due diligence, this sales tax issue is detected. It’s just a matter of time before states come looking for that money. Only he won’t have it and can’t go back to customers to get it. Under the three-year sales tax statute of limitations, the total uncollected, unremitted sales tax liability is at least $1.425 million before penalties and interest. That’s 28% of the deal price.
This presents two different risks for the buyer. The first risk is the obvious one — the states come knocking, wanting their pound of flesh after the deal closes, and the buyer is left holding the bag. The other risk is losing customers post-deal because of the increased cost of buying iSellStuff’s products at the sales-tax inflated cost. There’s no longer a “competitive advantage” based on total cost.
A buyer is unlikely to take on the first risk and will reduce the purchase price outright, demand monies be held in escrow for three years until the last of the sales tax audit risks expires, and/or have the seller warranty that they remain responsible for the liabilities to the states (including costs of enforcement). If an earnout tied to customer retention wasn’t on the table before due diligence, it is now because of the second risk. Both demands will impact the negotiations around the deal, including the timing and amount of purchase price the seller will get. Worst case, it kills the deal entirely if the seller, buyer, or both, being unprepared for the $1.425 million shock, decides to take his or her marbles and go home.
My advice to the owner of iSellStuff and any other online retailer is to take the bull by the horns today. Reach out to your:
- In-house systems and accounting resources to understand how you’re currently set up for your sales tax systems. Analyze your current customer base and revenue streams to quantify your sales (dollars, number of customers, number of transactions) by state;
- Accountant for help assessing the impact of Wayfair on your sales tax reporting requirements;
- E-commerce and other software providers to understand what the system currently provides for and what steps are being taken to update the system(s) in light of Wayfair; and
- In-house team to get your systems and processes aligned with the new sales tax rules.
Do it sooner rather than later. Significant changes may be needed to your information systems, including identifying and implementing the sales tax tool best suited for your business, updating your sales process, updating your customer database, and training your customers and team members on the new world order of sales tax. Noncompliance will be costly once the dust settles and states step up their enforcement. Whether you’re looking to buy, sell, or hold your business, the risk is real. Manage it.