Physical Presence Standard for Sales Tax VIA Quill Overturned - The Impact of the Supreme Court's Decision in Wayfair
Today, the U.S. Supreme Court has issued its opinion in South Dakota v. Wayfair, No. 17-174, in a 5-4 decision in favor of the State of South Dakota’s imposition of sales tax under economic nexus principles. The case upholds South Dakota’s application of sales tax to internet retailers who sell into South Dakota but have no property or employees (i.e. physical presence) in the state. The South Dakota law, initially passed in 2016, required all merchants to collect a 4.5 percent sales tax if they had more than $100,000 in annual sales or 200 or more individual transactions in a calendar year into the state.
This law challenged the physical presence requirements for sales tax nexus previously established in the Supreme Court’s 1992 holding of Quill Corp. v. North Dakota, 504 U.S. 298, 318 (1992), which held that sales tax nexus cannot be established without physical presence, pursuant to the Court’s dormant commerce clause power to restrict state taxation of interstate commerce.
Multiple companies, including Wayfair, chose not to register with South Dakota to collect sales taxes in the wake of this new law, resulting in South Dakota seeking suit with three of them (Wayfair, Overstock.com , and Newegg) to compel their registration and remittance. The holdings of the state courts prior to the Supreme Court’s review held for the internet retailers, and resulted in South Dakota’s appeal.
The Supreme Court’s majority opinion, authored by Justice Anthony Kennedy and joined by Justices Alito, Ginsburg, Gorsuch and Thomas in a 5-to-4 ruling, gave some insight into the Court’s reasoning, stating in dicta that:
- “the Quill decision had distorted the nation’s economy and had caused states to lose annual tax revenues between $8 billion and $33 billion.”
- “Quill puts both local businesses and many interstate businesses with physical presence at a competitive disadvantage relative to remote sellers”
- “[Wayfair’s] advertising…states that we do not have to charge sales tax…Wayfair ignores in its subtle offer to assist in tax evasion is that creating a dream home assumes solvent state and local governments.”
Further, Judge Gorsuch, in his concurrence, indicated that remote sellers under Quill at present:
- “…can avoid the regulatory burdens of tax collection and can offer de facto lower prices caused by the widespread failure of consumers to pay the tax on their own.”
Four justices (Chief Justice John Roberts, and Justices Breyer, Sotomayor, and Kagan) dissented, agreeing that the Court was incorrect in its holding in Quill but arguing that it was on Congress and not the Court to change, as well as emphasizing the brunt of the negative impact will be on small business.
Potential State Implications and Questions Moving Forward:
- Under the South Dakota law, the tax applies to sellers that deliver more than $100,000 worth of goods or services into the state annually, or engage in 200 or more separate transactions for deliveries into the state over the course of a calendar year – this will serve as the constitutionally upheld standard states may seek to emulate; while the case decided focuses on South Dakota law, the Supreme Court’s ruling applies across all states.
- 31 states currently have laws taxing internet sales; certain states may seek if their versions could survive to the extent they fail to follow South Dakota’s framework
- Smaller companies may be the most impacted by the decision, as they may not have the tax expertise or professionals on-hand to follow the rules across multiple state tax jurisdictions.
- Note that the Court specifically observed that South Dakota’s law, and its tax laws generally, minimizes the burden on interstate commerce. Other states are likely to craft their laws accordingly, and those states that deviate substantively may result in further litigation
- The Court did not decide whether states may impose sales taxes retroactively, which certain states may do so depending on how aggressive they choose to be in their enforcement.
- The Court is silent as to whether the other state economic nexus models are constitutionally valid (e.g. income and other similar taxes)
- The Court did indicate the possibility that certain transactions were “so small and scattered that no taxes should be collected” which may keep a door open as to certain transactions which would be exempt from establishing nexus.
Potential Federal Implications:
- Congress has previously proposed several federal legislative solutions to apply across the states:
- The Remote Transactions Parity Act – a destination-based system for collecting sales/use tax; states which meeting the simplification alternative can require out-of-state vendors to collect and remit the sales/use tax.
- The Marketplace Fairness Act – also creates a destination-based collection system for the sales/use tax when the vendor and customer live in different states, in which the amount of tax due is based on the location of the buyer. More specifically, the tax due is based on the sales tax rate in the location where the buyer receives the product (or service), if it is known. The MFA allows qualifying states to require all out-of-state vendors to collect and remit the tax due for sales sourced to their state.
- Rep. Bob Goodlatte (R-VA) Proposal: An origin-based system, titled the Online Sales Simplification Act, requiring vendors would collect the sales/use tax based on their state’s tax rates and remit that amount to a clearinghouse. The clearinghouse would then send the amount to the state where the customer is located.
- With today’s decision, there is increased potential for federal movement. State and Local Tax Professor Bruce P. Ely has opined that where such movement would previously have been viewed by the federal government as administering a new tax, it now has the potential to “bring clarity to the marketplace”
The multistate implications of the Wayfair decision will be ongoing as states seek to avail themselves of the ability to impose online retailers income tax. Withum will be monitoring the continued sales tax impact for its clients in the coming weeks, and encourage you to reach out to the Withum State and Local Tax Team to assist your business in evaluating the impact of Wayfair in the days to come.