June 25, 2018

States Win and E-Retailers Lose as U.S. Supreme Court Alters Sales Tax Collection Standard

4 min

States can now require internet retailers to collect sales taxes even if the retailer has no physical presence in the state.

In South Dakota v. Wayfair, the Supreme Court overturned its 1992 decision in Quill Corporation v. North Dakota, which limited a state's ability to impose its sales tax on an out-of-state retailer. In Quill the Court ruled that only a retailer that had a physical presence in a state by means of employees, stores, warehouses, or the like was required to collect such state's sales tax. The Quill decision is one of the main reasons why many e-commerce retailers did not have to collect sales tax for sales to out-of-state residents.

In recent years, states have tried all sorts of means to circumvent the Quill standard. For example, Colorado requires out-of-state retailers to report information about sales to Colorado residents, and Massachusetts tried (but eventually backed off) to claim that cookies on a customer's computer created a physical presence in the state. Other states enacted "economic nexus" laws that intentionally flout the Quill physical presence requirement by asserting nexus (or a "sufficient connection" with the state) based on the number and/or dollar amount of sales into the state.

South Dakota's economic nexus law was at the heart of the Wayfair case. South Dakota is not alone in enacting economic nexus legislation. About fifteen states currently have some form of such economic nexus laws that require remote retailers that satisfy the economic nexus threshold to collect and remit sales tax to the state regardless of the retailer's degree of physical presence in the state. And, under this new decision, states without economic nexus laws for sales tax purposes can be expected to rush to alter their existing standards to take advantage of the Court's liberalization of the nexus rules.

To try to predict what the new sales tax standard may look like, it is important to understand the details of Wayfair. Wayfair involved three major internet retailers (Wayfair, Overstock, and Newegg), which challenged South Dakota's economic nexus law. South Dakota's law requires an out-of-state retailer to collect sales tax if the retailer makes more than $100,000 of taxable sales of property or services into the state or makes taxable sales into South Dakota in 200 or more transactions.

With a 5-4 vote, Justice Kennedy authored the majority opinion, joined by Justices Thomas, Ginsburg, Alito, and Gorsuch. Justices Thomas and Gorsuch filed concurring opinions. Justice Roberts dissented, joined by Justices Breyer, Sotomayor, and Kagan. In dissent, Chief Justice John G. Roberts Jr. agreed with the majority opinion that the Court's prior rulings on this topic had been "wrongly decided." But he asserts that insufficient reasons exist to overrule those precedents and that the Court should leave Congress to address the issues as it is expressly authorized to do by the Commerce Clause.

The opinion lists three aspects of South Dakota's tax system as features that "appear designed to prevent discrimination against or undue burdens upon interstate commerce." These three features can be expected to guide other courts in evaluating whether sales tax statutes of other states meet the Commerce Clause's requirements so as to be upheld like South Dakota's law.

  • The first noted feature is that the South Dakota law, by means of the dollar amount and volume of transaction thresholds, applies a safe harbor to protect those retailers that transact only limited business in South Dakota from having to comply with the law.
  • The second noted feature of the South Dakota law is that by its own terms it ensures that no obligation to remit the sales tax may be applied retroactively. Whether such collection obligations could and would be imposed retroactively by states for prior years on remote retailers has been a much-debated topic. The Court's limited comment on retroactivity seems to dictate that such collection obligations should not be imposed retroactively.
  • The third noted feature is that South Dakota is one of more than twenty states that have adopted the Streamlined Sales and Use Tax Agreement. This Agreement serves to standardize taxes and reduce administrative and compliance costs by requiring a single, state-level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the state. Sellers that choose to use such software are immune from audit liability. The Court's comment on South Dakota's participation in the Agreement can be read as suggesting a requirement that a state be a member of the Agreement in order for its remote collection law to be valid under the Court's decision.

The Wayfair case now returns on remand to the South Dakota Supreme Court to be implemented. Many years of further proceedings can be expected across the forty-five states that impose sales tax, as unique situations in the states' economic nexus laws are tested against the standards of the Wayfair case.