On June 21, 2018, in South Dakota v. Wayfair, Inc., the U.S. Supreme Court struck down over fifty years of precedent when it ruled that retailers are no longer required to have a physical presence in a state to be subject to the state’s tax jurisdiction for sales tax purposes. Importantly, the question before the Court was never whether South Dakota has the authority to tax the sales of goods and services delivered to consumers within its borders, as there is no doubt that such transactions are subject to South Dakota sales and use tax. Rather, the question was: who bears the tax compliance responsibility – the retailer or the consumer?
Sales and use taxes can often be thought of as two sides to the same coin. If a transaction is subject to sales tax, generally, the retailer must collect the tax from the consumer then report the sale and remit the tax to the appropriate taxing authorities. If a retailer is not subject to the tax jurisdiction of the state (or local authority) to which the tax is owed, the consumer is required to remit the tax (as a use tax) and report their purchase to the appropriate taxing authority. The question before the Court in Wayfair was: when may a state exercise tax jurisdiction over a retailer and require such retailer to collect, remit and report sales tax to the state?1
In general, under the Commerce Clause, for a state to have tax jurisdiction for a specific tax, the tax must: 1) apply to an activity with a substantial nexus to the taxing state, 2) be fairly apportioned, 3) not discriminate against interstate commerce, and 4) be fairly related to the services the state provides. Complete Auto Transit, Inc. v. Brady.2 Further, taxes must not place an undue burden on interstate commerce.3 While it has long been the rule that states may impose income and franchise taxes on companies with “attributional” or “economic nexus”,4 Quill and Bellas Hess5 both previously held that to require a retailer to collect and remit sales tax for states in which the business lacked a substantial physical presence in the state would: i) place an undue burden on interstate commerce and ii) violate the substantial nexus prong of the Complete Auto requirements.
For years, states have been attempting to get around the physical presence requirement by broadly defining “physical presence” and some even go so far as using “virtual physical presence” or “click through” nexus definitions.6 South Dakota, however, used a more straightforward approach in its efforts to recapture lost sales tax revenue from online retailers who lack a storefront in South Dakota. Specifically, South Dakota passed a “threshold test law” requiring that all retailers that deliver $100,000 of goods or services or have 200 or more sales delivered in South Dakota must collect and remit sales tax as though they have a physical presence in the State. The South Dakota trial court issued a summary judgment in favor of Wayfair based on Quill, finding that: despite the threshold, taxing Wayfair was unconstitutional because Wayfair lacked an actual, physical presence in South Dakota. South Dakota’s Supreme Court affirmed the trial court’s decision, which set up the U.S. Supreme Court to consider the issue.
Wayfair is a 5-4 decision in which the majority concludes that, due to advents in technology: 1) requiring out-of-state retailers who meet South Dakota’s threshold requirements would not impose an undue burden on interstate commerce; 2) the South Dakota threshold meets the substantial nexus test; and 3) continuing to ignore the economic realities of internet commerce discriminates against in-state businesses by imposing collection obligations on them but not out-of-state retailers (thus increasing the cost of local sales because consumers pay sales tax for local sales but not online sales and thereby driving business to remote sellers).7 Included in the Court’s analyses are arguments concerning: the Streamlined Sales and Use Tax Agreement, which attempts to reduce the administrative burden on businesses for complying with all the various local sales and use tax laws; the impact of ecommerce on the overall economy; the estimated amount of lost sales tax revenue ($8-$33 billion annually); and the continued elimination of state borders through internet transactions.
In addition to upholding South Dakota’s threshold test as meeting the substantial nexus requirement, the Court’s decision eliminated the bright-line, physical presence test for determining the sales tax jurisdiction of a state; a test which, solely from an economic connectivity perspective, is outdated and has prevented state and local authorities from collecting significant tax revenue. The Court, for long held jurisprudential reasons, can only address the questions and issues directly before it. Unfortunately, this means Wayfair raises many more questions than it answers. For example:
• What is the threshold for substantial nexus? Is it less than South Dakota’s requirement of $100,000 in sales or 200 transactions? Note: Wyoming has enacted a threshold requirement identical to South Dakota’s threshold but Colorado has not enacted any such a requirement. See Wyo. Stat. 39-15-501.
• Arguably, every business with an internet site has a virtual presence in every state regardless of whether the business specifically directs economic or marketing activities to that specific state; however, that does not mean every business has a sufficient nexus with every state such that it is required to collect, remit and report sales tax for that state. If a state has not enacted a threshold like South Dakota, what is required in addition to virtual presence in order for the state to have the tax jurisdiction over a business such that the State can require the retailer to collect, remit and report sales tax on deliveries into the State?
• Wayfair states that a substantial nexus with a state “is established when the taxpayer (or collector) avails itself of the substantial privilege of carrying on business in that jurisdiction.” If a company is “doing business” within a state under the state’s laws, it must register to transact business in that state.8 State registration requirements, like state taxation, may not place an undue burden on interstate commerce.9 Now that Wayfair has upheld South Dakota’s threshold as establishing a substantial nexus for collection of sales tax, does meeting that threshold also mean that the out-of-state retailer is “doing business” in South Dakota; must register to do business with South Dakota through its Secretary of State’s office; and comply with the annual registration and reporting requirements for companies “doing business” in South Dakota?
