Banks that collect revenue in states where they do not have branches may be facing the prospect of higher income tax bills following a recent Supreme Court decision.
In a 5-4 opinion last month, the court ruled that many larger e-commerce firms that sell products to residents of South Dakota are required to pay sales taxes, even if they do not have physical operations in the state.
The ruling’s implications for Internet retailers are straightforward and have been widely discussed — lots of merchants that were not collecting sales tax from online shoppers in certain states will have to start doing so.
But some tax experts believe that the court’s ruling will also be used by officials in certain states to argue that out-of-state companies, including banks, need to start paying income taxes in their jurisdictions.
Already, one large bank has set aside a big chunk of cash to prepare for the ruling’s fallout. Wells Fargo said Friday that it recorded a net expense of $481 million in the second quarter, in large part because of the Supreme Court decision.
John Shrewsberry, Wells Fargo’s chief financial officer, explained during a call with reporters that the Supreme Court’s opinion has an income tax implication.
“Following the ruling, some of our affiliated entities may be considered to be taxable based on an economic presence in the state even if they have no physical presence,” he said.
Shrewsberry added that Wells Fargo recorded the $481 million expense based on a seven-year analysis. “On a go-forward basis, it really has a relatively marginal impact,” he said.
It is not at all clear how many banks will follow Wells Fargo’s lead. Each bank’s determination will rely on an analysis of how complex tax issues in particular states interact with its own specific business.
Perhaps the only point of clarity is that small banks that only operate within their home state should not be affected by the Supreme Court’s decision.
John Kinsella, vice president of tax policy at the American Bankers Association, said that more banks may wind up setting aside funds for state income tax payments.
“Will we see more of this? We might, as banks do their further analysis,” he said.
Valerie Dickerson, a partner with Deloitte Tax LLP, said in an email that the Supreme Court’s ruling could affect companies that previously relied on the argument that they do not have a physical presence in a particular state.
But she cautioned: “That doesn’t mean these companies are automatically subject to tax.”
For folks who are not steeped in tax law, it may be surprising that a court decision in a case involving sales taxes could apply to companies’ income tax obligations.
The Supreme Court case grew out of a 2016 law that South Dakota lawmakers passed in an effort to collect sales tax revenue from purchases that state residents make online. It applies to out-of-state retailers that do not operate stores or warehouses in the Mount Rushmore State, but do meet certain thresholds for sales to South Dakotans.
The two-year-old law was conceived as a way to challenge a 1992 Supreme Court decision that bars states from requiring retailers that lack a physical presence to collect sales taxes.
Prior to the rise of e-commerce, that ruling was disadvantageous to states but not necessarily an enormous problem. In more recent years, the 26-year-old decision has posed a bigger impediment to revenue collection by the states.
“Each year, the physical presence rule becomes further removed from economic reality,” Justice Anthony Kennedy wrote for the court’s majority.
Even though the South Dakota law has nothing to do with income taxes, the Supreme Court’s decision may impact how various states determine which companies owe such taxes.
Some states currently have regulations or guidance that articulate a so-called physical presence standard even though there is nothing in state law that requires the use of that standard, said Deane Eastwood, a principal at Ernst & Young LLP.
“The question will be, will they revise those standards?” Eastwood said Wednesday during a webinar about the income tax implications of the court’s recent decision.
