June 27, 2018
South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018) (Kennedy, J.).
Response by David Brunori
Geo. Wash. L. Rev. On the Docket (Oct. Term 2017)
Slip Opinion | The New York Times | SCOTUSblog
South Dakota v. Wayfair, Inc.: Will It End a Seemingly Endless Debate?
Do you ever wonder why sometimes you pay sales tax when you buy something online and sometimes you don’t? Do you ever notice when ordering from a catalog that the order form says that residents of certain states must add sales tax? The rules governing whether you ultimately pay tax on remote purchases arose from fifty years of Supreme Court precedent, and the Supreme Court just changed those rules in the most important state tax case in a generation.
On June 21, 2018, the Supreme Court held in South Dakota v. Wayfair, Inc.1 that the “physical presence” test no longer applies to the obligation of vendors to collect and remit sales and use tax.2 The sales tax is imposed by forty-five states (and thousands of local governments), and it accounts for about one-third of state tax revenue. The sales tax is effective because, although paid by the consumer, it is collected by the vendor.
The issue in Wayfair has plagued the states for decades. Can a state require an out-of-state vendor to collect sales tax? The Supreme Court faced this question on several occasions before Wayfair. In 1967, the Court held in National Bellas Hess, Inc. v. Department of Revenue3 that Illinois’s attempt to require out-of-state vendors to collect tax violated both the Commerce Clause and the Due Process Clause. In 1993, the Court in Quill Corp. v. North Dakota4 held that imposing tax collection requirements may not violate the Due Process clause, but also held that such requirements violated the Commerce Clause by creating an undue burden on interstate commerce. In doing so, the Court reaffirmed the physical presence test: a vendor cannot be forced to collect sales tax unless it has a physical presence in the state.
The physical presence test presented a challenge to the states: If the vendor does not collect the tax, the tax goes uncollected; and if a consumer does not pay tax on an item at the time of purchase, the consumer is liable for use tax. But consumers rarely pay use tax voluntarily. Quill was decided at the dawn of the internet, and in the years following the decision, electronic commerce exploded. The lost sales tax revenue was significant, and traditional brick and mortar stores did not like the Quill decision because they were collecting tax while their online competitors were not.
Since 1993, there has been a lot of activity designed to find ways to require out-of-state vendors to collect sales and use tax, including several commissions to study the issue. Congress, which has the power to regulate under the Commerce Clause, considered several different proposals. But as those efforts proved fruitless, the states increasingly took it upon themselves to challenge the physical presence test. Before the Court heard Wayfair, thirty-one states had adopted some form of remote tax collection that did not require physical presence. These included “cookie nexus,” affiliate nexus, and reporting requirements.5
South Dakota had one of the more aggressive approaches. It enacted a law in 2016 that required all vendors with at least $100,000 in sales or 200 transactions to collect sales tax on goods and services sold into the state—no physical presence was required. South Dakota was using this law as a vehicle to challenge the physical presence test. Internet retailer Wayfair, Inc. challenged the law, citing Quill.
Justice Kennedy wrote the majority opinion overturning Quill’s physical presence rule. He was joined by joined by Justices Thomas, Ginsburg, Alito, and Gorsuch. The majority began by describing the history of the Commerce Clause before the Court, emphasizing the “necessary balance between state and federal power.”6
The Court then explained that to the extent Congress has not acted, a state can impose its taxing jurisdiction within the parameters of the four-prong test in Complete Auto Transit, Inc. v. Brady.7 Under Complete Auto, the Court determined that the physical presence rule was no longer essential to meet the substantial nexus requirement. Citing the changing economy, particularly the rise of internet commerce, the Court held that the physical presence rule no longer fulfills its purpose of protecting interstate commerce from undue burdens. In fact, the Wayfair Court implied that the physical presence test imposed a burden on the states by prohibiting “the States from exercising their lawful sovereign powers in our federal system.”8 The Court overruled the decisions in both Quill and National Bellas Hess. The Court concluded that “nexus is clearly sufficient based on both the economic and virtual contacts” that Wayfair had with South Dakota.9
Chief Justice Roberts dissented in an opinion joined by Justices Breyer, Sotomayor, and Kagan. Chief Justice Roberts stated that he would have affirmed on stare decisis grounds.
It is important to note that in overturning Quill, the majority emphasized that the South Dakota law was acceptable under the Commerce Clause because it met three criteria. First, the law had a safe harbor ($100,000 in sales or 200 transactions) that protected small businesses that might be burdened. Second, imposing liability on the vendor for failure to collect sales tax from the consumer was not retroactive. And third, South Dakota is a member of the Streamlined Sales and Use Tax Agreement—which is designed to ease multistate tax compliance.
The physical presence test is decidedly dead. But the debate over who is required to collect tax will unfortunately continue. The first issue that will likely be scrutinized concerns the effect of Wayfair on state statutes that do not mirror South Dakota’s statute. Will a state law requiring collection by companies with less than $100,000 in sales or 200 transactions pass Commerce Clause scrutiny?
Another question that has already arisen is whether states will be able to apply their laws retroactively to all open years. There is a serious fairness issue (which may give rise to a Due Process challenge) in requiring out-of-state vendors to remit tax on sales that occurred two or three years ago. Those vendors were acting in good faith based on well-settled Supreme Court precedent. Luckily, several states, such as Iowa and Indiana, have prospective-only laws.
Another issue is that many states, including some of the largest, are not members of the Streamlined Sales and Use Tax Agreement. Does that matter? Should it? Membership in this agreement was cited by the Court as a reason why collection was not burdensome. Nonstreamlined states will argue that their systems and the systems of many private providers of software minimize compliance burdens.
Another future challenge not addressed by the Wayfair Court is how to deal with marketplace distributors such as eBay and Amazon. The states will not want to require individual sellers on eBay to collect tax. They will want eBay to collect. It is not clear how the Wayfair decision will address the marketplace provider issue.
Ending the physical presence test will not end the debate or discussion. There are bills in Congress setting limits—more onerous than those of South Dakota—on state taxing jurisdiction. Very few states have laws closely aligned with South Dakota, but considering the Court’s decision, perhaps there will be a flurry of laws that mimic South Dakota’s law. The question of retroactivity will be discussed as many states will want the revenue from past years. This monumental decision changes a lot, and the debate will continue.
David Brunori is a partner at Quarles & Brady where he specializes in state and local taxation. He is a Research Professor at the Trachtenberg School of Public Policy and Public Administration at The George Washington University where he teaches courses in state and local public finance, administrative law, and fiscal federalism. He also teaches state and local tax law at The George Washington University Law School.
- No. 17-494, slip op. (U.S. June 21, 2018).
- Id. at 22.
- 386 U.S. 753 (1967).
- 510 U.S. 859 (1993).
- See, e.g., Brian Howsare, If You Give a Mass. a Cookie . . . It’ll Ask You to Collect Sales Tax, Bloomberg (June 5, 2018), https://www.bna.com/insight-give-mass-n73014476253.
- Wayfair, slip op. at 6.
- 430 U.S. 274 (1977).
- Wayfair, slip op. at 17.
- Id. at 22.
Recommended Citation
David Brunori, Response, South Dakota v. Wayfair, Inc.: Will It End a Seemingly Endless Debate?, Geo. Wash. L. Rev. On the Docket (June 27, 2018), https://www.gwlr.org/south-dakota-v-wayfair-inc-seemingly-endless-debate.
