by Joseph Coletti
Senior Fellow, Fiscal Studies, John Locke Foundation
Advocates for higher taxes and spending were excited to see a new pool of economic activity from which to siphon money, but Gov. Roy Cooper’s Department of Revenue (NCDOR) may have overstepped its authority in interpreting state law and a recent U.S. Supreme Court decision to force out-of-state companies to collect North Carolina sales tax.
Legislators should provide guidance in three areas before NCDOR acts. First, identify the companies that should collect sales taxes. Second, determine which companies should be subject to audits for sales prior to the directive (all the way back to January 2017) to determine their liability for collecting sales taxes in November 2018. Third, consider whether the assumed tax increase should be offset by lower tax rates for North Carolina taxpayers.
Every citizen already is expected to pay sales tax, so this is not a tax increase in law, just in practice. Estimates of the additional sales tax revenue range from $50 million to $400 million per year. NCDOR justifies its collection plan on a statute that the Tax Foundation, which submitted an amicus brief in support of South Dakota, thinks could be unconstitutionally broad. The department uses its own directive to set thresholds to determine which companies must collect sales tax and so moves from simply interpreting the law to all but rewriting it.
An actual legislative debate that led to enacting legislation could also consider whether the state should receive a windfall from this change in enforcement policy. Based on the $400 million estimate, the sales tax rate could drop by a quarter-cent and remain revenue neutral. Legislators could also increase the standard deduction (zero tax rate) from $20,000 to an appropriate level based on estimates from Fiscal Research Division.
South Dakota’s U.S. Supreme Court victory against internet furniture retailer Wayfair revived the question of internet sales taxes in June. The court overturned the long-standing precedent that barred from imposing sales taxes on out-of-state companies that simply shipped goods to residents. The majority opinion stated that South Dakota’s law applied to companies that were doing enough business there to justify taxation and ensured companies would be protected from government overreach, but Bloomberg BNA notes, “The court stopped short of formally declaring South Dakota’s law valid.” Gov. Dennis Daugaard called a special legislative session on September 12 to implement the tax.
Despite the challenges to enforcement without a law, NCDOR unilaterally decreed that out-of-state companies selling goods and services into North Carolina must begin collecting sales tax in November if they had $100,000 in sales or 200 transactions into North Carolina. NCDOR decided it would limit collections to those occurring after November 1, though it would expect companies to determine their obligation based on sales in 2017 or through the first part of 2018. There is no statutory basis for any of these standards, and the Supreme Court’s decision in Wayfair does little to give states clear guidance.
North Carolina has no law that makes clear what constitutes nexus for a company to collect sales tax, but it does have one that declares every sale to be subject to sales tax, which is the basis for individuals paying the tax on their own. A bill to determine who must collect sales tax for online purchases that included the $100,000 or 200 transaction threshold (Senate Bill 81) passed the N.C. Senate in 2017 with unanimous Republican support and some Democratic opposition. But it died in the House this June. Because there is no North Carolina law, the Department of Revenue set its own standard based on South Dakota’s law even though North Carolina has more than ten times as many people and an economy more than ten times larger than South Dakota.
The bill’s very existence and its passage by the Senate show that the legislature did not think the Department of Revenue had authority to compel out-of-state businesses to collect sales taxes under current law, as Carolina Journal found. Andrew Moylan of the National Taxpayers Union calls the law NCDOR cites as its justification, “one of a rash of state laws passed to push the boundaries after … the Supreme Court ruled against state efforts to tax out-of-state businesses.” Between 2001 and 2009, the legislature expanded the law from mail-order sales to all remote sales but kept the basic premise that “any attempt to solicit business in a state should open an entity up to the state’s tax laws.”
North Carolina was updating its laws to include internet-based sales and was working with other states to develop common definitions of products so that nobody would need to wonder whether Twix is candy or a cookie. All of this was happening in the hope that the Supreme Court would reverse its 1992 decision in Quill Corp v. North Dakota that a company needed to have a substantial “physical presence nexus” in a state to be subject to sales tax.
Legislators and governors across the country got their wish in June’s Wayfair decision, and with that, the race has been on to start forcing out-of-state companies to collect sales taxes. There is no free option for sales tax help, but a host of companies ready to make their services available for a fee to companies of any size. North Carolina companies will need to understand tax laws in other states to know whether the software is exempting non-profits and business-to-business transactions or categorizing products correctly, and other issues in states that are not part of the Streamlined Sales Tax effort.
Local retail merchant associations defend their members with storefronts and are glad to see out-of-state retailers treated the same, even though a number of North Carolina merchants sell online to other states. Andy Ellen of the North Carolina Retail Merchants Association (NCRMA) sees it as a question of fairness for “main street retailers” who must collect sales tax from their first sale. In North Carolina, nearly all of the more than 12,000 sales tax districts across the country, many of which “don’t follow city boundaries, county lines … or even zip codes,” according to software provider Avalara, will see justification in the Supreme Court’s decision for their imposition of taxes on new companies. North Carolina companies that sell online and ship to other states do not and will not have a voice in the tax systems where they sell their products. North Carolina’s sales tax system is relatively straightforward, but by jumping in so quickly without legislative guidance on key questions makes local companies vulnerable to audits, arbitrary standards, and new liabilities in other states.
NCRMA’s Ellen says the new tax “will provide much-needed revenue to the state,” with estimates of up to $400 million in new tax collections. It seems doubtful that there is more than $5.7 billion in goods and services from outside North Carolina that are going untaxed, but if that estimate is correct, cutting the state sales tax by a quarter-cent would be an appropriate way to offset the higher tax burden in a way that helps those with lower incomes. Other revenue-neutral alternatives would be to cut the corporate income tax to from 2.5 percent in January 2019 to 1.0 percent or the personal income tax from 5.25 percent to 5.1 percent. At the very least, the legislature should delay the Department of Revenue’s revenue collections until details of collection can be worked out instead of forcing companies to try out new software just while trying to handle the busiest time of year.
In short, North Carolina’s Department of Revenue has precipitously sought to raise taxes without express direction from the legislature whether and how to impose a burden on out-of-state companies and North Carolina citizens. It has done this with the vaguest guidelines from the U.S. Supreme Court of what would be acceptable and no assurance of how Congress will respond. A prudent approach that also protects North Carolina companies selling to other states would be to delay new directives until the General Assembly actually passes a reasonable law.