Physical Presence No Longer Required to Assess Sales Tax

Yesterday, in a 5-4 vote, the US Supreme Court in South Dakota v. Wayfair ruled that states can begin collecting sales taxes from out-of-state merchants even when they don’t have a physical presence within the state.  The Court stated that “there is nothing unfair about requiring companies that avail themselves of the States’ benefits to bear an equal share of the burden of tax collection.  The judgement will impact sellers in every state across the nation and is estimated to generate between $8 billion and $23 billion a year in additional sales tax revenues. This ruling overturns the 1992 decision in Quill v. North Dakota, which had set a precedent to protect retailers’ out-of-state transactions from sales tax levies.

History on Quill v. North Dakota

The 1992 U.S. Supreme Court decision in Quill v. North Dakota introduced limitations on when sales tax could be assessed on out-of-state sellers. “Nexus” is a term that describes when a business should be subjected to the taxing laws of a certain jurisdiction. In Quill, the courts determined that for purposes of sales taxes, nexus could only be established if the out-of-state seller had a substantial physical presence in the state. Aside from having a business location within the state, substantial physical presence can be established when:

• Traveling through the state regularly to deliver goods;
• Storing merchandise within state borders; or
• Visiting states to call on potential or existing customers.

In the Quill ruling, the Court justified its decision by citing the Dormant Commerce Clause, which is a legal doctrine extrapolated from the Constitution that prohibits states from interfering with interstate commerce. In this doctrine, it is understood that interstate commerce should only be overseen by the Federal government.

Quill’s Reach Has Been Challenged over the Years

The ripples caused by Quill were far-reaching. Seeing their potential for earning sales tax revenues from out-of-state sellers dwindle, many states hoped for its demise. As e-commerce businesses became more prevalent, states began testing the ruling. In 2016, for example, Alabama Rule 810-6-2-.90.03 established that any seller with “economic presence” in their state was required to collect and remit sales taxes. Later that same year, South Dakota passed Senate Bill 106 that stated out-of-state retailers would be required to collect sales taxes, regardless of physical presence, as long as they realized a certain volume or dollar value of sales within the state. These calculated changes to existing states laws have set the stage for Quill to be challenged at the Supreme Court level, as it was with South Dakota v. Wayfair.

Details on the Wayfair Decision

Wayfair is an online retailer of furniture and home goods and has no physical presence within South Dakota. Because Wayfair does not assess sales taxes in South Dakota (a fact that it proudly advertised), the State argued that e-commerce businesses like Wayfair were given a significant advantage over in-state retailers. The State claimed that Wayfair’s tax-free solicitation of customers was diverting commerce away from in-state businesses and therefore stymieing their chance to fund its needed public services with sales tax dollars. In the official Court Opinion, the Court stated that “there is nothing unfair about requiring companies that avail themselves of the States’ benefits to bear an equal share of the burden of tax collection. Fairness dictates quite the opposite result.” When considering whether or not it was fair or just to tax Wayfair and other online retailers, the Court voted 5-4 in favor of fairness.

The facts surrounding Quill are decidedly different than those surrounding Wayfair; in 1992 when Quill was decided, most interstate commerce was achieved through catalog sales. Justice Anthony Kennedy stated in the Wayfair decision that the Quill ruling was outdated in our new e-commerce-centered world.

What to Expect Going Forward

South Dakota v. Wayfair opened the door for individual states to begin requiring out-of-state businesses to collect and remit sales tax, and we expect many states to take advantage. Currently, 16 states have laws in place that would allow them to begin collecting sales taxes now that the Wayfair ruling has deemed it acceptable – just like the ones in Alabama and South Dakota that we mentioned above. The remaining states would have to revise their current laws to reap any benefits from this decision.

Even though consumers will be the ones ultimately paying the tax bill, online retailers will be financially burdened, as well. Online retailers will need to enhance their tax compliance budgets to account for their new tax collection duties. Each state’s sales tax laws are unique, and complying with all of these different laws can be costly, especially to small- and medium-sized online businesses.

Still Some Unknowns

Some are wondering if this is just the beginning – will we soon see a shift away from the amalgamation of state sales tax laws, and instead move toward one unified, nationwide law? At times, it seems that nationalization is inevitable, but we can also see states continuing to fight for their right to control what happens within their own borders. And indeed, our country’s shift away from a global tax plan to a more territorial one with the passage of the Tax Cuts and Jobs Act is a statement that speaks volumes. Time will tell what comes next, and until then, we have enough on our plates to remain busy.

If you are an e-commerce business and would like to talk through how the South Dakota v. Wayfair decision will affect you, contact us here.