Last week, the Supreme Court handed down a decision in South Dakota v. Wayfair, Inc., that could have far-reaching effects on the U.S. business landscape. In the course of this decision, the Court held that a state can require out-of-state sellers with no physical presence in the state to collect and remit sales tax on sales delivered to in-state customers, thereby overruling two of the Court’s prior decisions. While Wayfair could be a boon to cash-hungry states, it also means that out-of-state sellers with limited physical presence in the states in which they sell — looking at you, internet companies — will have to get up to speed on the sales tax laws in those states real quick or else suffer the consequences.
What was Wayfair About?
Wayfair involved a South Dakota sales tax law enacted in 2016 that required out-of-state sellers with non-de minimis annual sales into the state to collect and remit sales tax in the same manner as sellers that had a physical presence in the state. South Dakota filed a declaratory judgment action in state court against Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc., requesting a declaration that the law was valid. However, South Dakota conceded that the law would be invalid under Supreme Court’s prior decisions in Quill Corp v. North Dakota (1992) and National Bellas Hess, Inc. v. Department of Revenue of Illinois (1967). These decisions had, on constitutional grounds, rejected the application of state sales tax to sellers with no physical presence in a state. Bowing to these prior decisions, the trial court and South Dakota Supreme Court ruled against South Dakota. The Supreme Court granted certiorari.
What are the Constitutional Requirements for State Sales Taxes?
In order for a state’s tax on out-of-state sellers to pass constitutional muster, the tax must meet the requirements of both the Due Process Clause of the Fourteenth Amendment and the Commerce Clause in Article I of the Constitution.
Generally, the Due Process Clause requires a minimum connection between a state and the person, property, or transaction to be taxed.
The Commerce Clause has more requirements than the Due Process Clause. Under the Commerce Clause, a state tax is valid only if it: (1) applies to an activity that has a substantial nexus to the state, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the state provides.
What Did Bellas Hess and Quill Say?
Predating the massive internet economy of today, both Bellas Hess and Quill involved the application of sales tax to mail-order companies. In the 1967 Bellas Hess case, the Supreme Court held that a seller’s lack of physical presence in a state caused the state’s sales tax to fail under both the Due Process Clause and the Commerce Clause. Twenty-five years later, the Court’s decision in Quill made clear that a seller’s lack of physical presence was not determinative under the Due Process Clause but would cause a state’s sales tax to lack substantial nexus and thus be invalid under the Commerce Clause. As a result, in the years since Quill, a seller that did not have a physical presence in a state could not be subject to that state’s sales tax.
What Happened in Wayfair?
The Supreme Court’s decision in Wayfair overturned both Bellas Hess and Quill. Wayfair held that the mere lack of physical presence in a state was not determinative under either the Due Process Clause or the Commerce Clause. The majority opinion, authored by Justice Kennedy, noted that the growth of the internet in the decades since Quill had caused the Court to doubt the appropriateness of the physical presence rule. Arguably, this rule gave internet companies delivering goods into a state in which they lacked physical presence an advantage over their brick-and-mortar competitors. As a result, these internet companies wouldn’t be required to collect sales tax for the state while their competitors that had physical presence in the state would be required to collect sales tax. At the same time, the physical presence rule was said to deprive states of much-needed revenue.
The Court also noted the similarity between the tests under the Due Process Clause and the Commerce Clause and pointed out that Quill itself had acknowledged that physical presence wasn’t determinative under the Due Process Clause. The Court therefore reasoned that physical presence also should not be determinative under the Commerce Clause. As such, the Court held that the South Dakota sales tax law could not be found invalid merely because it applied to sellers that lacked physical presence in the state.
Still, the Court left the door open for other challenges to the South Dakota sales tax law as well as other similar laws that may be enacted in Wayfair’s wake. For instance, the Court noted that complex state tax systems or the application of a sales tax to businesses lacking physical presence and doing minimal business in a state could be found to be invalid under the Commerce Clause. The Court refused to rule on these issues, as they had not been litigated in the lower courts.
Dissent: What About the Little Guy?
A dissenting opinion, authored by Chief Justice Roberts and joined by Justices Breyer, Sotomayor, and Kagan, argued that Quill should be upheld on grounds of stare decisis (a.k.a., “precedent”) and that it was more appropriate to leave it to Congress to figure out whether to scrap the physical presence rule. Like the majority, the dissent pointed to the substantial growth in internet sales since Quill, but argued that the elimination of the physical presence rule could have a negative impact on the economy and, in particular, on small internet businesses.
As we noted in a previous blog post, the ability to force out-of-state internet companies to collect and remit sales tax could be a tremendous boon to the states. In 2014, for instance, Texas estimated that requiring online retailers to collect sales tax would increase its annual state sales tax revenue by as much $800 million and would increase annual local sales tax revenue by as much as $200 million.
Nevertheless, Wayfair will make it more complicated for internet companies to sell products nationwide. Whereas online businesses previously could sell their products remotely in other states with some degree of impunity, they’ll now potentially have to deal with the hodgepodge of each state’s sales tax collection requirements or else limit the states in which they sell.
In the aftermath of Wayfair, expect to see not only more internet businesses collecting sales tax, but also a bevy of challenges against the application of sales tax laws to out-of-state sellers on grounds other than lack of physical presence (for example, de minimis sales into a state or issues with overly complex state sales tax laws). The business outcry and potential increase in litigation may even spur Congress to take some action in this area, although don’t count on it.