On April 17, the U.S. Supreme Court will hear arguments on South Dakota v. Wayfair, en route to clarifying an issue that has vexed states since the court’s 1992 decision in Quill Corp. v. North Dakota -- the attempt by states to have remote sellers collect tax on sales to customers in their states. The stakes are huge, with states waiting to collect – or not – billions of dollars of sales tax going forward.
The court’s 1992 decision in Quill established the physical presence test for sales and use tax nexus. Since the beginning of online sales by remote sellers, states have struggled to find ways to collect tax revenue from online sales by sellers located outside the state.
In 2016, South Dakota created a direct challenge to the Quill test by enacting legislation implementing an economic nexus standard requiring remote sellers without a physical presence in the state to collect sales tax if certain gross revenue or transaction thresholds were met. A number of states followed suit by enacting similar legislation in 2017. The South Dakota law was held to be unconstitutional in the state’s circuit court and the South Dakota Supreme Court, setting up the challenge that the U.S. Supreme Court will attempt to resolve.
“The court could go one of many ways,” said Jamie Yesnowitz, a principal and SALT National Tax Office leader at Top 5 Firm Grant Thornton. “It could conceivably go the procedural route and decide that the law is invalid based on precedent. I don’t see that as a likely solution, but it’s not outside the realm of possibility.”
“The court say simply that the legislation is good, or that Quill is gone. Or it could set its own standards in this area and evaluate the South Dakota legislation in terms of its own standard,” he continued. “As a final alternative, the court could say the legislation is bad because it’s up to Congress to decide the question.”
Yesnowitz doesn’t expect the court to speak with one voice on the issue. “Courts have been very divided on this issue,” he said. “It doesn’t fall neatly within political lines. As a result, there may be a lot of concurring opinions and dissents.”
An issue for legislators?
Congress has always had the power to clarify the situation but had chosen not to, according to Tom Wheelwright, a CPA and CEO of wealth strategy firm WealthAbility, and the author of "Tax-Free Wealth." “Under the Constitution’s Commerce Clause, individual states are not to have authority to regulate interstate commerce – that’s reserved for Congress. That’s what Quill and Wayfair are all about.”
“But Congress has not done anything to regulate interstate commerce in this area, other than P.L. 86-272. [Public Law 86-272, the Interstate Income Act of 1959],” he continued. “All that regulates is income tax when all a company does is to solicit orders. It does not regulate service industries at all, and it has nothing to do with sales tax.”
“The Supreme Court said that even if Congress does nothing, there’s still an implied negative commerce clause – an implied restriction on states having an impact on transactions that take place across state lines,” he added. “Quill said that to impose a collection responsibility on a company for sales or use tax the company had to have a physical presence in the state. It appears that the reason the court made a requirement of physical presence was that it felt that the burdens on the companies to collect the sales and use tax outweighed the benefit that the company would receive without a physical presence.”
For example, Wheelwright observed, a company with employees in the state benefits from police and fire department protection for its property and employees.
”There are costs that the state would incur, and corresponding benefits that the company would if it had a physical presence. The question in Quill was that there was a substantial burden on interstate commerce to require the collection of a sales or use tax when there was no physical presence,” he said.
“What changed was the internet, and software,” he said. “When Quill was decided, nobody knew what the internet was, so collecting sales and use tax required physical effort. The challenge of Wayfair will be that between the internet and the use of software that’s available to impose and collect sales and use tax, does the cost to the company still outweigh the benefit it receives from the state?”
“With sales tax compliance software, the burdens of collecting, remitting, and filing in multiple states are not as significant as they were 25 years ago,” agreed Jeff Glickman, partner-in-charge of state and local tax at Top 100 Firm Aprio. “States are also beginning to enact onerous laws to work around the physical presence requirement, such as use tax disclosure laws, which have been upheld by the 10th Circuit Court of Appeals. Given these factors, it seems that Quill and its physical presence standard are ripe for reversal.”
“The challenge for the court will be drafting guidance for any new standard,” he said. “The level of clarity provided by the court could help limit the number of varying state interpretations, as we have with physical presence now.”
“It is important that if the court decides to overturn Quill that it clearly states its decision is prospective only. The South Dakota law at issue has a ‘prospective only’ clause, but that is not the case for all other states that have enacted similar laws. For remote sellers to be on the hook for back sales taxes based on their reliance on Quill would arguably create an undue burden that should be avoided,” he said.