States wind down tax relief, amp up search for more revenue
The takeaway: States strapped for cash because of COVID-19 are likely to broaden sales tax and increase enforcement of remote sales tax laws. They may also seek to legalize (and tax) recreational marijuana and sports betting, and raise taxes on vapor products.
Federal, state, and local officials scrambled to support struggling businesses and individuals when the coronavirus (COVID-19) first hit. They placed temporary moratoriums on evictions, pushed income tax due dates to July 15, and waived interest and penalties on late payments of beverage alcohol tax, communications tax, sales tax, etc. Millions of Americans received stimulus checks, and more than 4.8 million small businesses obtained loans through the Paycheck Protection Program that was set to expire today (June 30, 2020).
Yet as time passes, relief is winding down. Evictions have been allowed to proceed in many parts of the country. Federal and state income tax payments will soon be due. Sales tax and other taxes must now be remitted on time in most states. Stimulus payments have long since been spent.
Congress is working to provide additional assistance through the HEROES Act, which was approved by the House and now needs approval from the Senate. If enacted, it would put a moratorium on certain evictions and foreclosures; expand the Paycheck Protection Program; support pandemic premium pay for essential workers; provide payments and other assistance for state, local, tribe, and territorial governments; send another round of stimulus checks; and more.
States, too, are looking for creative solutions to an ongoing pandemic and economic recession. Unlike the federal government, most must balance their budgets and thus will need tax revenue to pay for essential services and support programs. To that end, many states — particularly those most reliant on sales tax revenue — could look to:
- Broaden sales tax to exempt goods and services
- Enforce compliance of remote sales laws
Other possibilities include legalizing and taxing recreational marijuana, legalizing and taxing sports wagering, and increasing taxes on vapor products.
Broaden sales tax
Although the service sector accounts for roughly 67% to 77% of gross domestic product, most states still tax far more goods than services. The independent tax policy nonprofit Tax Foundation thinks now is a good time to change that. It recommends broadening the sales tax base rather than embracing “more harmful tax increases.”
Data and digital services
If the past few months are any indicator, the coming months and years will likely see increased consumption of a wide variety of online goods and services, including education, entertainment, games, news, etc. Approximately 30 states already tax some digital goods and services (e.g., ebooks and streamed music) but not others (online fitness classes or video conferencing). In the remaining states, most digital goods and services are exempt.
Taxes on digital services are gaining momentum worldwide. For example, the U.K. started taxing social media and search engines on April 1, 2020, and Poland is taxing streaming media as of July 1, 2020. As more U.S. states look to do the same, new taxes on data or digital services are starting to emerge.
Maryland was on track to tax certain digital products and gross revenues from digital advertising services starting July 1, 2020, but Governor Larry Hogan vetoed the bills because of COVID-19. A bill under consideration in Maine would tax digital audiovisual works, digital audio services, and digital audio works. Two New York lawmakers would like to see the state adopt an excise tax on the sale of data.
Taxes on streaming services tend to be complex: They can include communications taxes as well as sales taxes, and can apply to everything from online fitness and cooking classes to streamed audio, video content, and virtual events. Defining and sourcing these sales can be challenging. Nonetheless, our newfound reliance on the internet to exercise, relax, socialize, work, and even cut our hair during the pandemic will likely accelerate state efforts to tax data streams.
Groceries, shopping, and delivery services
States could also expand tax to grocery shopping and delivery services, which have surged since the pandemic. A recent survey of 1,500 people found 42% of respondents were purchasing groceries online at least once per week — one-third of them for the first time ever. At Instacart, customer demand has risen by 300% year over year. In fact, ecommerce sales of food and beverages in the U.S. are likely to grow by more than 23.4% this year, to $32 billion (a pre-COVID-19 projection that’s likely low).
