United States Supreme Court Issues Opinion Expanding the Reach of States to Collect Sales Tax from Online Retailers

Americans love to shop on-line. Lured by the convenience of shopping from home, competitive prices, and wide selection, on-line shopping has become commonplace for many people, especially during peak holiday shopping season. The benefit of no sales tax has also been attractive.

However, on June 21, 2018, the United States Supreme Court took a step towards closing the no sales tax loophole by ruling that Internet retailers can be required to collect sales tax – even in states where they have no physical presence. South Dakota v. Wayfair Inc., 585 U.S. No. 17–494. (2018).

In earlier Supreme Court cases, the Court had ruled that an out-of-state seller’s liability to collect and remit sales tax to the consumer’s State depended on whether the seller had a physical presence in the State. It had also held that the mere shipment of goods into the buyer’s State following an order did not satisfy the physical presence requirement. National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Supreme Court’s decision in Quill had helped online retailers grow their businesses nationwide; it effectively allowed these companies to sell anywhere in the United States without being required to collect and remit state and local sales taxes.

In States that impose a sales tax, it is common for the State to employ a parallel use tax regime. Under use tax laws, when the sales tax is not collected and remitted by the seller, the instate consumer becomes separately responsible for paying use tax at the same rate as the sales tax. However, consumer compliance rates with respect to use tax obligations are extremely low.

In the Wayfair case, the Court cited estimates that States were losing between $8 and 33 billion every year due to its previous rulings in Bellas Hess and Quill. To that end, the Court was sympathetic to the argument by States with no income tax – such as South Dakota – that substantial reliance on revenue from sales and use tax was necessary to fund essential state services.

In 2016, in a state of “emergency,” the South Dakota legislature enacted a law allowing the State to collect sales tax from “remote sellers.” The law required out-of-state sellers to collect and remit South Dakota sales tax “as if the seller had a physical presence in the state.” The law applied to sellers that delivered more than $100,000 of goods or services into the State or engaged in 200 or more separate transactions for the delivery of goods or services into the State.

The dispute that teed up the case before the Supreme Court was between South Dakota and three online retailers: Wayfair, Inc., Overstock, Inc. and Newegg, Inc. These three retailers had no physical presence in South Dakota but they easily met the minimum sales or transactions requirement of the 2016 South Dakota sales tax law. South Dakota sued the three companies in state court when the companies did not collect and remit the required South Dakota sales tax. South Dakota lost at the state court level and also before the South Dakota Supreme Court. South Dakota appealed to the United States Supreme Court.

The Supreme Court’s analysis in the Wayfair opinion covers the history of the U.S. Constitution’s Commerce Clause, a topic that scores of second year law students learn and struggle to understand. Writing for the majority in Wayfair, Justice Anthony M. Kennedy emphasized that the Court’s modern Commerce Clause doctrine rests upon two principles marking the boundaries of a State’s authority to regulate interstate commerce: (1) state regulations may not discriminate against interstate commerce; and (2) States may not impose undue burdens on interstate commerce. The Quill decision had concluded that the physical presence rule was necessary to prevent undue burdens on interstate commerce.

But the online economy has changed drastically since the Quill decision in 1992. In 1992, mail-order sales in the U.S. totaled $180 billion. In 2017, e-commerce retail sales were estimated at $433.5 billion. Justice Kennedy, sympathetic to the plight of local businesses at a competitive disadvantage relative to remote sellers, writes: “In effect, Quill has come to serve as 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.” Later, he writes: “A virtual showroom can show far more inventory, in far more detail, and with greater opportunities for consumer and seller interaction than might be possible in local stores. Yet the continuous and pervasive virtual presence of retailers today is, under Quill, simply irrelevant. This Court should not maintain a rule that ignores these substantial virtual connections to the State.”

To take advantage of the Supreme Court’s Wayfair ruling that eliminates the physical presence requirement, states will need to change their sales tax laws and a flurry of activity by state legislatures has been predicted. Justice Kennedy left open the possibility that some transactions are so small and scattered that no taxes should be collected. Therefore, the boundaries of exactly how far State sales tax laws can reach remain untested.

If you have concerns about state sales or use tax delinquencies, a tax lawyer near Gilbert may be able to help you. Silver Law PLC is a respected tax law firm in Arizona and Las Vegas that has experience handling state and federal tax audits and tax collection activities. Our attorneys have all worked as prosecutors for the IRS, so they have a unique perspective on how to defend your case. Contact us today to talk with a tax lawyer about your legal options.

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