On June 21, 2018 the United States Supreme Court issued the much anticipated decision in the case of South Dakota v. Wayfair. In short, the Court held that the physical presence rule for creating Sales Tax nexus (i.e. online sales tax) that was established in earlier decisions, Quill Corp. v. North Dakota and National Bellas Hess v. Department of Revenue, was not sound and that those cases should be overturned. In a 5 to 4 vote, the Court ruled in favor of South Dakota.
How did the Court reach this Decision?
To reach its decision, the Court utilized the four-pronged test from the 1977 ruling in Complete Auto Transit, Inc. v. Brady as their standard to reach a decision, agreeing that it is “not the purpose of the [C]ommerce [C]lause to relieve those engaged in interstate commerce from their just share of state tax burden.” The Court concluded that South Dakota law will be enforceable if it:
- applies to an activity with a substantial nexus with the taxing state;
- is fairly apportioned;
- doesn’t discriminate against interstate commerce; and
- is fairly related to the services the state provides.
The Court’s opinion notes that sales tax is complex, in that state taxes differ not only in the rate imposed, but also in the goods and services that are subject to tax. Further, the Ruling points out that eventually software will be available at a reasonable cost to make compliance easier for small businesses when the physical presence rule no longer controls. In fact, there are already automated tax software solutions in the marketplace that provide tax calculation and electronic filing capabilities, including QuickBooks Online.
Did everyone agree?
Yes, but no. The decision was a 5-4 vote, but one thing that was consistent, even in the dissenting opinion, was that all of the Supreme Court judges on the case agreed that the Quill and Bellas Hess decisions and the requirement that there be physical presence in order to trigger a tax obligation were wrong. Referring to the Bellas Hess case, Chief Justice Roberts noted in his dissent that he didn’t think precedent should be overturned just to “expiate a mistake it made over 50 years ago.” Roberts believes that Congress should be the one to make the change in this case, not the Court.
Who is happy now?
The states. This decision presents a myriad of opportunities for the states to regain the revenue they have historically lost to online sales where taxpayers are not then reporting the complimentary use tax on their annual tax return.
In overturning Quill, the Court’s opinion expressed concern about enforcing a judicially created “tax break” for out-of-state internet sellers at the expense of in-state brick-and-mortar stores in today’s modern national economy, which has completely changed due to the internet’s prevalence and power. It was pointed out that if the Quill standard remained, a small company with a diverse physical presence might be equally or more burdened by sales tax compliance costs than a large remote seller. Further, overturning Quill is not increasing anyone’s tax bill, it is just giving the states a better avenue for tax collection. In all states that impose a sales tax, purchasers owe tax on all taxable purchases. This is true whether the customer purchases from a store or from an online retailer. If tax is not collected at the time of the purchase, the consumer is actually required to pay a use tax equivalent on an annual tax return. The number of annual tax returns that account for use tax is historically very low.
The public. If the states are gaining back a revenue loss of anywhere from $8 to $33 billion per year due to the change in physical presence rules, then there will be more money available to support schools, recreation, police, fire, and other state or city public services.
What are the next steps?
In the short-term, the impact of the South Dakota law appears to have a mild-moderate effect on online retailers. South Dakota’s law has a threshold to include only out-of-state sellers with a “substantial” amount of sales into the State, which means that many out-of-state online retailers will not face a compliance requirement. Those that meet the thresholds, $100,000 in sales or exceeding 200 sales transaction per year, will be required to find a way to administrate and comply with South Dakota’s sales tax laws. Larger retailers meeting the thresholds will face very little burden as they generally already comply in many other states. Smaller retailers who are currently single-state filers will face much larger challenges, which potentially leads to automating their compliance efforts to ease their burden.
In the long-term, however, the impact broadens. As more states like North Dakota, enact laws similar to South Dakota, or if Congress moves forward with overarching legislation, the burden of administration and compliance could potentially expand into an exponentially larger group of out-of-state online retailers. It is expected that this will be the trajectory and once again software that takes the pain away from compliance will be a necessary tool in everyone’s toolbox.