Will the Supreme Court End “Tax-Free” Shopping?
The Supreme Court of the United States has ruled in favor of South Dakota in South Dakota v. Wayfair, Inc. The state is now free to enforce its Remote Seller Compliance law (SB 106), which requires out-of-state sellers with more than 200 taxable sales transactions delivered into South Dakota in a calendar year, or more than $100,000 in gross revenue from the same, to collect and remit sales tax.
South Dakota v. Wayfair, Inc. challenged the physical presence standard upheld by the Supreme Court in Quill Corp. v. North Dakota (1992). Quill held that a state cannot tax a business unless it has a substantial connection (nexus) with the state, defined as a physical presence. That decision has now been repealed, and the case has been remanded to the South Dakota Supreme Court "for further proceedings not inconsistent with" the Supreme Court opinion.
How we got to here
The case centered on South Dakota SB 106, which establishes economic nexus and maintains that not being able to tax remote sellers is eroding South Dakota’s sales and use tax base, causing “imminent harm to this state.”
In petitioning the court to take the case, South Dakota argued that “the physical-presence exception for sales tax collection duties is causing serious harms this Court could not have seen when it decided Quill in 1992.” Reasons given included:
- It harms states, which are deprived of critical revenue
- It harms brick-and-mortar retailers, which are deprived of a level playing field
- It harms interstate commerce itself, “Quill ends up burdening a lot of interstate commerce — achieving the opposite of its own design.”
In petitioning the court to reject the case, George Isaacson and the rest of the Wayfair team argued that:
- “Congress is the proper institution to address this complex issue”
- South Dakota’s challenge to Quill is “non-justiciable”
- Principles of stare decisis strongly weigh against granting the petition
- The petition ignores the issue of retroactive liability
- Developments in other states further counsel denial of the petition
In the justices’ words
The court held: “Because the physical presence rule of Quill is unsound and incorrect, Quill Corp. v. North Dakota, 504 U.S. 298, and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753, are overruled.” Justice Kennedy delivered the opinion, joined by Justices Thomas, Ginsburg, Alito, and Gorsuch. Justices Thomas and Gorsuch filed concurring opinions. Justice Roberts dissented, joined by Justices Breyer, Sotomayor and Kagan.
The court found Quill to be “flawed on its own terms,” noting, “Quill creates rather than resolves market distortions.” The opinion reads, “The Internet's prevalence and power have changed the dynamics of the national economy." The physical presence rule “is a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers, something that has become easier and more prevalent as technology has advanced. The rule also produces an incentive to avoid physical presence in multiple States, affecting development that might be efficient or desirable.”
The court noted that South Dakota alone loses approximately $48 to $58 million every year because it cannot compel out-of-state vendors to collect and remit sales tax. For the majority, Justice Kennedy wrote:
- “This Court should not prevent States from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the State.”
- “Quill puts both local businesses and many interstate businesses with physical presence at a competitive disadvantage relative to remote sellers.”
- “In the name of federalism and free markets, Quill does harm to both. The physical presence rule it defines has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.”
- “It is essential to public confidence in the tax system that the Court avoid creating inequitable exceptions. ... By giving some online retailers 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 court found that “South Dakota affords small merchants a reasonable degree of protection” under SB 106. Furthermore, the state’s tax system “includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce.” The court also noted that South Dakota is a member of the Streamline Sales and Use Tax Agreement, which “standardizes taxes to reduce administrative and compliance costs.”
Dissenting, Justices Roberts wrote, “I agree that Bellas Hess was wrongly decided.” However, he “oppose[s] discarding the physical presence rule,” maintaining that “any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.” He further noted that the Supreme Court “does not overturn its precedents lightly.”
The dissenting justices wrote:
- “The Court proceeds with an inexplicable sense of urgency,” especially given that “states and local governments are already able to collect approximately 80 percent of the tax revenue that would be available if there were no physical-presence rule.”
- “The Court … breezily disregards the costs that its decision will impose on retailers.”
The dissenting opinion highlights the more than 10,000 tax jurisdictions and the complexity of state sales tax laws: “A few examples: New Jersey knitters pay sales tax on yarn purchased for art projects, but not on yarn earmarked for sweaters. ... Texas taxes sales of plain deodorant at 6.25 percent but imposes no tax on deodorant with antiperspirant.”
The crux of the dissenting opinion is that Congress is better positioned “to address these questions in a wide variety of ways.” It reads: “Congress can also provide a nuanced answer to the troubling question whether any change will have retroactive effect.”
Concluding, Justice Roberts wrote, “I would let Congress decide whether to depart from the physical-presence rule that has governed this area for half a century.”
Next steps for South Dakota
South Dakota Attorney General Marty Jackley, who argued the state’s case before the Supreme Court, has been working for years to overturn Quill. Upon hearing the decision, he said, “Today’s landmark decision is a win for South Dakota and for Main Street businesses across America that will now have a level playing field and tax fairness.” His sentiment was echoed by South Dakota Governor Dennis Daugaard, who issued a statement thanking “all who helped us achieve this victory for tax uniformity.” He added, “This is a great day for South Dakota.”
South Dakota Congresswoman Kristi Noem, who successfully ran against Jackley to become the 2018 Republican gubernatorial candidate, is a long-time proponent of a Congressional solution to this issue. Her legislation, the Remote Transactions Parity Act (H.R. 2193), would allow states to require remote sellers to collect sales tax from the buyer, but would also require states to provide free software to in-state businesses to help them comply, and largely protect businesses using this software from audit.
Upon hearing the court’s ruling, Noem issued the following statement on Twitter, “Out-of-state retailers have, for yrs, been given an unfair advantage over the businesses that hire in our local communities. Overturning Quill was the right decision, but it’s only the 1st step in creating an environment where our hometown businesses can compete & thrive.”
Andy Gerlach, Secretary of the South Dakota Department of Revenue, says “the state will offer guidance to out-of-state online retailers after reviewing the opinion.”
It’s likely that other states will work to enact economic nexus legislation in the same vein as South Dakota SB 106. Already, in the months since the court agreed to hear this case, several states have adopted economic nexus, including Connecticut, Georgia, Kentucky, Hawaii, Illinois, and Iowa.
However, a Supreme Court ruling in favor of South Dakota could also spur Congress into action. If it decides to answer Justice Roberts’ call, it could move to strictly regulate interstate commerce by pursuing the No Regulation Without Representation Act (H.R. 2887) or pursue the Remote Transactions Parity Act or the similar Marketplace Fairness Act (S. 976), both of which would allow states to tax certain remote sales.
With or without Congressional action, it will take some time for the effects of this decision to play out. To learn more about how the ruling in South Dakota v. Wayfair, Inc. could impact your business, attend our July 12, 2018, Q&A panel discussion with Scott Peterson, Vice President of U.S. Tax Policy and Government Relations at Avalara, and Rachel A. Le Mieux — CPA, CMI, and partner at Peterson Sullivan LLP. Sign up here.
Avalara helps businesses of all sizes achieve compliance with transactional taxes, including sales and use, VAT, excise, communications, and other tax types. The company delivers comprehensive, automated, cloud-based solutions that are designed to be fast, accurate, and easy to use. Avalara’s Compliance Cloud™ platform helps customers manage complicated and burdensome tax compliance obligations imposed by state, local, and other taxing authorities throughout the world.