• Conceptually, the decision is easily applied to most goods. If a retailer delivers a product to a consumer in a state (and all the other tests are met), the retailer must collect, remit and report sales tax for that state regardless of the retailer’s lack of physical presence in the delivery state. But some services are subject to sales tax. If the service is performed by the provider in one state but the consumer receiving the benefit of those services is in another state, which state has tax jurisdiction and can require the retailer to collect, remit and report sales taxes on those services?10
• While the Wayfair decision is grounded solely in the Commerce Clause, as the Court notes: “Due Process and Commerce Clause standards may not be identical or coterminous, but there are significant parallels.”11 If an out-of-state retailer is now subject to a state’s sales tax jurisdiction under the Wayfair decision, does that business now also meet the minimum contacts test for Due Process such that it meets the personal jurisdiction requirements for bringing an out-of-state entity within the general judicial jurisdiction for that State?
• The Streamlined Sales and Use Agreement (SUSA) has only been signed by 23 States and the 23 States are mostly small population States, e.g. Wyoming, North Dakota, South Dakota and Utah. Big population centers such as California, New York and Texas are not signatories. Did the Court place too much faith in SUSA while ignoring the burdensome realities for retailers in states such as Colorado that have home rule cities and counties (or similar versions) all with their own sales and use tax ordinances? Further, local tax jurisdictions within SUSA must all follow the same tax rules, i.e. if a sale would be taxable in one county in the state, it will be taxable in all the state’s counties. The only local variances within a SUSA state are the tax rates. In non-SUSA states, such as Colorado, the local tax rules do not necessarily conform to the state laws. Does demanding compliance with multiple and varied local tax rules within a state constitute an undue burden on interstate commerce?12
• There is, perhaps, an opportunity for a cottage industry or software program to assist businesses with multi-state and multi-locality tax collection, reporting and payment requirements. However, tax law advice must be given by either an accountant or lawyer licensed to practice in the state on whose law the assistance is being provided. How do the roles of licensed tax advisors, software and national compliance companies fit into this new world of tax collection, remittance and reporting obligations?
Only time and even future Court decisions, laws and regulations will truly provide answers as Wayfair is not the end but rather a continuation of the seemingly perpetual question of whether and when a state or local taxing authority can impose sales tax obligations on a business. Additionally, I believe it can be safely predicted that Wayfair will have the most impact on medium sized businesses who lack the monetary and administrative means of companies such as Amazon and Wayfair but that are not small enough to avoid exceeding, in multiple states and local jurisdictions, whatever threshold is now necessary for a taxing authority to require retailers to collect, remit and report state and local sales tax. Further, national but small businesses may be forced, by Wayfair’s impacts, to sell their products through retailers such as Amazon and Etsy in order to comply with state and local sales tax collection, remittance and reporting requirements. Finally, in order to recapture lost tax revenue in states such as Colorado, the state and the local tax jurisdictions within the state may have to agree on one set of sales and use tax rules along with one governmental department or entity for the collection, distribution and audit of sales and use tax revenue for sales delivered in the state.
1 As Wayfair points out, consumers fail (whether intentionally or through ignorance) to comply with their local use tax remittance and reporting obligations; and this lack of compliance has been costing states, counties and cities significant revenue. Needless to say, it is much easier for a tax authority to pursue one retailer and force it to collect, remit and report sales tax than it is to seek use taxes from all the retailer’s in-state customers.
2 430 U.S. 274 (1977).
3 See Wayfair, Slip Opinion at page 7.
4 See Int’l Harvester Co. v. Wisconsin Dep’t of Taxation, 322 U.S. 435 (1944) and Geoffrey, Inc. v. South Carolina Tax Com’n, 437 S.E.2d 13 (South Carolina 1993).
5 Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and Nat’l Bellas Hess, Inc. v. Dep’t of Revenue of Ill., 386 U.S. 753 (1967).
7 Interestingly, Quill was an 8-1 decision on the Commerce Clause issue in Quill and two Justices (Kennedy and Thomas) were in the majority in both Quill and Wayfair. Kennedy wrote the Wayfair Opinion and Thomas’ Concurring Opinion states specifically that he believes he should have joined Justice White in his Quill dissent and that “it is never too late to surrender former views to a better considered position.”
8 See e.g. Colo. Stat. 7-90-801 and Wyo. Stat. 17-16-1501.
9 Eli Lilly & Co. v. Sav-On-Drugs, Inc., 366 U.S. 276 (1961).
10 Wyoming has specifically answered this question as to services provided in Wyoming but where an online middleman (lacking a physical presence in Wyoming) collected the purchase price. See Travelocity.com LP v. Wyoming Dept. of Revenue, 329 P.3d 131 (Wyo. 2014)(ruling by the Wyoming Supreme Court that the online middleman must collect and remit Wyoming sales tax).
11 See Wayfair Slip Opinion at 11.
12 SUSA states must also only have one authority to which the retailer must report tax. That is, the retailers report sales within all local tax jurisdictions to the state departments of revenue (or similar department) and remit tax for all the jurisdictions within the state. Non-SUSA states, such as Colorado, have multiple authorities to which retailers selling goods throughout the state must report and remit tax (as a small example a company-such as Amazon-must collect, report and remit sales tax for the State of Colorado, City of Boulder, City and County of Denver, etc.).