Wayfair 2.0 averted, for now

A lawsuit over Colorado's home-rule sales tax has been dismissed. Other cases against remote sales tax requirements are brewing.

The online home store Wayfair gained fame in certain circles for suing South Dakota over its online sales tax requirement. The retailer lost that battle when the U.S. Supreme Court sided with South Dakota and freed states to tax remote sales with its decision in South Dakota v. Wayfair, Inc. (June 21, 2018). But Wayfair wasn't quite finished suing over sales tax. For Wayfair 2.0, it took on the city of Lakewood, Colorado, and the Colorado Department of Revenue.

First, we'll explain what happened with Wayfair in Colorado. Then we'll look at other significant remote sales tax cases. So, this blog post will cover:

• How home rule creates a confusing tax landscape for businesses

• Why Lakewood says Wayfair has nexus and owes local sales tax

• Why Wayfair sued Lakewood

• Why Wayfair sued the Colorado Department of Revenue

• What happened with the Wayfair 2.0 lawsuit in Colorado

• Will there be another Wayfair 2.0?

Home rule creates confusing tax landscape for businesses

Colorado is a home-rule state where local governments have the authority to administer and levy local sales and use taxes.

There are hundreds of home-rule jurisdictions in Colorado. Most are "state collected," meaning the Colorado Department of Revenue collects sales tax for them. But about 70 jurisdictions are what's referred to as "self collected" or "self collecting": They administer their own local sales and use taxes and require businesses to remit local taxes to the local tax authorities.

Having state-collected and self-collected jurisdictions on top of the state sales tax requirement creates a confusing tax landscape for businesses.

When Wayfair opened a distribution facility in Aurora, Colorado, in September 2017, the Massachusetts-based online retailer began collecting and remitting the Colorado state sales tax as well as state-collected local sales taxes. It did not register to collect and remit local sales taxes in self-collecting districts.

Lakewood is a self-collecting jurisdiction, so Wayfair did not collect applicable Lakewood sales tax.

Lakewood says Wayfair has nexus and owes local sales tax

On October 20, 2021, Lakewood gave Wayfair a notice for a whopping $604,322.17 in unpaid local sales tax, penalties, and interest for the period May 2018 through July 2021: $460,518.69 in tax, $46,051.87 in penalties, and $97,751.61 in interest - plus any interest accruing after the date of the notice.

Physical presence nexus

According to the ensuing legal complaint, Wayfair began employing drivers to make deliveries in Lakewood and other parts of the state from its Aurora facility sometime around July 16, 2018. The "vast majority" of Wayfair's sales into Lakewood were reportedly "delivered from out-of-state locations by common carrier." A "small number" were "delivered by Wayfair truck drivers from its Aurora facility."

Exactly how many deliveries comprise "a small number" is unclear. The Lakewood Municipal Code of July 2018 holds that a person is "engaged in business in the city" and therefore liable for Lakewood sales and use tax if it's 1) a retailer in the state of Colorado and 2) makes more than one delivery into the city within a 12-month period.

The audit period began before the South Dakota v. Wayfair, Inc. ruling, and before the state of Colorado established economic nexus and began taxing remote sales. So, the case concerns physical nexus. But it's also about economic nexus because Colorado adopted economic nexus on December 1, 2018, and Lakewood adopted economic nexus on January 16, 2021. Both were during the audit period.

Economic nexus and Colorado's move toward simplification

Economic nexus laws base a sales tax collection obligation on a remote seller's sales activity. Jurisdictions generally provide an exception for businesses with very little economic activity in the jurisdiction. Colorado's economic nexus threshold was initially $100,000 in sales or 200 transactions in the state in the current or previous calendar year. It dropped the 200-transactions threshold as of April 14, 2019.

Lakewood's economic nexus code uses the same threshold as Colorado. Retailers with no physical nexus in the state of Colorado must collect and remit Lakewood sales tax when they make retail sales into Lakewood and:

1. Their sales into the state during the previous calendar year exceeded the state's economic nexus threshold; or

2. In the current calendar year, 90 days have passed following the month in which they made retail sales into the state exceeding the state's economic nexus threshold

On January 16, 2021, the same day economic nexus took effect in Lakewood, the city joined the Colorado State Department of Revenue Sales and Use Tax System, or SUTS. This one-stop portal was created to facilitate the collection and remittance of sales tax in the state.