With dining out limited or restricted during the pandemic, grocery sales are on the rise. This impacts state and local tax revenue because restaurant meals are subject to tax, and often a higher rate of tax, while food for home consumption is exempt in many states. The Tax Foundation considers grocery exemptions “well-meaning” but believes they carve “a significant hole in sales tax collections.” Rather than offer a widespread exemption, it suggests states provide a refundable grocery tax credit to low-income families.
Increase enforcement of remote sales tax
It’s been more than two years since the Supreme Court of the United States overruled a long-standing physical presence rule in South Dakota v. Wayfair, Inc. (June 21, 2018). The decision authorized states to base a sales tax collection obligation solely on an out-of-state seller’s sales in the state (economic nexus).
Today, 43 states enforce economic nexus, along with Washington, D.C., and parts of Alaska. Most provide an exception for small sellers, such as those with less than $100,000 in sales or fewer than 200 transactions in the state annually. Yet many businesses are still unaware of the Wayfair ruling and its potential impact (i.e., that they could be required to collect and remit sales tax in other states).
States have generally eased into enforcing economic nexus, but those days are gone. Bloomberg Tax reports that “revenue departments will be under intense pressure to ramp up audits after states begin lifting shelter-in-place orders and business restrictions.” Revenue losses will “force departments to double down on enforcement and collection efforts to revitalize exhausted revenue streams.” A main target: “Wayfair nexus audits.”
In other words, states are likely to take a “hard line on out-of-state taxpayers with economic nexus.”
If businesses that have already established economic nexus are at risk, so are online sellers whose business increased during the pandemic. Some states require remote sellers to register and start collecting sales tax as soon as they cross the economic nexus threshold (i.e., before the next invoice). Ecommerce sellers struggling to meet a sudden surge in demand may not have closely tracked sales into states with economic nexus laws and, as a result, could be out of compliance.
States will also look to ensure marketplace facilitators and sellers are compliant. Marketplaces are responsible for collecting and remitting tax on all sales made through the platform in most states, but some states still require third-party sellers to file returns.
Marketplace laws also help states identify businesses that have been selling into the state through marketplaces for years, potentially establishing a sales tax collection obligation through inventory stored in the state. California is among the states actively seeking past non-compliance among marketplace vendors.
Tax pot, sports betting, and vapor products
The cost savings of decriminalization coupled with the tax benefits of legalization are leading a growing number of states to legalize and tax the sale of recreational marijuana.
Approximately 33 states have legalized some form of marijuana, and 11 (plus D.C.) have legalized recreational marijuana sales. States looking to legalize (and tax) recreational marijuana in 2020 include Arizona, Montana, New Jersey, Oklahoma, and South Dakota.
Even before COVID-19 took a significant bite out of state revenues, states were looking to legalize, regulate, and tax sports wagering. In fact, about 25 states already have, four since the start of the coronavirus outbreak: Louisiana, Oklahoma, Virginia, and Washington (Oklahoma Governor Kevin Stitt signed gaming contracts with the Comanche Nation and the Otoe-Missouria Tribe).
California, Massachusetts, and Ohio are now looking to do the same. But not all states are ready to legalize sports betting. A bill seeking to authorize sports wagering in Kansas died in the Kansas Legislature on May 21, 2020.
California Governor Gavin Newsom wants to raise the tax on vapor products by $2 per 40 milligrams of nicotine. If approved, e-cigarettes would be taxed at a higher rate than tobacco cigarettes. The administration also supports a statewide ban of all flavored nicotine products.
A tax of 15% of wholesale and $1.50 per cartridge takes effect in Kentucky August 1, 2020. Other states with new taxes on vapor products include Utah, Virginia, and Wyoming. Colorado and Michigan are looking to increase taxes on vapor products as well.
No matter what happens with the pandemic, states need more tax revenue, and they need it soon. To get it, some will try to broaden the tax base. Many will likely increase enforcement of remote sales tax laws. This will complicate the already complicated process of calculating, collecting, and remitting sales tax, and filing returns.
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