Groundbreaking decision finds “unsound and incorrect” requirement of physical presence for sales tax nexus no longer required.
On June 21, 2018, the U.S. Supreme Court struck down the “physical presence” standard for sales tax nexus, adopted 26 years ago in Quill v. North Dakota. In the 5-4 decision authored by Justice Anthony Kennedy, the court called the Quill physical presence requirement an “unsound and incorrect” standard that creates market distortions and judicially created tax shelters for out of state businesses. Thus, states can now enact legislation imposing sales and use tax collection requirements on out of state retailers who do not have a physical presence in the taxing state. This Wayfair decision essentially brings the sales and use tax nexus standards up to the 21st century and out of the antiquated “brick and mortar” era of Quill. An important factor in this decision is the court’s recognition of the rapid growth of interstate commerce under the Quill standard. Under the Quill veil, out-of-state sellers received, “an arbitrary advantage over their competitors who collect state sales taxes, Quill’s physical presence rule has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field”, the majority argues. The court does not address what is needed to create a constitutionally valid state statute subjecting retailers to sales and use tax collection requirements, instead they rejected Quill as “flawed on its own terms”.
South Dakota enacted S.B. 106 on March 22, 2016. Under S.B. 106, a remote seller is required to collect and remit sales tax if (1) South Dakota sales exceed $100,000; or (2) the seller has more than 200 separate sales transactions into South Dakota. South Dakota then filed suit to have the case heard by the higher courts with expectations of overturning the Quill decision. South Dakota argued in its appeal to the Supreme Court that the “States’ inability to effectively collect sales tax from internet sellers imposed crushing harm on state treasuries and brick-and-mortar retailers alike.” It is South Dakota’s economic nexus standard for sales and use tax collection that is at issue in Wayfair.
In addition to the economic nexus thresholds, S.B. 106 provided for an expedited appeals process. Shortly after enactment, South Dakota filed a declaratory judgment action against remote sellers in South Dakota. The trial court quickly disposed of the case by granting summary judgment in favor of the sellers, citing Quill as judicial precedent. The case was then appealed to the South Dakota Supreme Court. The South Dakota Supreme Court also ruled in favor of the sellers, again noting that Quill remains controlling precedent, and, as a lower court, it could not overturn the Court’s precedent.
On October 2, 2017, South Dakota then filed a Petition for a writ of certiorari with the United States Supreme Court. On January 12, 2018, the Court granted South Dakota’s petition. The Supreme Court heard oral arguments on April 17, 2018 and issued their decision on June 21, 2018.
While the impact of the Wayfair decision may seem simple and straightforward, in reality, it is far from it. The court left major aspects of constitutionality and application up to the states, leading to further uncertainty. The uncertainty lies with how states will determine what creates substantial nexus; the threshold Commerce Clause requirement that now needs to be met following the court’s axe to the Quill physical presence standard. In Complete Auto Transit v. Brady, the court provides a four-part test to determine if a state’s actions violate the Commerce Clause. This test in Complete Auto protects the flow of commerce from undue state regulation, including taxes that would impede interstate commerce. Complete Auto holds that substantial nexus is established when a taxpayer purposefully avails itself of the privileges of doing business in the taxing state, without such nexus it is unconstitutional for a state to impose a taxes on the business. It is almost certain that states will adopt their own interpretations of what creates substantial nexus for sales and use tax, creating a myriad of compliance headaches for retailers throughout the U.S.
In addition to failing to clarify the backbones of a substantial nexus requirement, the court also left open other areas for concern when laying out the far-reaching impact of the Wayfair decision. Specifically, can states look to retailers to cover past sales tax liability incurred before the Wayfair decision? Further, the court also failed to bless South Dakota’s standard of imposing tax on retailers with 200 transactions or annual in-state sales exceeding $100,000, instead vacating, and remanding the case back to South Dakota. At the state level, other Commerce Clause questions may well arise. If South Dakota’s threshold passes constitutional muster, what happens if a different state imposes a standard in which sales only need to exceed $1,000? Close attention should be paid to both the courts and the states as further challenges are likely to help better define the new standard.
We encourage remote sellers and online retailers to discuss the immediate implications of this case with their tax professionals, especially if they sell to consumers in states that have enacted economic nexus statutes with respect to sales and use tax collection or reporting requirements.
We have the following concerns, which may have an impact on businesses in the near future:
- The 10 or so states that have enacted or have pending legislations for similar sales/use tax nexus standards will likely enact and impose the standards immediately. Businesses should review their current and projected sales footprint to determine if they have sales in states that have pending or enacted legislation following the South Dakota standard.
- All other states will be encouraged to enact similar sales/use tax economic nexus legislation following the South Dakota model. Businesses should stay abreast of the latest legislation in all states where they have sales.
- Many businesses will be liable for sales tax collection and/or reporting in a substantial number of new states. This decision likely will affect all out of state sellers, not just online retailers. In Wayfair, the court does not differentiate between types of out of state sellers. Likely, states will impose sales and use tax collection burdens on all out of state sellers.
- It is important to keep in mind that goods and services may be exempt from sales and use tax in one state, and be taxable in another. A determination of the taxability of all products and services a business offers on a state-by-state basis should be considered.
- Businesses should complete a thorough review of their nexus footprint prior to the Wayfair Voluntary disclosure programs should be utilized for noncompliance and remittance as state statutes of limitation may apply to past periods.
We Can Help
The state and local tax (SALT) professionals at Elliott Davis will be providing further coverage and analysis of this landmark decision in the days, weeks and months to come. If you have questions about your particular tax situation or need help in evaluating the impact for sales and use tax collection on out-of-state vendors, please contact your Elliott Davis tax advisor. Elliott Davis has a team of experienced SALT professionals who can assist you with your sales and use tax guidance needs.