U.S. Supreme Court overrules previous decisions requiring physical presence for sales tax collection. Unless Congress acts, significant changes and burdens requiring remote sellers to collect state sales taxes are here to stay.
E-commerce retailers have exploited Quill as a competitive advantage to realize extraordinary growth over the past 25 years. In fact, the Court quoted one of the taxpayer’s websites that “one of the best things about buying through Wayfair is that we do not have to charge sales tax.” This advantage – described by the Court as “a judicially created tax shelter” – has come to an end in the Supreme Court’s decision in South Dakota v. Wayfair. The Court found that its bright-line physical presence rule was arbitrary, unsound and created an unfair tax loophole. In overruling its precedent, the Court found that a modest sales volume (under South Dakota’s law) and associated “substantial virtual connections” are sufficient under the Commerce Clause’s substantial nexus prong to require sales tax collection. But important questions remain as to whether Congress will step in to limit or clarify the Court’s decision, and how states will implement and enforce sales tax collection requirements on such retailers.
Justice Kennedy invited states to mount a challenge to the bright-line physical test articulated in Quill v. North Dakota 26 years ago and delivered the fatal blow today. The Court analyzed the continued viability of the physical presence standard, created by its own judicial precedent, under the restrictions of the dormant Commerce Clause.
The Court’s analysis began with fundamental Commerce Clause protections that prohibit states from discriminating against or imposing undue burdens on interstate commerce. In previous decisions, these principles led the Court to adopt a four-pronged test for whether states taxes impose an undue burden on interstate commerce. The first prong requires that the tax be applied to an activity with substantial nexus with the taxing state. The Court’s previous decisions in Bellas Hess and thereafter in Quill held that the substantial nexus prong was not satisfied for sales tax collection unless the retailer has an in-state physical presence. But in 1992 when Quill was decided, the Court could not have known the immense impact this rule would have on the e-commerce industry.
In Wayfair, the Court found that the correlation between an in-state physical presence and burdens of sales tax collection was artificial. This rule created an arbitrary tax loophole for remote sellers, as opposed to retailers who have one employee or store a small inventory of goods in the state. Perceived as helping customers evade a lawful tax, the Court closed this loophole focusing on the economic realities of the 21st Century and extreme growth of Internet sales. The Court concluded that the taxpayers’ “economic and virtual contacts” with South Dakota clearly established that the e-commerce retailers availed themselves of substantial privileges of carrying on business in the state and, therefore, could be required to collect sales tax, even without a physical presence.
Although it failed to reach restrictions beyond the substantial nexus prong, the Court very importantly cautioned that several protections included in the South Dakota law were weighed in finding the economic nexus standard did not violate the Commerce Clause. First, and most importantly, the South Dakota Act did not require retailers to remit sales tax retroactively. Although it remains to be seen as to how aggressively states will pursue vendors for previous periods – some states, such as Massachusetts have already begun – implicit in the Court’s opinion is that retroactive enforcement would unfairly burden remote sellers. The Court also mentioned South Dakota’s economic nexus thresholds ($100,000 of sales or 200 transactions delivered into the state) and adoption of the Streamline Sales and Use Tax Agreement as justifying the fair imposition of sales tax collection on remote vendors. Yet, questions remain as how states may impose similar economic nexus standards if these protections are not present.
Justices Thomas and Gorsuch, both skeptics of the dormant Commerce Clause, issued concurring opinions.
The dissenting opinion, written by Chief Justice Roberts and joined by liberal Justices Kagan, Sotomayor and Breyer, emphasized that Congress holds the ultimate authority in this area and, even if Bellas Hess and Quill were mistakes, the proper avenue for reversing those decision was through legislative act.
Ultimately, the physical presence rule is no more and significant fallout for remote sellers is sure to result as e-commerce retailers scramble to determine how to comply with nationwide sales tax collection. We will be monitoring this situation for, among other things:
- Will Congress step in to limit or clarify the Court’s decision in Wayfair? Several bills had been introduced but will likely need modified in light of today’s decision.
- How will states enforce economic nexus laws that have already been enacted? For instance, Ohio’s economic nexus standard for sales tax collection became effective January 1, 2018 and Massachusetts’ administrative regulation was effective October 2017. Presumably, based upon the Wayfair decision, states may not enforce sales tax collection on retailers lacking a physical presence until remote sellers have a reasonable time to comply with the Court’s decision.
- More states who have not already done so will likely enact laws similar to South Dakota’s that require remote sellers with a certain sales volume or deliveries into the state to collect tax.