WASHINGTON – With its ruling last week in the case South Dakota v. Wayfair, tax law experts say the Supreme Court has opened up the floodgates for states to establish and/or expand their taxation of online sellers.
While all Supreme Court decisions are significant, the Wayfair ruling is noteworthy both for its potential impact and the fact that it overturns a decades-old precedent.
In a 5-4 decision, the justices rejected precedent set in the 1992 case Quill Corp. v. North Dakota and the 1967 case National Bellas Hess, Inc. v. Department of Revenue of Ill, under which a company must have some manner of physical presence in a state in order to be subject to sales taxation in that state.
In the ruling issued last Thursday, the majority held that “because the physical presence rule of Quill is unsound and incorrect, Quill Corp. v. North Dakota… and National Bellas Hess, Inc. v. Department of Revenue of Ill… are overruled.” (Internal citations removed.)
The full impact of the decision won’t be clear until questions left unresolved by the court are addressed by Congress and/or further litigation on some of the issues. The immediate impact, some experts say, is likely to include a lot of states quickly moving to collect sales taxes from online retailers under their existing laws or altering their current laws to take advantage of the ruling.
“Other states are sure to follow suit and enact laws establishing nexus based on low-threshold sales,” Paul Graney of Marcum LLP, an accounting and tax advisory firm, wrote for Marketwatch. Graney also noted that several states “currently have laws with higher thresholds, but they have been on hold pending the outcome of this case.”
“The end result of the ruling will be an increase in tax revenue for states and higher operating costs for internet sales companies, which will inevitably translate into higher costs for consumers,” Graney added.
The prospect of states lowering their thresholds for out-of-state companies to qualify for state sales tax is something for all online sellers to keep an eye on, because it could be the difference between this decision being an interesting irrelevancy or a burdensome requirement. While most adult online retailers won’t reach the sales and revenue thresholds present in the South Dakota law at issue in this case, there’s no guarantee other states will set their baselines as high as the Mount Rushmore State.
The court’s ruling also left a lot of questions in the case unanswered, attorney Larry Walters noted.
“The decision, itself, did not resolve all the issues in the case, and the litigation could go on for years,” Walters said. “Meanwhile, website operators are left scratching their heads on how to remain in compliance with a multitude of differing state tax laws.”
Walters added that one thing is clear, however: The ruling – and the rush of varying state tax requirements which will come with it – could prove to be a major pain in the neck for online retailers, adult and mainstream alike.
“The Wayfair decision will be a nightmare for small internet retailers, absent quick Congressional action setting uniform tax rates and thresholds,” Walters said. “Each of the many taxing jurisdictions has its own rates, exemptions, and definitions. A particular product or service may be taxable in one state but exempt in another.”
The Wayfair case hinged on the question of whether South Dakota could require online retailers to collect and remit sales tax in the purchaser’s state of residence. South Dakota argued sales made to its residents created a sufficient nexus between businesses and the state for South Dakota to assert its authority to impose sales tax on such transactions.
Relying on the precedent set in Bella Hess and reaffirmed in Quill, Wayfair and the other respondents argued that since they had no physical presence in South Dakota, they should not be subject to the state’s law requiring online merchants to collect the tax.
The trial court awarded Wayfair summary judgment in the case and the State Supreme Court upheld the trial court’s decision, setting the stage for the showdown at the U.S. Supreme Court.
The majority’s decision focuses on problems with the precedent set in Quill, declaring that the decision was “flawed on its own terms,” in part because the “the physical presence rule is not a necessary interpretation” of the nexus requirement.
“The physical presence rule has long been criticized as giving out-of-state sellers an advantage,” the Justice Anthony Kennedy wrote for the majority. “Each year, it becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.”
Image of Justice Anthony Kennedy By The Oyez Project, Public Domain
