If you are a fan of online shopping, you may need to brace yourselves; taxes have found their way into your check-out cart. On June 21, 2018, the Supreme Court handed down a ruling in South Dakota v. Wayfair, Inc. that clears the way for States to begin levying taxes on online purchases. The holding overrules prior precedent that required businesses to have a physical presence in a state in order to be subject to that state's sales tax. As Justice Kennedy made abundantly clear in his opinion, modern e-commerce and the need for a physical presence are no longer aligned in reality.
A Test Removed from Economic Reality
In 2016, South Dakota passed the law at issue in this case, which provides for the collection of sales taxes from "remote sellers." South Dakota v. Wayfair, Inc., No. 17-494, slip op. at 3 (U.S. June 21, 2018). The law has important limitations, however. First, the law only requires sellers to remit sales taxes if they "deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State." Id. Second, the Act also foreclosed retroactive application of the requirement. Id.
Justice Kennedy, writing for a 5-4[1] majority, held that the physical presence rule of National Bella Hess v. Department of Revenue of the State of Ill., 386 U.S. 753, 87 S. Ct. 1389 (1967) and Quill Corp. v. North Dakota, 504 U.S. 298, 112 S. Ct. 1904 (1992) as applied today, is an incorrect interpretation of the Commerce Clause. Wayfair, slip op. at 10. These prior cases required a business to have a physical presence in a state before that state could force the business to collect sales taxes. Id. at 8. Justice Kennedy declared, "[e]ach year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States." Id. at 10. Indeed, according to Justice Kennedy, the physical presence rule must give way to the structural and societal changes caused by the cyber age. Id. at 18.
Not only is the physical presence rule removed from the realities of the cyber age, but it serves as a "judicially created tax shelter for businesses" that do not have a physical presence in a state. Id. at 13. The end of the physical presence rule, as Justice Kennedy states, "ensure[s] that artificial competitive advantages are not created by [the] Court's precedents." Id. at 13.
A Move Toward More Taxes
This opinion is almost certainly going to lead to more taxes at some level. As Justice Kennedy pointed out, the states lost between $8 and $33 billion dollars in sales tax revenue under Bella Hess and Quill. The Wayfair decision throws open a previously closed door to an incredibly easy source of tax dollars for states and allows them to avoid raising income taxes, a move we all know is unpopular and fodder for campaign ads. While it is possible Congress could act in order to ensure some uniformity across the nation, considering that ball was in the legislature's court (some pun intended) for 26 years, it's unlikely they will act now. Moreover, a number of legislators (including Heidi Heitkamp (D-ND) who brought the Quill case in 1992) think states should be given a chance to pass their own laws.
It is important to understand, however, that there is still a rule in place that governs whether a remote seller can be taxed by a state. Simply put, does the tax apply to a business with a substantial connection to the taxing state? Wayfair, slip op. at 22. Justice Kennedy noted the Court's approval of the structure of the South Dakota law because $100,000 worth of goods or 200 separate transactions would only occur if a seller was intentional about conducting business in the state (Id. at 22-23), as opposed to a business that may make a few occasional sales in the state.
Since South Dakota's bill has now passed muster in the Supreme Court, it is likely that a number of other states will begin introducing similar bills in the near future. Moreover, if states prevent the tax from taking retroactive effect, take steps to standardize their tax administration, and provide access to tax software; it will help states avoid a claim that the tax places an undue burden on out-of-state businesses. Id. at 23.
The question of burden to out-of-state business was a point of contention raised by Chief Justice Roberts in his dissent. The Chief Justice pointed out that in their effort to level the playing field for local businesses; the majority had subjected remote sellers to a potentially baffling number of tax implications in thousands of jurisdictions. Id. at 5-6 (Roberts, C.J. dissenting). For instance, New Jersey taxes yarn for art projects, but not yarn earmarked for sweaters. Id. at 6. This ensuing patchwork could hamper businesses as they try to navigate the complexity of thousands of tax jurisdictions and taxing idiosyncrasies. This could also harm small businesses as they could struggle to do business nationwide if they must worry about remitting varying sales taxes all over the country. Id.
The tension between the majority and dissent on this point is one that will likely be litigated when more states come out with their own tax bills. Based on the majority's opinion, it seems likely that states will follow the trend of requiring high dollar and/or high volume sales in order to satisfy the "substantial nexus" test. We will undoubtedly see challenges that question whether states have set the bar too low, however.
What does this mean for businesses and consumers?
For businesses, the Wayfair ruling will require a certain level of vigilance over the coming months and years. As states roll out new tax bills, it will be important to understand how many transactions the business does in that state and the dollar amount of those transactions. This opinion will obviously affect high volume and high dollar businesses and require those businesses to invest in accounting tools that aid in remitting taxes to multiple states with multiple sets of rules. Smaller businesses that only make occasional or low dollar sales in other jurisdictions may not be affected, but the target is likely to vary from state to state. Again, though, it will be important to see how other states wield their new found taxing powers.
For the average consumer, this opinion may not make a huge amount of difference. Prior to this decision, Amazon and a number of other online retailers voluntarily began collecting and remitting taxes to states where they do not have a physical presence. Indeed, Chief Justice Roberts cited to a recent Government Accounting Office report that stated between 87 and 96 percent of the top 100 internet retailers already collect and remit state sales taxes. Id. at 5. There will still be many, many online retailers (such as Wayfair and Overstock) who will have to charge more to cover taxes now, however, so be prepared for some pricier check-outs.
[1] Justices Kennedy, Thomas, Ginsburg, Alito, and Gorsuch comprised the majority, while Chief Justice Roberts and Justices Breyer, Sotomayor, and Kagan were in dissent.
