In a much-anticipated ruling that confounded the expectations of many court watchers, the U.S. Supreme Court has given state and local governments the green light to impose sales taxes on out-of-state online sales. The 5-4 decision in South Dakota v. Wayfair, Inc. was met by cheers from brick-and-mortar retailers, who have long believed that the high court’s previous rulings on the issue disadvantaged them, as well as state governments that are eager to replenish their coffers. The publicity of this case focused on “online sales.” Regardless of the method used to make a purchase, all out of state sales are subject to this ruling.
The sales tax at issue
In response to the rise in online sales and the corresponding effect on sales tax collections, South Dakota enacted a law requiring out-of-state retailers that made at least 200 sales or sales totaling at least $100,000 in the state to collect and remit a 4.5% sales tax. The 2016 law also included a clause declaring an emergency in light of the need “for the support of state government and its existing public institutions …”
South Dakota subsequently sued several online retailers with no employees or real estate in the state. It sought a declaration that the sales tax was valid and applicable to the retailers, along with an injunction requiring the retailers to register for licenses to collect and remit the tax. A trial court dismissed the case before trial, and the State Supreme Court affirmed, citing its obligation to follow U.S. Supreme Court precedent, however persuasive the state’s arguments against the physical presence rule might prove.
The Supreme Court’s reasoning
The majority opinion — penned by Justice Kennedy but joined by the unusual mix of Justices Thomas, Ginsburg, Alito and Gorsuch — didn’t mince words. It described the physical presence rule as “unsound and incorrect.” According to the Court, the rule becomes further removed from economic reality every year.
Quill, the opinion said, creates market distortions. It puts local businesses and many interstate businesses with a physical presence at a competitive disadvantage compared with remote sellers that needn’t charge customers for taxes. Kennedy wrote that the earlier ruling “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 — something that has become easier and more prevalent as technology has advanced.”
In addition, the Court found that Quill treats economically identical actors differently for arbitrary reasons. A business with a few items of inventory in a small warehouse in a state is subject to the tax on all of its sales in the state, while a seller with a pervasive online presence but no physical presence isn’t subject to the same tax for the sales of the same items.
Ultimately, the Supreme Court concluded that the South Dakota tax satisfies the substantial nexus requirement. Such a nexus is established when the taxpayer “avails itself of the substantial privilege of carrying on business” in the jurisdiction. The quantity of business the law required to trigger the tax couldn’t occur unless a seller has availed itself of that substantial privilege.
Of course, as the Court acknowledged, the substantial nexus requirement isn’t the only principle in the Commerce Clause doctrine that can invalidate a state tax. The other principles weren’t argued in this case, but the high court observed that South Dakota’s tax system included several features that seem designed to prevent discrimination against or undue burdens on interstate commerce, such as a prohibition against retroactive application and a safe harbor for taxpayers who do only limited business in the state.
The significance of the Supreme Court’s ruling was felt almost immediately in the business world, with the share prices of major online retailers quickly dropping (even those that do collect and remit sales taxes). It’s not just the behemoths that could be affected, though.
The Court recognized that the burdens of nationwide sales tax collection could pose “legitimate concerns in some instances, particularly for small businesses that make a small volume of sales to customers in many States.” But, it said, reasonably priced software eventually may make it easier for small businesses to cope. Perhaps in response to this assertion, prices for shares in a company that makes a popular tax-processing software climbed after the Court released its opinion. The ruling also pointed out that, in this case, the law “affords small merchants a reasonable degree of protection,” such as annual sales thresholds.
Further, the Court noted, South Dakota is one of more than 20 states that are members of the Streamlined Sales and Use Tax Agreement (SSUTA). These states have adopted conforming legislation that provides uniform tax administration and definitions of taxable goods and services, simplified tax rate structures and other uniform rules.
Only about 15 states currently have sales tax laws similar to South Dakota’s, so it’s likely there will be a staggered imposition of sales tax collection and remittance responsibilities on online retailers. Other states may need to revise or enact legislation to meet the relevant constitutional tests — including, but not limited to, the substantial nexus requirement. If you have questions regarding sales tax collection requirements for your business in light of the Supreme Court’s decision, please contact us.