On June 21, the U.S. Supreme Court overturned a longstanding tenet of sales tax rules, and it likely will result in a considerable uptick in the application of sales taxes where none were previously due. In South Dakota v. Wayfair, Inc.,1 the Court addressed the issue of when remote sellers without a physical presence in a state, or “nexus,” can be required to collect and remit sales taxes on the sale of otherwise taxable products and services to customers within the state. Pepper Hamilton will issue a more-detailed analysis of Wayfair in the coming days, but we begin with the history leading up to the case and the practical implications of the decision.
Remote-Sales – Before the Internet
In 1967, the Supreme Court considered whether mail order sellers without a physical presence in a state — those sellers with no property, employees or independent contractors in the state — could be subject to state sales tax. The Court held that they could not because, without property or personnel in the state, the seller had no nexus with the state.2 The Court reconsidered this issue in 1992 in Quill Corp. v. North Dakota.3 The decisions in both cases found that the Commerce Clause of the U.S. Constitution prevented states from requiring sellers to collect and remit sales taxes unless those sellers had a physical presence in the state.
The Rise of Internet Sales
Twenty-six years after Quill was decided, the Court in Wayfair cited Department of Commerce statistics documenting the rise of retail over the internet. According to Commerce, when it first started tracking internet sales, those sales accounted for 0.8 percent of all retail sales. More recent statistics show that internet sales have increased tenfold, accounting for 8.9 percent of all sales. Further, again according to Commerce, internet sales are growing at a rate four times faster than traditional retail sales.
Lost Sales Tax Revenue
As internet sales increased, remote sellers had better access to in-state markets without having to physically enter the state. The Wayfair Court noted that buyers are supposed to remit use tax on purchases for which the vendor does not collect sales tax, but it observed that compliance is notoriously low. The Court cited estimates provided by South Dakota and the General Accounting Office that the sales tax revenue lost nationally as a result of the physical presence requirement ranges from $8 to $33 billion annually. South Dakota estimated it lost sales tax revenue in the neighborhood of $50 million a year.
The States React
States, in reaction to the rise of internet sales and the subsequent lost revenue, strictly interpreted the physical presence requirement so that the slightest physical presence, no matter how small or irregular, would result in a determination of nexus for sales tax purposes. Additionally, states enacted legislation, such as New York’s infamous Amazon law, providing that relationships with third parties could be deemed to satisfy the physical presence requirement. Other states, such as Colorado, imposed onerous reporting and information requirements on companies that sold products in state but did not collect and remit sales tax.
The South Dakota Law at Issue
The South Dakota law at issue in Wayfair required sellers that deliver more than $100,000 of goods or services in the state, or that engage in 200 or more such transactions in the state, to collect and remit sales tax. The law also barred the retroactive application of these requirements.
The Wayfair Decision
The decision overturns, on a 5-4 basis, the physical presence rule. The Court stated, “Quill’s physical presence rule intrudes on States’ reasonable choices in enacting their tax systems. And that it allows remote sellers to escape an obligation to remit a lawful state tax is unfair and unjust.”
Implications of the Decision
The Court looked favorably on South Dakota’s dollar value/transaction thresholds, as well as the statutory limitation that it would not apply the tax retroactively. This should offer some comfort to small businesses selling remotely, as well as those concerned about retroactive collection of sales taxes, as the Court specifically noted that other aspects of a law requiring remote sellers to collect sales taxes could still run afoul of the Commerce Clause.
Additionally, the possibility of congressional action looms, as the Court noted that Congress could choose to regulate these aspects of sales tax collection and remittance under the Commerce Clause. Indeed, Congress has considered federal legislation in this arena before, such as the Marketplace Fairness Act. This decision may be a call to revisit such legislation.
Vendors should consider participating in the Streamlined Sales Tax Registration System (SSTRS). Under the Quill physical presence regime, participation in the system was less desirable because vendors had to collect in all of the streamlined states without regard to their physical presence in a state, giving up a competitive advantage to in-state sellers that were required to collect sales tax. With the removal of the physical presence requirement, the competitive advantage is erased; as a result, the ability to collect and remit sales taxes efficiently in more than 20 states, with approved software solutions, service providers and liability protection for vendors, is much more attractive.
Finally, any additional costs of sales tax compliance for vendors should be offset, at least somewhat, by the reduction in use tax compliance costs on their own account. Vendors purchasing items for their own use, such as a computer, are required to self-assess and remit use tax on the purchase if the vendor that sold them the computer did not collect sales tax on the purchase. With the removal of the physical presence requirement, the hypothetical computer vendor is much more likely to be required to collect the sales tax upfront, reducing the need for use tax compliance.
1 No. 17-494 (U.S. June 21, 2018).
2 Nat'l Bellas Hess v. Dep't of Revenue, 386 U.S. 753 (1967).
3 504 U.S. 298 (1992).
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship. Internal Revenue Service rules require that we advise you that the tax advice, if any, contained in this publication was not intended or written to be used by you, and cannot be used by you, for the purposes of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.