PetMed Express, Inc. (PetMeds), a Florida-based online seller of pet medication, has appealed an assessment of more than $1,340,000 in Illinois retailers’ occupation tax (ROT), use tax, and interest for remote sales made to Illinois customers. PetMeds claims that the state’s current tax scheme for remote retailers violates the Commerce Clause of the U.S. Constitution as expressed in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018). The Petition was filed with the Illinois Independent Tax Tribunal under Docket Number 23TT104 on November 28, 2023.
At issue in the case are provisions of Illinois’ Leveling the Playing Field legislation that became effective January 1, 2021. PetMeds claims the provisions discriminate against interstate commerce, impose an undue burden on interstate commerce, and discriminate against certain types of taxpayers.
PetMeds’ claim centers on 35 ILCS 120/2-12(6), which created “destination sourcing” rules that apply only to remote retailers that do not have a physical presence in Illinois. Remote retailers must charge state and local taxes in effect at each location where their items are shipped or delivered.
Illinois retailers, meaning retailers that have a physical presence in the state, continue to use “origin sourcing” rules. Under origin sourcing, the tax rate charged is based on where the retailer’s predominant and most important selling activities take place. This can include the location of order and payment acceptance or where inventory is held, including “brick and mortar” stores. If the composite of selling activities occurs outside Illinois, Illinois retailers are only responsible for reporting state use tax at 6.25% on their sales to Illinois customers.
35 ILCS 120/2-12(6) creates new destination sourcing rules that apply only to remote retailers. Thus, remote retailers like PetMeds are responsible for reporting up to 1,500 taxing jurisdictions with rates exceeding 10%. Illinois retailers with an in-state presence are categorically excluded from this administrative burden and may only be responsible for reporting use tax at 6.25%. PetMeds claims this system caused its compliance costs to rise substantially compared to Illinois retailers. The Commerce Clause of the U.S. Constitution specifically regulates discrimination in instances where interstate commerce appears to be impaired.
PetMeds also claims that the Illinois regime creates an undue burden on interstate commerce. In Wayfair, the Supreme Court noted that South Dakota was a member of the Streamlined Sales and Use Tax Agreement (SSUTA). The Court noted that SSUTA requires a single, state-level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides retailers access to tax administration software paid for by the state.
The Illinois regime has none of those benefits. The state justifies its regime by pointing out that remote retailers are now required to charge the same rate of tax as sales made at physical stores in Illinois. But this response is incomplete because Illinois retailers that sell online enjoy a different set of rules that result in lower compliance burdens and potentially lower tax rates compared to remote retailers. If the goal was parity between Illinois retailers and remote retailers, the same set of rules should apply. Instead, the rules promote gamesmanship by incentivizing retailers to establish a de minimis presence in Illinois unconnected to selling activities to take advantage of the lower use tax rate.
For example, a remote retailer selling to Illinois customers was recently audited. Destination sourcing rules for remote retailers made them subject to both state and local taxes on their sales. Unfortunately, their tax software had been set up under the pre-2021 rules and was not charging local taxes.
During the audit, it was discovered that the retailer had hired a remote employee in Illinois mid-way through the audit period. This made the company an Illinois retailer subject to origin sourcing rules for subsequent periods. Because orders were still accepted outside Illinois and the company held no inventory in Illinois, those sales were only subject to the 6.25% use tax rate. Hiring an Illinois employee, with no other changes to business operations or tax software configuration, saved the retailer thousands on its audit assessment and reduced the amount of tax it was obligated to collect on future sales.
“This is one of those peculiar nuances Illinois has created in sourcing methodologies between in-state retailers, remote retailers, and out-of-state retailers,” said Michael Willer, Principal at Ryan. “It creates a competitive advantage for those who can systematically reduce the collection requirement to the lowest rate, the 6.25% use tax. The PetMed Express, Inc. appeal will be an interesting case to follow as it questions the fairness of the Leveling the Playing Field legislation.”
For now, Willer noted that Illinois taxpayers are charged with analyzing multiple “flow charts,” years of case law on “selling activities,” and administrative regulations to determine tax collection obligations. Even the “short cuts” in the regulations, intended to address “unique and complicated” sales processes, cannot address all “unique” fact patterns.
With all these complex collection and reporting requirements, it is incumbent on taxpayers to carefully evaluate their obligations in Illinois. Ryan tax experts have extensive experience assisting businesses navigating these requirements, providing valuable insights and strategies to minimize your tax obligations. Reach out to our experts today to see how we can help.
TECHNICAL INFORMATION CONTACTS:
Michael Willer
Principal
Ryan
630.515.0477
michael.willer@ryan.com
Brian Stromen
Principal
Ryan
763.445.4200
brian.stromen@ryan.com
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