The long-running debate regarding whether and how online sales are taxable appears to have come to an end. The ruling? Taxable.
The Supreme Court’s decision in South Dakota v. Wayfair, Inc., et al. 585 U.S. _____ (2018) overturns the prior decisions of Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967). Specifically, the Wayfair decision eliminates the “physical presence rule,” which prohibited assessment of sales tax on a transaction for goods or services when the seller did not maintain a physical presence in the taxing state. Absent the “physical presence rule,” the Supreme Court examined assessment of sales taxes on online interstate transactions using the simpler “substantial nexus” test articulated in Complete Auto Transit v. Brady, 430 U.S. 274 (1977), which scrutinizes whether the tax applies to an activity which has a substantial nexus to the taxing state. The Court stated nexus is established when the taxpayer avails itself of the privilege of carrying on business in the taxing state. In the case of online retailers, the Court noted the standard is easily met; large, national online retailers “maintain an extensive virtual presence,” and with respect to South Dakota, engage in commerce at a level establishing the online sellers had availed themselves of the substantial benefits of transacting business in the state.
The opinion makes several references to the substantial policy considerations supporting taxation of online sales. Notably, the Court stated:
According to respondents, it is unfair to stymie their tax-free solicitation of customers. But 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. Helping respondents’ customers evade a lawful tax unfairly shifts to those consumers who buy from their competitors with a physical presence that satisfies Quill—even one warehouse or one salesperson—an increased share of the taxes. It is essential to public confidence in the tax system that the Court avoid creating inequitable exceptions. This is also essential to the confidence placed in this Court’s Commerce Clause decisions. Yet the physical presence rule undermines that necessary confidence by giving some online retailers an arbitrary advantage over their competitors who collect state sales taxes.
In the name of federalism and free markets, Quill does harm to both. The physical presence rule it defines has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.
The Court continued, noting the “physical presence rule” allows a de facto competitive advantage for out-of-state retailers, and effectively encourages local brick & mortar businesses to shut their doors. As such, the “physical presence rule” has a significant adverse effect on commercial real estate:
Worse still, the rule produces an incentive to avoid physical presence in multiple States. Distortions caused by the desire of businesses to avoid tax collection mean that the market may currently lack storefronts, distribution points, and employment centers that otherwise would be efficient or desirable. The Commerce Clause must not prefer interstate commerce only to the point where a merchant physically crosses state borders. Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court’s precedents.
The Wayfair decision does not provide an immediate fix, and taxation of online sales could take some time to implement. Statutes allowing for assessment, collection, and remittance of online sales will take a while for some states, and may be right around the corner for others, depending on what the tax laws in the respective states say. The Wayfair opinion interpreted a South Dakota law, and they remanded the matter back to South Dakota. That said, the Court liked South Dakota’s law because it was specifically tailored by the South Dakota legislature to meet the Supreme Court’s substantial nexus test; it is limited to out-of-state businesses which do in excess of $100,000 in revenue, or more than 200 transactions in the state. If a state has laws on the books which are close to the South Dakota law, and regulations in place to administrate it, that state could implement the tax quickly. Other states could have to wait for their legislatures to pass a bill (most are adjourned). Still others may try to get it done at the regulatory level.
All that said, what we can predict is this: it is highly likely the state laws, once in place, will look very similar to the South Dakota law.
We also anticipate online retailers will run (sprint) to Congress, in an attempt to temper the blow (estimates are the Wayfair opinion will result in ~$8-33 billion in found money for state and local governments). In fact, eBay has already blasted an email to its users requesting they sign a petition “for Congress to act on legislation that protects small businesses.” Congress may be sympathetic, or they may not. However, immediately following issuance of the opinion, the President celebrated the Wayfair decision over Twitter. So, whether Congress can get tempering language passed and signed by the President is a significant question.
More details will surface as the dust settles in the aftermath of Wayfair, and legislatures nationwide evaluate this revenue opportunity. Please contact Jon Leleu or Kerrie Kramer at any time to discuss any questions you may have.