The U.S. Supreme Court's Historic Ruling in South Dakota v. Wayfair Changes the Landscape for State Sales and Use Tax Collection

On June 19, 2018, the U.S. Supreme Court held, in a 5-4 decision written by Justice Kennedy, that states may require an out-of-state retailer to collect and remit sales tax on purchases by residents within that state.  [South Dakota v. Wayfair].  Until now, the states could not compel any retailer to collect the tax unless it had a physical presence in the state. 

Wayfair is a historic ruling that will change the landscape for state sales tax collection.  Many states have already enacted legislation in anticipation of a favorable ruling in Wayfair, and it is anticipated that the states that have not done so will move quickly to enact such legislation to increase their revenues.   

Wayfair also leaves many unanswered questions, including whether the decision is limited to legislation that closely mirrors South Dakota’s statute or to states that are members of the Streamlined Sales and Use Tax Agreement, like South Dakota.  Unless Congress acts to provide consistent treatment among the states, Wayfair may result in a variety of efforts to maximize state sales tax collections.

Background

Since 1967, the Court has held that, unless a retailer maintains a physical presence within the state, the state lacks the power under the U.S. Constitution to require the retailer to collect sales tax on its sales into the state.  National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967) and Quill Corp. v. North Dakota, 5014 U.S. 298 (1992).  For years, states have complained that the physical presence test does not reflect the current economy, gives out-of-state retailers an unfair advantage, and results in significant revenue losses by the states. 

In 2016, South Dakota enacted legislation requiring out-of-state retailers to collect and remit sales taxes if they delivered more than $100,000 of goods or services into South Dakota or engaged in 200 or more separate transactions for the delivery of goods and services into the state on an annual basis.  The legislation was not retroactive.  South Dakota is a member of the Streamlined Sales and Use Tax Agreement, which standardizes taxes to reduce administrative and compliance costs.  Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc. (“Respondents”) were online merchants with no employees or real estate in South Dakota.  None of the Respondents collected sales tax in South Dakota. 

South Dakota filed suit in state court, seeking a declaration that the Act’s requirements were valid and applicable to Respondents and an injunction requiring Respondents to collect and remit sales taxes in South Dakota.  The trial court granted Respondents’ motion for summary judgment, which was affirmed by the South Dakota Supreme Court on the ground that Quill was the controlling precedent.  The Court granted certiorari to reconsider the scope and validity of the physical presence test.

The Court’s Decision

In a 5-4 decision written by Justice Kennedy, the Court overruled its decisions in Bellas Hess and Quill and held that “physical presence is not necessary to create a substantial nexus” with the state.  Among its reasons, the Court observed that “the Quill Court did not have before it the present realities of the interstate marketplace, where the Internet’s prevalence and power have changed the dynamics of the national economy” and that “attempts to apply the physical presence rule to online retail sales have proved unworkable” and resulted in significant losses to the states.

The Court also found that the physical presence test discriminates against local businesses and results in a competitive disadvantage to remote sellers who can offer their products at lower prices.  “Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a state’s consumers.”  The Court found that the physical presence test helps consumers evade a lawful tax, prevents sellers from competing on a level playing field, and intrudes on states’ reasonable choices in enacting their tax systems.

Key to the Court’s decision was that South Dakota’s law requires a merchant to collect the tax only if it does a considerable amount of business in the State, the law is not retroactive, and South Dakota is a party to the Streamlined Sales and Use Tax Agreement.  It is uncertain whether a state sales tax collection law that does not contain these elements would survive the Court’s scrutiny.  The Court acknowledged in its opinion that there are a variety of potentially related issues, including retroactivity, but that those issues were not before the Court and “their potential to arise in some later case cannot justify retaining [the physical presence test] that deprives States of vast revenues from major businesses.”

Moving Forward 

The Court’s decision in Wayfair will cause a major shift in state tax policy.  Unless Congress acts, Wayfair will likely result in a variety of dollar amount or transaction thresholds in which a state may assert nexus.  Regardless, state tax collection will become the “new normal” for online retailers that have more than a nominal amount of sales within a state. 

Williams Mullen will continue to monitor the developments and provide updates to you on the Wayfair decision.