The U.S. Supreme Court’s (the Court) decision last week in the case of South Dakota v. Wayfair, Inc. brings with it a monumental shift in the way states can assert authority to collect sales tax from sellers located outside of their state. The Court’s finding in favor of South Dakota may be viewed as unfavorable to many, however it provides some clarity and certainty to sales tax rules that vary greatly state-to-state.
South Dakota law for sales tax collection provides a minimum threshold for when a seller has nexus to collect and remit sales tax. South Dakota deems a seller to have nexus (and a sales tax collection requirement) if they have (a) sales in excess of $100,000, or (b) more than 200 transactions in any year to customers in South Dakota. The online retailer Wayfair met both minimum standards in South Dakota but did not collect and remit sales tax on its sales shipped to South Dakota. South Dakota argued Wayfair has nexus and a sales tax collection obligation in South Dakota based on these so-called “economic nexus” standards. Wayfair asserted it had no nexus based on having no physical presence in South Dakota.
The Wayfair case made it to the Court when the South Dakota Supreme Court ruled against South Dakota citing prior precedent established by the Court’s 1992 decision in the case Quill Corp v. North Dakota. The Court ruled in Quill that a vendor must have a physical presence in a state for that state to impose a burden of collecting sales tax on a vendor. To otherwise impose a burden would restrict interstate commerce, which would violate the U.S. Constitution’s Commerce Clause.
Congressional Authority and Action (err, Inaction)
Sales tax collection laws have been challenged over the years by sellers based on arguments that they restrict or impede interstate commerce. Congress has the power to regulate interstate commerce under Article I of the U.S. Constitution, which gives Congress the authority to regulate States’ power to collect sales tax. However, Congress’s power under the Commerce Clause has not been asserted. Recent congressional proposals such as the “Marketplace Fairness Act” have attempted to provide regulations to streamline sales tax collection in the 50 states, but these proposals have ultimately gone nowhere.
Where Congress has failed to provide legislation, the Court has often been called upon to provide its interpretation of what may restrict or burden interstate commerce, which it did in its 1992 Quill opinion. However, the self-described “modern” Court finds flaw in its 1992 Quill opinion and in the 2018 Wayfair opinion Justice Kennedy states “it is inconsistent with the Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation.” This led the Court majority to upend its own precedent and not rely on congressional action to address questions of sales tax collection.
Supreme Court Opinion in Wayfair
In the Wayfair opinion written by Justice Kennedy, the Court finds flaw in the physical presence standard from its 1992 Quill decision, finding the physical presence standard “arbitrary” and that it “creates rather than resolves market distortions.” Justice Kennedy states “the Internet revolution has made its earlier error all the more egregious and harmful.” In defense of South Dakota’s economic nexus standards, the Court finds that certain features in South Dakota’s law prevent a discrimination upon interstate commerce:
- There is a safe harbor to those transacting limited business in South Dakota (200 transaction or $100,000 in sales);
- No retroactive obligation to collect sales tax until the minimum standards are met; and
- South Dakota follows the Streamlined Sales and Use Tax Agreement, which more than 20 states follow and provides for uniformity amongst the adopting states.
Finding in favor of South Dakota, the case was sent back to the lower court to be resolved consistent with the Court’s opinion that the South Dakota economic nexus standards are adequate, and that physical presence is not required to create nexus.
We can expect more states to introduce economic nexus standards like South Dakota now that the Wayfair decision has created a base-line standard upon which other states will be judged in the future. Most pressing, however, is there are many states (approximately 13) that have already implemented similar standards. Due to uncertainty of the outcome of the Wayfair case, some sellers may have been hesitant to follow what, until now, were untested economic nexus rules while relying on physical presence standards.
Now is the time to review potential exposure, which may have retroactive implications based upon when state laws were enacted. In addition, you may wish to explore voluntary disclosure programs that are available to help minimize the cost of coming into compliance with states that have already passed economic nexus standards.
If a state with existing economic nexus standards does not have voluntary disclosure programs, they may benefit from creating one or implementing a finite term amnesty program related to liabilities now due considering the Wayfair decision. It’s too soon to know if any states will take this course of action, however it seems feasible.
In the meantime, while Wayfair creates a base-line standard, it does not answer directly the question: What is the minimum contact a business must have with a state to create nexus? With states in constant battle to balance their budgets, it would not surprise us if states become aggressive in applying the Wayfair case to new legislation aimed at increasing sales tax revenue. This could create a significant burden of sales tax collection and reporting requirements for small and mid-size businesses until Congress acts to pass legislation. Given the speed in which the Tax Cuts and Jobs Act was passed in December 2017, it is feasible that Congress could take immediate action, but we don’t suggest you hold your breath.
The Tax Warriors® at Drucker & Scaccetti can help you in reviewing what this important decision means for your business. Whether it’s reviewing your exposure to sales tax filing obligations or guiding you through a voluntary disclosure program, The Tax Warriors are prepared to help.