Does the Illinois PetMeds Case Threaten Economic Nexus?

Charles Maniace
January 2, 2024

This blog was last updated on January 2, 2024

Ever since Louisiana eliminated its economic nexus transaction count threshold and rendered the Halstead Bead challenge to its remote collection requirements moot, the sales tax community has been anticipating whether any new litigation would spring up. Indeed, it has. This newest case was recently filed in the Illinois Independent Tax Tribunal by PetMeds Express. This re-opens the million-dollar question: can a taxpayer win a Constitutional argument against economic nexus?

What is PetMeds complaining about?

PetMeds Express is an online pharmacy that sells pet medications, pet food, dietary supplements, and other taxable items. They market directly to consumers throughout the United States through a website, mobile app and toll-free number.

Following the South Dakota v. Wayfair Supreme Court decision in 2018, Illinois enacted a remote seller collection law. Companies making over $100,000 in sales annually or engaging in more than 200 separate transactions became obligated to collect Illinois tax. This new rule took effect on October 1, 2018, but this case is not about whether PetMeds exceeded those thresholds (they did). It’s all about whether the Illinois remote seller collection rules are unconstitutionally complex or illegally discriminatory.

Are Illinois sales tax requirements complex?

Illinois sales tax rules are different from other states. Its sales tax is called the “Retailer’s Occupation Tax” or ROT. It’s properly charged at the state and local level when the buyer and the seller are both physically present in Illinois. Since Illinois is an origin-based state, local-level ROT is derived from the location of the seller, not the buyer.

Additionally, Illinois imposes a seller’s use tax that is properly charged when the item being sold originates from an out-of-state location. Importantly, there is no local-level seller’s use tax. This meant, prior to Wayfair, sales originating from outside Illinois were taxed at a decidedly lower total rate than in in-state sales.

Leveling the playing field

When Illinois first adopted an economic nexus requirement, the rule for qualifying remote sellers was the same as for sales by in-state sellers that originated out of state. Both charged state sellers use tax. No local tax applied. This changed when Illinois enacted new rules intended to “Level the Playing Field” between in-state sellers, remote sellers and marketplace facilitators. These rules became effective on January 1, 2021, and substantially changed the requirements for remote sellers. In an attempt to provide clarity, the Illinois Department of Revenue (DOR) published a flowchart explaining the type of tax each seller was required to collect.

As explained below, it’s this adjustment that likely creates the biggest legal exposure for Illinois.

Does PetMeds Express have a point?

In its petition PetMeds makes two basic arguments. First, it alleges that the Illinois requirements discriminate against interstate commerce. In making this case, PetMeds explains that remote retailers are compelled to collect local tax based on the customer’s location while in-state retailers selling from in-state locations collect local tax based on their place of business. This means that remote sellers must manage more local rates. This argument is not particularly compelling because the same requirements exist in all the other states that have origin-based local tax sourcing. These states include Arizona, California, Missouri, Ohio, Tennessee, Texas, Utah and Virginia. In fact, only one state changed its in-state sourcing rules subsequent to the Wayfair decision, that being New Mexico. This disparate requirement existed before the Wayfair decision and still exists today. The only thing that’s changed is that post Wayfair, far more remote sellers now have a collection obligation.

What seems more compelling is an argument that PetMeds mentions but gives a little less attention to, that being the disparate treatment between remote sellers and in-state sellers selling from a remote location. If you trace the “Leveling the Playing Field” flowchart, you see that in-state sellers selling from out-of-state locations only charge state level use tax at the rate of 6.25%, while similarly situated remote sellers are obligated to charge both state and local ROT.

As an example, a fully remote seller like PetMeds, selling from their Florida headquarters to a customer in Springfield, Illinois must charge a total ROT rate of 9.75% (6.25% state tax, 1% county tax and 2.5% city tax). However, an Illinois company selling to the same customer from from a Florida office only charges 6.25% state use tax, assuming that with respect to this sale, no “selling activity” occurs in Illinois.

It’s hard to comprehend how this disparate treatment “levels the playing field” and it’s even more difficult to discern how it’s not discriminatory against the out-of-state seller.

