An online retailer recently filed a petition with the Illinois Independent Tax Tribunal in May over disputes with 57 issued Notices of Tax Liability amounting to $518,293.68 in total. The petition raises key concerns about managing multi-state sales and use tax for ecommerce businesses operating in the post-Wayfair world. Specifically, it questions the constitutionality of Illinois’ economic nexus rules under the Wayfair Decision, including its Level the Playing Field Act that established different sourcing standards for remote retailers. We discuss the details of the case below, what a successful appeal would mean, and how this case reflects the challenging landscape of complying with economic nexus thresholds.
Background on Coast to Coast Computer Products, Inc. v. Illinois Department of Revenue
The Petitioner, Coast to Coast Computer Products, Inc., is a telemarketing company that sells a variety of computer-related supplies. Its headquarters are in California with its only other office location being in Nevada. The Petitioner does not maintain offices or agents in Illinois and does not conduct any local advertising in the state. Rather, it has a website where customers can view products before placing an order through phone or email. The Petitioner mostly sells to other organizations, which are either exempt from paying tax or are making purchases for resale. As a final note, the Petitioner does not have any employees dedicated to tax compliance and relies on its CEO, Controller, and Operations Director as a de-facto tax department.
Illinois started requiring collection of retailer occupation (ROT) and use tax by retailer’s located outside the state as of October 1, 2018 after the U.S. Supreme Court’s Wayfair Decision. These obligations applied to businesses with either 200 or more separate transactions or cumulative receipts of $100,000 or more in the previous four quarters.
As a home rule state, Illinois allows local municipalities to impose additional ROT and use tax rates on top of the state’s 6.25 percent rate. Retailers are generally required to collect at the tax rate based on the location of their selling activities. However, out-of-state businesses were not subject to these local ROT and use taxes because their selling activities occurred outside Illinois, which meant they collected use tax at the statewide 6.25 percent rate. In response, Illinois passed the Leveling the Playing Field Act in 2021, which requires out-of-state retailers to collect and pay the combined state and local rate that applies where goods are shipped or delivered in the state (i.e., destination-based sourcing).
How the Petition Challenges the Economic Nexus Rules in Illinois After the Wayfair Decision
Outside of its claims over tax-exempt transactions, the Petitioner raised three arguments in its complaint to the Illinois Tax Tribunal over the constitutionality of the state’s economic nexus laws for remote retailers under the Commerce Clause:
- The rules placed an undue burden on out-of-state retailers in violation of the U.S. Commerce Clause.
- The rules violated the Commerce Clause as applied in the Wayfair decision because the Petitioner did not have extensive virtual contacts in Illinois.
- Illinois’ Leveling the Playing Field Act is in violation of the Commerce Clause because it discriminates against online retailers.
How Illinois’ Economic Nexus Laws May Have Placed an Undue Burden on Out-of-State Retailers
The first argument focuses on the undue burdens placed on certain out-of-state retailers who were given little time and resources for complying with Illinois’ ROT and use tax after the Wayfair decision. Under the U.S. Constitution’s Commerce Clause, states may only regulate interstate commerce so long as the burdens imposed are not clearly excessive to the putative benefits. The Petitioner cites three important guardrails that South Dakota provided in its sales and use tax enforcement efforts that were essential for meeting this constitutional requirement:
- South Dakota adopted the Streamlined Sales and Use Tax Agreement, which provided sellers with software to reduce their administrative and compliance costs.
- South Dakota provided a safe harbor for out-of-state retailers with limited business transactions in the state.
- South Dakota’s economic nexus rules were not retroactively applied.
Illinois is not part of the Streamlined Sales and Use Tax Agreement and provided no grace period for online retailers to set up systems for determining their tax obligations. The Petitioner alleges that this lack of support and time drastically departed from the example set in Wayfair, creating an undue burden.
What ‘Extensive Virtual Contacts’ Are Sufficient for Enforcing Economic Nexus on an Out-of-State Retailer?
The Wayfair decision clarified that state taxes must be tied to activities with substantial nexus to the state, which effectively requires both economic contacts and extensive virtual contacts. The Petitioner asserts this requires a more case-by-case analysis of nexus to determine if an individual has availed itself of a state’s tax obligations. While the transaction thresholds speak to the economic contacts in a state, the Petitioner distinguishes itself from the large online retailers that were the subject of the Wayfair decision. Specifically, the Petitioner notes that it has a static website and does not engage in targeted advertising unlike other online retailers that offer instant access and other tools to generate greater opportunities for interactions with consumers.
Does the Leveling the Playing Field Act Discriminate Against Out-of-State Retailers Through Its Sourcing Requirements?
The final issue raised in the petition is Illinois’ allegedly discriminatory sourcing standards for out-of-state retailers, which determines the effective rate for collecting sales and use tax. As discussed above, the Leveling the Playing Field Act established two sourcing methods. In-state retailers apply origin sourcing to their transactions while out-of-state retailers must apply destination-based sourcing by using the rate where products are delivered in Illinois. The effect of this difference is that in-state retailers only have to manage the combined ROT and use tax rate where they conduct business in Illinois while out-of-state retailers could potentially have several different combined rates they must track depending on where they ship goods.
Clarifying Sales and Use Tax Concerns for Smaller Online Retailers Across the United States
The petition from Coast to Coast Computer Products, Inc. could be an appeal worth monitoring for smaller online retail shops across the United States. Many states interpreted broad authority to impose their sales and use tax obligations on out-of-state retailers post-Wayfair, but this appeal highlights some of the potentially unfair standards of overly-burdensome tax administration. These types of appeals are likely to increase over the next few years as state revenue departments finalize their initial rounds of audits and assessments following Wayfair. Resolution of these claims could take time and result in significant changes to multi-state sales and use tax or end in an affirmation of current practices in certain states.
In either case, now is the time for business owners to address their out-of-state operations to mitigate the risk of costly audits and over-assessments of their sales tax liability. If you need help with an economic nexus study or seek to challenge an unfavorable assessment in Illinois as an out-of-state retailer, meet with our sales tax professionals for additional help today.