Since tax reform passed at the end of 2017, the topic has been front and centre. The taxes at stake in the US amount to some $3.3trn at the Federal level and some $2.5trn at the state and local levels. Property taxes in 2017 amounted to $33bn. Because of tax reform, not all the taxes imposed at the state and local level, including property taxes, are deductible against Federal tax.
This change has had an enormous impact on the after-tax income of many taxpayers in states where the cost of living is high. It has led to several governors trying to mitigate the incremental burden by offering workarounds. There is no limit on charitable deductions, so schemes have been developed that would allow taxpayers to make charitable contributions to funds that would be directed to meet the uses normally met from school and property taxes. Such contributions would ‘forgive’ the taxpayers’ obligations to pay taxes.
These schemes are a thinly disguised attempt to circumvent the new tax law and many mayors have rightly said they do not intend to expose their municipalities to the administrative inconvenience of running such schemes nor their taxpayers to the risk of interest and penalties. The Treasury has said it believes such schemes are abusive and that it will target those who participate.
Another area that has been much abused is that of sales tax on online commerce. A decision taken in 1992 and referred to simply as Quill has been the standard since 1992 for collecting sales tax on out-of-state sellers. The case concerned mail order catalogues. The test under Quill was whether there was a substantial nexus. Substantial nexus was the analogue of an actual physical, bricks and mortar presence and considered the extent of sales presence in the form of, for example, visiting representatives.
Bricks and mortar retailers have no escape from collecting sales tax on all assessable transactions. They have long complained they are at a competitive disadvantage to vendors selling within a state but who have no physical presence. The mail order problem has been dwarfed by the growth of internet sales, which were estimated to be $453.5bn nationally in 2017.
The case – South Dakota v. Wayfair, Inc. – was brought to the Supreme Court by the State of South Dakota after passing legislation that allows the collection of sales tax on sales in the state in excess of $100,000 per annum or 200 transactions regardless of physical presence. The law was expressed not to become effective until the Supreme Court ruled on its constitutionality. The constitutional issue involved the so-called Dormant Commerce Clause, a legal doctrine used to prohibit discrimination by state legislatures against interstate commerce. The Supreme Court decided last week by majority decision to overturn Quill. The majority held that the substantial growth of online commerce had obsoleted the rules set out by Quill. The Government Accountability Office estimated that sales tax revenue lost on remote sales by out-of-state vendors approximated $13.7bn in 2017. The issue, of course, is less buyers’ willingness to pay than it is sellers wish to collect. It is far easier for states to pursue and collect from sellers than it is for them to audit – or expect self-reporting from – buyers.
The Wayfair decision affects South Dakota only. Their legislation is now ready to be implemented. Other states must draw up
their own laws. They would be wise to follow South Dakota’s law as closely as they can to avoid challenges. Another issue left open by the Supreme Court is whether states may pursue sales tax retroactively. This would likely draw more challenges
The minority view in the Supreme Court was primarily that of respecting legal precedent – in effect overturning a previous Supreme Court decision. The minority suggested that the right way to approach this – a common argument when justices prefer not to act – was through the Federal legislature. The current state of play in the Federal legislature does not augur well for such an initiative; nor did the majority believe that the Federal legislature could in any event deal with the constitutional issue raised by the Dormant Commerce Clause.
The impact of tax reform continues to roll on. There is much more to come…
Neil is the CEO of Sevara Capital Advisors. He is passionate about solving tax, accounting and regulatory problems for institutions that have invested billions of dollars of capital in multiple jurisdictions. His company provides solutions for banks, insurance companies and hedge funds to tackle their problems related to tax returns, financial statements, accounting and internal finance matters. Neil holds a master’s degree in Law from the University of Cambridge.