PetMeds makes the secondary argument that the Illinois rules are unduly burdensome because it requires remote retailers to “manually determine, register, and report each destination to which sales are delivered and its specific local tax rate.” Granted, reporting local tax on the Illinois state sales tax return is complex but fundamentally, requiring a retailer to apply the correct local rate based on their customer’s location in a state like Illinois where local tax is largely administered by state government, is readily addressed through robust tax automation.

What will happen next?

The Illinois Tax Tribunal is an independent agency created by the legislature to resolve disputes between taxpayers and the DOR. The case will be heard by an administrative law judge who will ultimately author a written decision. This ruling can be appealed to the state appellate court system.

It seems likely that this case will find its way to the courts and it’s an open question as to whether Illinois can justify the disparate requirements between similarly situated taxpayers. Although it will require new legislation, it’s possible that Illinois could take a page from Louisiana and attempt to render the case moot by re-leveling the playing field by treating remote sellers and in-state companies alike.

Stay tuned for further developments…

Take Action

Reach out to our team for the latest news and updates about Illinois economic nexus.

Sign up for Email Updates

Stay up to date with the latest tax and compliance updates that may impact your business.

Author

Charles Maniace

Chuck is Vice President –Regulatory Analysis & Design at Sovos, a global provider of software that safeguards businesses from the burden and risk of modern tax. An attorney by trade, he leads a team of attorneys and tax professionals that provide the tax and regulatory content that keeps Sovos customers continually compliant. Over his 20-year career in tax and regulatory automation, he has provided analysis to the Wall Street Journal, NBC, Bloomberg and more. Chuck has also been named to the Accounting Today list of Top 100 Most Influential People four times.
Share this post

Hungary Supplemental Insurance Premium Tax
EMEA IPT
July 11, 2022
Extra Profit Tax: An Introduction to Supplemental IPT in Hungary

This blog was last updated on October 28, 2024 Update 7 October 2024 by Edit Buliczka Hungarian Tax Office Updates IPT Declaration Form for 2023 The procedure necessary to correct an underdeclared premium figure in Hungary can be complicated. The complexity of a correction for return form 2320 has become even more challenging. Following a […]

sales tax vs. use taxes
North America Sales & Use Tax
November 8, 2024
Demystifying Tax Types: Sales Tax vs. Seller’s Use Tax vs. Consumer’s Use Tax

This blog was last updated on November 8, 2024 One of the core concepts in sales tax compliance is also one of the most frequently misunderstood: the differences between sales tax and use tax. These tax types may look similar on the surface, but knowing the differences is essential for staying compliant and avoiding costly […]

2025 bond project
North America Tax Information Reporting
November 4, 2024
The Insurer’s Guide to the 2025 Bond Project

This blog was last updated on November 4, 2024 The regulatory landscape for insurance companies is undergoing significant changes with the Principles-Based Bond Project which is set to take effect on January 1, 2025. These changes, driven by the National Association of Insurance Commissioners (NAIC), will impact how insurance companies classify and value bond investments, […]

E-Invoicing Compliance EMEA VAT & Fiscal Reporting
November 1, 2024
VAT in the Digital Age Approved in ECOFIN

This blog was last updated on November 7, 2024 The long-awaited VAT in the Digital Age (ViDA) proposal has been approved by Member States’ Economic and Finance Ministers. On 5 November 2024, during the Economic and Financial Affairs Council (ECOFIN) meeting, Member States unanimously agreed on adopting the ViDA package. This decision marks a major […]

what is peppol
E-Invoicing Compliance North America
October 29, 2024
What it is PEPPOL?

This blog was last updated on October 29, 2024 Peppol E-invoicing explained: What it is and how it works The global adoption of electronic invoicing is accelerating. Governments worldwide are pushing to adopt e-invoicing to digitally transform their national systems and, often, to close the VAT gap. While many countries have introduced their own e-invoicing […]

remote sellers sales tax
North America Sales & Use Tax
October 28, 2024
Will Congress Act to Simplify Remote Seller Sales Tax Collection

This blog was last updated on November 5, 2024 When the United States Supreme Court ruled in 2018, that South Dakota’s law imposing sales tax collection requirements on sellers without in-state physical presence was constitutional, it did not grant states free reign. States are still responsible for ensuring that their sales tax requirements are manageable, […]