It’s a question of nexus. For a while, online shoppers did not have to pay sales tax, but the U.S. Supreme Court’s decision in 2017 in South Dakota v. Wayfair determined even online sellers with no physical office in a particular state may still need to collect sales tax from customers in that state and remit those taxes to the state. The online seller need not have a physical connection, a "nexus" to its customers, simply an economic one, even if it’s virtual.
The floodgates are open. While it didn’t establish a constitutional minimum sales or transaction threshold, the decision nevertheless implied that a small-seller threshold would be necessary in order to sustain the constitutionality of an economic sales tax nexus provision.
Almost every sales tax state now has a remote seller provision for sales tax nexus based on economic activity in the states, says Matt Talcoff, consumer products industry tax leader at accounting firm RSM. "Wayfair also impacts income/franchise tax and gross receipts tax," he says. "For example, Hawaii has adopted a ‘Wayfair threshold’ for their corporate income tax beginning in 2020. Philadelphia has adopted a Wayfair threshold, as has San Francisco. The point is that Wayfair addressed a constitutional issue—not a sales tax exclusive issue—and we will begin to see more of this flow over from the sales tax nexus changes to income tax in the coming year."
It is important to remember, Talcoff says, that Wayfair did not replace the requirement for physical presence; it simply changed the test used to determine nexus.
"Physical presence will almost always establish nexus for sales tax purposes. However, there are some interesting legal issues that could be challenged for the great many businesses that do not meet Wayfair thresholds, but do have inventory that is not under their control in a state," Talcoff notes.
The Wayfair decision also complicates tax filings for restaurant franchisees, says Stephen Bickert, a partner at Concannon, Miller & Co. with a specialty in franchise tax law. "What we’re seeing from a franchisee perspective is if they use a third-party delivery service like DoorDash or similar, then sales tax is now being remitted by that third party. This further complicates the sales tax filings for the restaurant franchisees," Bickert says.
Franchisees who have territories in multiple states must factor in not only state but also county-specific sales tax, points out Michael Goodman at Fox Rothschild LLP.
He, not unsurprisingly, suggests that franchisees hire good accounting and legal advisors.
What franchisees can do
From a sales/use tax perspective, the key considerations for taxpayers are nexus, taxability determination of products (i.e. is software as a service or other products taxable and do exemptions apply) and overall compliance: where to file, how to file, do they have a process in place to properly comply in all of the jurisdictions.
In order to mitigate the risk of sales/use tax exposure, everyone needs to properly analyze their footprint to understand where they have nexus, or conduct a nexus study, Talcoff advises. "Franchisees could have a taxability matrix in place, which is a necessary second step after understanding nexus footprint. Then have a process in place to fully comply. This most likely will require some type of sales/use tax software to churn out the returns and/or outsourcing," Talcoff adds.
"Assuming taxpayers address the foregoing and discover they in fact have exposure, they could mitigate that risk by entering into voluntary disclosure agreements with the states to limit the lookback period and get penalties waived," Talcoff says.
The rest of the landscape
What else should franchisees prepare for when it comes to other sales taxes? Look for continued increase in the sales tax base to include more service-based transactions, Talcoff says. "This has been a trend in the last decade and while significant sales tax base reform has not occurred, every year states continue to add to the list of taxable services," he says. This could affect services the franchise is purchasing or selling. Further guidance and expansion to the digital goods space continues to occur.
Remember soda taxes? "Soda taxes had gained popularity a few years ago and then almost went out of existence. Now they seem to be coming back, mostly imposed on a local level," Talcoff says.
Along with soda taxes, other so-called sin taxes have been popular over the last few election cycles, including those on vape and electronic cigarette products, plus higher taxes on tobacco and alcohol. "This trend is likely to continue because they are excellent revenue generators and a lot of voters prefer tobacco to be taxed higher than their restaurant meals or gas," Talcoff adds.
Dirk Ahlbeck, partner at law firm Sassetti, says franchisees, especially in the restaurant industry, should take advantage of tax laws that allow for a first-year depreciation deduction of 100 percent for certain assets. "Restaurant equipment and furniture and fixtures qualify and can be new or used," he says.
Finally, the maximum corporate tax rate has been reduced to a flat tax rate of 21 percent. This tax law change will only affect larger corporations or those franchisees who are structured as C-corporations, Bickert says.
"It’s a great time to be in franchising, but along with growth and opportunity comes complexity," Talcoff says. "Franchisees are dealing with the changing landscape of technology and innovation, increased costs and reduced pool of labor. Those who plan ahead have a much better chance of success. Businesses have a great opportunity to improve cash flow under the new federal tax act by determining the best entity by which to operate, determine when to make capital improvements and to ensure they reduce taxes through maximum tax writeoffs," he adds.