SUTS functions as the single point of remittance for state and state-administered sales taxes. Colorado allows - but does not require - self-collecting home-rule districts to participate as well. There's a list of participating home-rule, self-collecting jurisdictions on the Colorado Department of Revenue website.

Lakewood didn't offer a comparable system for businesses prior to joining SUTS, despite having a complicated local tax system. There are at least 12 different zip codes within the city limits of Lakewood, many with addresses both inside and outside the city limits. Indeed, the sales tax rate in Lakewood's Belmar district was different from the rate in effect in other parts of Lakewood during the audit period, and the rate for businesses located in the district was different from the rate for businesses located outside the district. This is described at length in pages 7-10 of the legal complaint.

Whether physical or economic or both, Lakewood determined Wayfair had nexus with the city during the audit period and was therefore liable for unpaid sales tax, penalties, and interest.

In response, Wayfair sued.

Why did Wayfair sue Lakewood?

Wayfair sued Lakewood for the following four reasons:

1. Requiring Wayfair to collect and remit Lakewood sales tax imposes an undue burden on interstate commerce in violation of the Commerce Clause of the U.S. Constitution.

   1. Lakewood did not provide a single, statewide system of tax administration for state and local taxes during the tax period, or provide access to free tax administration software that would protect Wayfair from audit liability.

   2. Lakewood is one of 71 home-rule jurisdictions. Each charges a separate registration fee to retailers such as Wayfair, and each claims the right to audit out-of-state retailers, potentially exposing a company like Wayfair to 70-plus individual audits for the same tax period.

   3. It's complicated and expensive for retailers to comply with all these requirements. To file the Colorado state return plus 71 home-rule jurisdiction returns requires a company like Wayfair to compile a 150-page spreadsheet for each return filed.

2. Discrimination against interstate commerce violates the Commerce Clause.

   1. Imposing a Lakewood sales tax requirement on Wayfair discriminates against interstate commerce in several ways, including that it treats out-of-state retailers differently from retailers physically located in the Belmar district, and applies different sourcing rules for businesses located in or outside the city.

3. Wayfair did not engage in business in Lakewood; delivery alone is an insufficient nexus.

   1. Wayfair says it was not engaged in business in Lakewood during the audit period because it did not have a "fixed or transitory situs in the taxing jurisdiction" and delivery alone is an "insufficient nexus."

4. Wayfair lacked substantial nexus with Lakewood under the Commerce Clause.

   1. Wayfair argues that it didn't have sufficient physical presence with Lakewood for the period May 1, 2018 (the start of the audit period) through June 21, 2018, when the Supreme Court overturned the physical presence rule with its decision in South Dakota v. Wayfair, Inc. Therefore, "it was improper for the City to assess sales tax, interest, and penalties against Wayfair for that time period."

Wayfair argued that state regulations - and by extension municipal ordinances - may not discriminate against interstate commerce. And states - and by extension municipalities - may not impose undue burdens on interstate commerce. The Dormant Commerce Clause, as defined by the Supreme Court, holds these two principles to be true.

Why did Wayfair sue the Colorado Department of Revenue?

Wayfair included the Colorado Department of Revenue in the first count, arguing that the department violated the terms of the Commerce Clause and placed an undue burden on businesses by failing to create rules and policies to simplify the collection and remittance of self-collected home-rule sales taxes.

What happened with the Wayfair 2.0 lawsuit in Colorado?

The case against the Colorado Department of Revenue was dismissed on January 10, 2024, due to a lack of authority. The department administers state and state-collected sales taxes; it did not create nor can it amend laws pertaining to the state's complicated home-rule sales tax system.

The case against Lakewood is also a no-go. In a stipulation filed July 11, 2024, Wayfair and Lakewood agreed to dismiss all claims with prejudice: The two parties are responsible for paying costs and fees affiliated with the lawsuit to date.

Speaking about the case during a regularly scheduled Colorado Sales and Use Tax Simplification Task Force meeting, the Lakewood City Attorney shared that Wayfair settled the past tax due from 2019 to 2021. Other details are confidential. The city attorney said the settlement doesn't create precedent for other businesses because there was no court decision.

