On Thursday, June 21, 2018, the United States Supreme Court issued a landmark decision that will significantly alter the e-commerce landscape and result in significantly increased sales tax collection by the states. The new ruling holds that states may require online retailers to collect sales tax even if the retailer has no physical presence in the state.
In 1967, National Bellas Hess, Inc. v. Department of Revenue of Illinois, and again in 1992, in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the Supreme Court held that a state’s power to require an out-of-state seller to collect and remit sales tax to the consumer’s state depended on whether the seller had a physical presence in that State, and that the mere shipment of goods into the consumer’s state based on a catalog order did not satisfy the physical presence requirement.
Since the Quill opinion in 1992, commerce in the United States has experienced a seismic shift. With the advent of the Internet and e-commerce, state borders and physical distance have become far less relevant, with consumers able to purchase from sellers regardless of location. States have long argued that Quill’s physical presence requirement costs them billions of dollars in tax revenue, as they are prohibited from requiring retailers without a physical presence to collect and remit sales tax on sales to their residents and collecting tax directly from customers has been problematic. Over the last 26 years, neither Congress nor the Courts have disturbed Quill.
South Dakota v. Wayfair, Inc.
South Dakota directly challenged Quill by passing S. 106, requiring out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the state” if, on an annual basis, the seller delivers 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. The state then filed a declaratory judgment action against online merchants, Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc., none of whom have employees or real property in South Dakota. The merchants obtained summary judgment based on Quill’s authority and the South Dakota Supreme Court affirmed.
The United States Supreme Court took the case and explicitly overruled Bellas Hess and Quill, holding that “Quill is flawed on its own terms” because “the physical presence rule is not a necessary interpretation of the requirement that a state tax must be ‘applied to an activity with a substantial nexus with the taxing State.’” South Dakota v. Wayfair, No. 17-494, slip op. 10 (2018). Especially in the Internet age, with the “continuous and pervasive virtual presence of retailers,” physical presence is an anachronism. Moreover, “Quill creates rather than resolves market distortions,” because it gives out-of-state merchants a price advantage over in-state merchants, who must collect the tax. Id. Finally, “Quill imposes the sort of arbitrary, formalistic distinction that the Court’s modern Commerce Clause precedents disavow.” The court thus concluded “that the physical presence rule of Quill is unsound and incorrect,” and overruled it.
Immediate and long-term impacts
The effects of Wayfair will be significant and immediate. At least seven states have already passed state laws very similar to South Dakota’s, many knowing that the law’s validity depended on Quill being overruled. On June 14, 2018, for example, Connecticut passed Public Act No. 18-152, which significantly expands the conditions under which out-of-state retailers must collect and remit Connecticut sales tax, targeting “market facilitators” like eBay and Etsy. Similarly, on June 4, 2018, Illinois passed H.B. 3342, which requires remote retailers with cumulative gross receipts of at least $100,000 in sales into the state or 200 or more separate transactions in a year to collect and remit sales tax. At least Minnesota, Oklahoma, Pennsylvania, and Washington have also passed similar laws expanding the collection of sales tax from out-of-state online retailers. Other states have attempted to expand their ability to collect sales tax from out-of-state merchants even if Quill were upheld. Ohio, Rhode Island, and Massachusetts, for example, have attempted to equate online activity with physical presence, claiming that the use of retailers’ software (including cookies and data tracking tools) by in-state customers on their computers or devices satisfies Quill’s physical presence requirement. Without Quill, such arguments are unnecessary and it is only a matter of time until most states have passed laws similar to South Dakota’s. Wayfair thus spells the end of an era in which merchants could sell significant quantities of goods to buyers in a state where the merchant had no physical presence and not collect sales tax. Merchants with an online presence must prepare now to put in place the collection and remittance infrastructure for all states in which they conduct significant online business. New Hampshire, which has no sales tax, swiftly criticized the Wayfair decision as placing a devastating burden on its small businesses, which, until now, have not collected sales tax on any sales, but will soon be subject to every state’s taxing jurisdiction. This position is likely to gain traction with small businesses advocacy groups, and perhaps other states that do not impose sales tax.
Wayfair is thus almost certain to prompt a new push for a federal law to protect small online retailers by limiting states’ ability to require small businesses to collect out-of-state sales tax. Whereas states have, until now, been the major advocates for Congressional action in this area, this new push will come largely from Internet retailers and catalog businesses seeking limits on state action.
Wayfair will likely also lead to states taking increasingly more aggressive positions with respect to income and franchise tax nexus.
ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm whose lawyers practice throughout a network of offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy, technology and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.