Editor: Mark Heroux, J.D.
Economic nexus was affirmed by the Supreme Court's June 2018 decision in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018). Wayfair invalidated the Supreme Court's long-standing precedent that a business must have a physical presence in a state for the state to require the business to register for, collect, and remit sales and use tax to the state. Because of the decision, most states that impose a sales tax have updated their statutes to include economic nexus thresholds for out-of-state sellers. In many states, that threshold is $100,000 in sales to in-state customers or 200 in-state transactions per year.
The impact on not-for-profits
Several states provide sales tax exemptions to not-for-profits, whether they be for purchases to support their mission, their sales, or both. This relief comes in the form of specific exemptions, which vary from state to state, as well as from one type of not-for-profit to another.
Illinois provides sales tax purchasing exemptions to churches, charities, schools, county fair organizations, and select senior citizen organizations (Ill. Admin. Code, tit. 86, §130.120). To use the exemption, an organization must apply for exempt status from the Illinois Department of Revenue. However, sales by those not-for-profits are subject to sales tax with the exception of sales to members primarily to further the organization's mission, or sales that are noncompetitive with for-profit businesses (Ill. Admin. Code, tit. 86, §130.2005) (an example would be a dinner at a fundraising event).
New York has a similar exemption (N.Y. Tax Law §1116) for religious, charitable, educational, and other select organizations. The exemption must also be obtained from the state agency. This exemption applies only to purchases made by qualifying organizations. A limited exemption for sales made by exempt organizations is available for qualifying fundraising sales, select admissions sales, specific auction events, and other limited sales (N.Y. Dep't of Tax. and Fin., Publication 843, A Guide to Sales Tax in New York State for Exempt Organizations).
In California, sales tax is generally imposed on purchases and sales made by not-for-profit organizations. However, specific exemptions are available for both, including sales made by select charitable organizations that operate for welfare purposes to relieve poverty and distress (Cal. Rev. & Tax. Code §6375). Additionally, thrift stores on military bases are provided a sales tax exemption (Cal. Rev. & Tax. Code §6363.4). Other limited exemptions also apply (Cal. Dep't of Tax and Fee Admin., Publication 18, Nonprofit Organizations).
Effect of the shift to economic nexus on purchases from vendors
Prior to the use of the economic nexus model, many purchases made from out-of-state vendors may not have included sales tax, even if the item purchased was taxable. The reason was that the out-of-state vendors lacked sufficient physical presence to require them to register for, charge, and remit sales tax to that state. Now, more out-of-state vendors find themselves exceeding economic nexus thresholds and being required to collect sales tax on transactions with customers in these states.
Perhaps the not-for-profit has an exemption from sales tax; if so, it will prospectively need to provide its vendors with the proper certification to support its exemption to avoid sales tax on purchases for which an exemption is available. If the organization does not have an exemption from sales tax, it may now have to revise its use tax accrual process and procedures to ensure it does not pay double tax on purchases from vendors that have started to collect sales tax due to economic nexus requirements.
It is important to note that on pre-Wayfair purchases, the not-for-profit should have self-assessed and remitted use tax directly to the state if an exemption did not apply, assuming the vendor did not collect sales tax. Most states have a use tax requirement for purchases made from vendors where sales tax was not charged if the item purchased was otherwise subject to sales tax.
Effect of economic nexus on not-for-profit sales
Not-for-profits that sell goods or services may find themselves needing to register for sales tax accounts in other states to remain in compliance. As discussed earlier, while many states may provide an exemption from sales tax on purchases made by certain not-for-profits for direct use in their mission, states often have more limited exemptions for sales by those organizations.
Therefore, if an exempt organization has sales to customers in other states, and those amounts exceed the economic nexus thresholds, the organization will need to determine if the goods or services it sells to customers in those states are subject to sales tax. This analysis is commonly referred to as a taxability study.
For example, a not-for-profit university may have online classes as well as bookstore sales to customers in other states. Sales-by-state data would need to be reviewed to determine if economic nexus thresholds are exceeded in any states. If sales exceed economic nexus thresholds, the organization needs to determine if those sales are subject to sales tax, and, if so, register in those other states and begin to collect and remit sales tax on taxable sales to out-of-state customers.
Other not-for-profits may sell items online for fundraising purposes, e.g., branded merchandise such as clothing, drinkware, blankets, hats, etc. Those organizations may now find themselves needing to comply with sales tax laws in other states as well.
When considering the impacts of economic nexus, it is important to note that states vary significantly on what sales transactions count toward the economic nexus thresholds. For example, California only considers sales of tangible personal property to count toward its economic nexus threshold of $500,000 in sales (Cal. Assembly Bill No. 147, Chapter 5). Therefore, organizations that sell tangible products as well as services only need to consider their product sales to California customers for purposes of economic nexus. New Jersey (N.J. Rev. Stat. §54:32B-2), Ohio (Ohio Rev. Code §5741.01), and South Dakota (S.D. Codified Laws §10-64-2) are examples of states that consider all sales to customers in their state to count toward the thresholds, not just sales of tangible personal property.
Not-for-profits' responses to these changes
Not only do not-for-profit organizations need to consider the amount of sales and transactions in a particular jurisdiction, but they also need to consider the taxability of their revenue streams from customers in other jurisdictions. Just because they have an exemption for sales to customers in their home state, they do not necessarily have a similar exemption in another state.
The taxability of products and services varies significantly from state to state. For example, organizations that sell clothing will likely find themselves tracking which states provide an exemption for clothing sales and which states impose sales tax. An educational organization may find itself trying to understand which states tax the sale of textbooks to students and which states provide an exemption for those transactions. Furthermore, the applicability of sales tax to these textbooks may be different depending on whether the student receives the book in a tangible format versus downloading a copy or remotely accessing it.
Wayfair and the shift to economic nexus resulting from that ruling will have a profound impact on not-for-profits' purchasing functions, bookkeeping requirements, and available exemptions, as well as their fundraising transactions, sales of goods and services, etc.
Prior to economic nexus, many not-for-profits limited sales-and-use-tax compliance to the states where they had a physical presence. Today, Wayfair propels these organizations into a multistate tax environment and forces them to confront the challenges of understanding what exemptions they may have, how sales tax applies to their transactions, and how to achieve substantial compliance in many more states.
Mark Heroux, J.D., is a principal with the Specialty Tax Services Group at Baker Tilly Virchow Krause LLP.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.