In a nutshell:
- The Michigan Department of Treasury will start collecting sales tax in October from online sellers with $100,000 or more in sales or 200 or more online transactions in the previous calendar year.
- This change is made possible by the June U.S. Supreme Court ruling in South Dakota v. Wayfair, allowing states to tax online retailers that do substantial business in a state.
- Michigan state tax revenues could increase by a few hundred million dollars, with most allocated to the School Aid Fund and state revenue sharing.
Frequent online shoppers may notice more retailers charging Michigan sales tax starting in October. Earlier this month, the Michigan Department of Treasury announced a new rule increasing the number of online vendors that will have to collect the 6 percent tax from Michigan customers. While Amazon and other retailers that have a physical presence in the state are currently required to do so, a recent U.S. Supreme Court ruling allows states to collect sales taxes from far more out-of-state vendors. These changes could have a significant effect on state revenues.
Wayfair and Out-of-State Tax Authority
The decision reverses years of established precedent, and is a reaction to how online commerce has transformed how we shop. In 1992, when mail-order was the primary way we bought goods from out of state, a U.S. Supreme Court ruling limited states’ ability to collect sales taxes on those purchases. The Commerce Clause of the U.S. Constitution requires, among other things, that taxes on inter-state transactions are applied to an activity that has “considerable nexus” (in plain English, a strong connection) to the state.
In Quill Corp. v. North Dakota (1992), the Court ruled that a retailer needed to have a physical presence to have a nexus in the state. The decision was based on precedent set in National Bellas Hess v. Department of Revenue of Illinois (1967), where the Court ruled mail-order companies did not have to collect sales tax unless they had such a presence. As a result, the ruling regarding e-commerce was based on a legal interpretation that pre-dated commercial use of the Internet, when compliance with different state and local sales taxes could have created significant compliance burdens.
At the time of the Quill decision, Internet sales were a novelty, as the Internet was relatively new. Today, e-commerce is a mainstay of the retail market. The U.S. Census Bureau estimates that e-commerce represented 9.3 percent of all retail sales in the first quarter of 2018, almost triple the share from a decade prior, and more than 23 times the total value of online sales from the first Census Bureau estimate in 1999.
Compliance with state and local sales-tax codes has also become much easier; online interfaces already require businesses with the aforementioned physical presence to add tax to purchases made by customers in these states. Making the change to collect taxes from other customers require reprogramming existing systems. While many online-only retailers, like Amazon, have been collecting sales tax revenues in most states for years now, many businesses without a large physical footprint, and third-party sellers on sites like Amazon, have been selling tax-free.
Because the changing marketplace reduced purchases from brick and mortar stores and limited taxation on online sales, state revenue streams suffered. While many (including Michigan) used alternatives like the use tax to try to increase revenues, states were largely unsuccessful at monetizing online sales. Michigan’s individual income tax returns included a line to voluntarily report online purchases and remit the tax due, but compliance was limited. The Senate Fiscal Agency estimated that as much as $470 million in additional revenue could be collected if taxes on mail-order transactions and e-commerce were collected at the point of sale instead of relying on individuals paying the use tax out of a sense of obligation (or guilt).
With the decision in South Dakota v. Wayfair Inc. (2018), the Supreme Court overturned the precedent set in Quill. A large part of the reasoning was the arbitrary, market-distorting effects that Quill placed. By preventing states from treating online and out-of-state retailers the same as in-state sellers, the rule created an incentive to purchase goods from outside the state. In the end, this ruling gave benefits to companies that had no physical presence in a state over ones that might only have a warehouse, for no particular rationale.
Adopting the South Dakota Model
Treasury’s new rules, effective October 1, will require any online retailer that conducts business in Michigan in the amount of $100,000 or more in total sales or 200 or more transactions in the previous calendar year to collect and pay the 6 percent state sales tax. Smaller vendors, and those that do not do much business in Michigan, that currently do not have to collect taxes, will not be required to do so. These are the same parameters set out in South Dakota’s 2016 law that sparked Wayfair.
Technically, the new rules do not expand the tax base, as online customers already are liable for the state use tax. But as noted, few taxpayers heed the obligation. The Senate Fiscal Agency estimates that only about 1.6 percent of Use Tax owed is actually remitted to the state. While the rules do not increase state taxes (either by increasing the tax rate or expanding the base), by making them harder for customers to avoid, they will increase compliance, which should result in more revenues.
These changes could have a significant effect on revenues, but the state will probably not see the full $470 million in estimated payments. As our Tax Outline noted in 2015, the state enacted laws in 2014 to expand what was considered “nexus” that would require organizations to collect sales and use taxes, and Michigan is already part of the Streamlined Sales Tax Project. In addition, several large online retailers, like Amazon and Walmart, already comply, because they have a physical presence in the state. As a result, a new plan may have diminished value. Treasury expects the new rules to increase revenues by about $200 million for Fiscal Year 2019. Because sales taxes are reported monthly, these changes will affect the state’s cash flow starting in November.
Additionally, the new rules would have consequences for how the revenues are used. The rules would treat any revenue from qualifying online sellers as part of the sales tax. As a result, three-quarters of sales taxes would flow to the School Aid Fund, with local governments capturing the remaining quarter, via revenue sharing.
A decline in use tax collections is likely with the shift of online collections to the sales tax. The shift will reduce General Fund revenue, because two-thirds of use taxes go to the General Fund. Consequently, General Fund revenues could actually fall, over the long term, though the reduction would be fairly small as revenue lost would be from current compliance with the use tax.