Michigan considers economic nexus in the wake of Wayfair

Update 8.2.2018: The Michigan Department of Treasury has approved the new nexus standards discussed below. Additional information is available in this notice and this notice.

The Michigan Department of Treasury is considering an economic nexus standard for sales tax that would require an out-of-state seller doing a certain amount of sales in Michigan to register with the state, collect and remit sales tax, and file returns.

Nexus is the connection between a state and a business that allows the state to tax the business’s transactions. For decades, it was based solely on physical presence: States had the authority to tax sales by a business with a physical presence in the state, but they couldn’t tax sales by out-of-state sellers with no physical presence.

The Supreme Court of the United States upheld the physical presence rule in 1992 in Quill Corp. v. North Dakota, prior to the birth of ecommerce. It overturned Quill’s physical presence rule on June 21, 2018, in South Dakota v. Wayfair, Inc.

While physical presence remains a trigger for nexus, the Wayfair decision permits South Dakota and other states to tax remote sellers based solely on their economic activity in the state (economic nexus). Approximately 20 states have adopted economic nexus to increase remote sales tax revenue (see a list of them here). Michigan may soon do the same.

How to establish nexus in Michigan

A draft Revenue Administration Bulletin (RAB) under consideration by the Department of Treasury explains that nexus can be established in Michigan in several ways:

• Physical presence
• Representational, attributional, or click-through nexus (adopted by the state in 2015)
• Economic nexus, as discussed in Wayfair

Economic nexus in Michigan

According to the RAB, starting after September 30, 2018, economic nexus is established in Michigan when a seller:

• Has sales (both taxable and non-taxable) in Michigan exceeding $100,000 in the previous calendar year; or
• Completes 200 or more separate transactions of sales (both taxable and non-taxable) in the previous calendar year.

Once one of the above thresholds has been met, a seller must collect and remit tax in Michigan and file all necessary returns.

The draft RAB provides more information than many state economic nexus laws. For example, it defines sales as both taxable and non-taxable. It also states that after establishing economic nexus in Michigan, a remote seller must continue to remit tax “until a calendar year passes in which it does not meet the economic thresholds discussed in this RAB.”

Keeping it constitutional

Michigan clearly wants to create an economic nexus provision in line with the Supreme Court decision in South Dakota v. Wayfair, Inc. This is easier said than done, because the ruling is quite broad: It simply repeals the physical presence rule. Nonetheless, the draft RAB explains how the Supreme Court “found three factors important in finding South Dakota’s law constitutional.” These are:

• It allows a safe harbor for small sellers (the small seller exception)
• It applies prospectively only (the state cannot hold sellers liable for taxes owed prior to the yet-to-be determined effective date)
• South Dakota is a member of the Streamlined Sales and Use Tax Agreement (it has simplified and standardized sales tax to reduce administrative and compliance costs).

Michigan, too, is a Streamlined Sales Tax state. And the economic nexus policy proposed in the draft RAB includes a small seller exception and prospective enforcement.

Sales tax vs. use tax

The draft bulletin also explains when a seller needs to collect sales tax and when it must collect use tax:

• Sales tax is due to the state when a seller has nexus in Michigan
• Use tax is due to the state when a seller with no nexus in Michigan opts to voluntarily collect and remit tax on their sales into the state

What happens next?

Being unable to tax remote sellers has always been a thorn in the side of some states, but the unprecedented rise of ecommerce has made it more so. The Wayfair ruling provides a path to taxing remote sales, and it’s a path many states are interested in pursuing.

The Michigan Department of Treasury may adopt the economic nexus policy described in the draft RAB. Until further notice, however, it remains a focus of discussion only.

Learn more about the South Dakota v. Wayfair, Inc. ruling and its potential impact on businesses at this Avalara resource page.