And there could be another lawsuit one day. Not every home-rule jurisdiction in Colorado participates in SUTS. And several jurisdictions - including the City of Boulder - have an economic nexus law for local sales tax.

"It is unfortunate that this case won't answer the question about whether local home rule authorities have the right to require remote sellers to collect self-collected and administered local taxes," says Diane Yetter, founder of Sales Tax Institute. "This is a critical open question and I do not believe home rule localities that self administer their tax meet the provisions defined in the U.S. Supreme Court decision. Separate registration, separate filing and the potential for different taxability rules puts an undue burden on the remote seller.

Will there be another Wayfair 2.0?

Though it doesn't feature Wayfair, a similar case may be brewing in Illinois. Two different out-of-state retailers claim the Illinois remote sales and use tax laws are unduly burdensome.

In a petition lodged with the Illinois Independent Tax Tribunal on November 28, 2023, Florida-based PetMeds argues Illinois discriminates against interstate commerce because remote retailers must collect Retailers Occupation Tax (state and local rates) based on the delivery address (destination sourcing), while in-state sellers collect the tax in effect at their place of business (origin sourcing). So, the rate imposed on a remote seller could be higher for a customer than the rate would be if they bought from an in-state seller.

The complaint also points out that in-state retailers selling from out-of-state locations charge a state-level use tax on all sales in the state, while out-of-state retailers with no physical presence in Illinois must charge both state and local tax. For remote retailers, the company argues, complying with sales and use tax requirements in Illinois is unduly burdensome.

In short, the company insists the state's Leveling the Playing Field laws have not leveled the playing field at all. Quite the opposite.

The second Illinois case involves a computer supply telemarketing company with no physical presence in illinois. The company argues, in part, that:

• Illinois created an unconstitutional undue burden by requiring the company to collect Illinois use tax less than four months after the Wayfair decision. (Illinois began enforcing economic nexus on October 1, 2018.)

• The state's economic nexus statute violates the Commerce Clause as applied to the company, which does not have extensive virtual contacts with Illinois.

• The state's Leveling the Playing Field Act discriminates against interstate commerce and remote retailers like the petitioner and so violates the Commerce Clause.

We're watching these two cases with interest. A bill sitting on the desk of Illinois Governor J.B. Pritzker would eliminate one of the issues. "This legislation would equalize the obligation for businesses that ship from outside the state but have physical presence in Illinois," says Scott Peterson, VP of Government Relations at Avalara. "While this is being done to try to fix a perceived Constitutional issue, it will result in even more sellers having to collect using the complicated destination basis, while those in the state still get to collect on the simpler origin basis.

What about Colorado and other home-rule states?

Unless another self-collecting jurisdiction in Colorado issues a weighty sales tax assessment for past tax periods on a company with deep pockets, there may not be another Wayfair case in Colorado. The state's taken huge strides toward simplifying its sales tax system for both in-state and out-of-state sellers.

Past simplification measures in Colorado include eliminating the 200-transactions economic nexus threshold, implementing destination sourcing for in-state businesses, and instituting SUTS. And earlier this year, the Colorado Legislature passed laws prohibiting self-administering home-rule jurisdictions from requiring businesses with no physical presence in the state to register with the local tax authorities or collect and remit local sales and use taxes.

Additional sales tax simplification measures in Colorado are to come. For example, effective July 1, 2025, Colorado is harmonizing state administration of local sales and use taxes.

The home-rule states of Alabama and Louisiana are also working to simplify their onerous sales and use tax systems. Louisiana recently dodged a potential Wayfair 2.0 lawsuit when it eliminated its own economic nexus transaction test. An Arizona-based online retailer that was suing the state no longer had standing once the transaction threshold was eliminated so dropped its case against the Pelican State. However, the law eliminating the transaction test should help simplify sales tax compliance for other taxpayers because it requires the state to establish a single-remittance system.

Yet businesses know how burdensome even simplified sales and use tax requirements can be, especially for companies with a requirement to collect and remit sales tax in multiple states.

Businesses of all sizes can reduce the burden of compliance by automating collection and remittance with Avalara AvaTax. Curious? Here's more information about automating tax compliance.