The Supreme Court and Sales Tax: What You Need to Know
For online retailers, few issues are as confusing and cumbersome as understanding sales tax obligations in various states. Most companies either try to find an automated solution or stick their heads in the sand and hope for the best. In the face of this complexity, the Supreme Court recently agreed to hear South Dakota v. Wayfair, Inc., which challenges the high court’s 1992 decision in Quill Corp. v. North Dakota. If the court sides with South Dakota and overturns Quill, the impact will likely be significant and, at least in the short run, expose many more sellers to today’s sales tax compliance complexity.
What Is 'Quill' and Why Does It Exist?
Much like today, the late 1980s was a time when states were actively seeking ways to get retailers to collect sales tax everywhere. Many states adopted new use tax nexus laws, and a plan developed to find a way to get the U.S. Supreme Court to reconsider a 1967 decision declaring that physical presence was the constitutional test for sales tax collection. In the early 1990s, Heidi Heitkamp, North Dakota’s tax commissioner, filed suit against Quill Corporation, an office supply retailer, to get Quill to collect North Dakota’s use tax on sales made to North Dakota residents.
The North Dakota circuit court ruled in favor of Quill, but the North Dakota Supreme Court overturned the lower court in favor of the state. Quill challenged the state Supreme Court’s assertion, resulting in Quill v. North Dakota. Quill argued that it had no physical presence in North Dakota and therefore no nexus for tax purposes. The U.S. Supreme Court heard the case and sided with Quill, reaffirming that states could only require a business with a physical presence in the state to collect and remit sales tax. As a result, most online sellers collect and remit sales tax only in states where they have a physical location, such as an employee, store, warehouse or office.
Today, however, the Internet has radically changed retailing, making it much easier for sellers to reach consumers in all states. Because of the Quill decision, issued before online shopping even existed, states are not collecting sales tax on most of those sales. According to an estimate from the Government Accountability Office published in December 2017, states are losing up to $13 billion in sales tax revenue annually. This has been especially hard on a state like South Dakota, which has no income tax and relies heavily on sales tax collection to fund the government.
Like the late 1980s, states are again actively trying to force retailers to collect sales tax everywhere. And just like the late 1980s, state efforts include another run at the Quill decision, only this time it's from the other Dakota. In 2016, South Dakota enacted a sales tax collection law challenging the Quill physical presence precedent. The new South Dakota law asserts that an economic nexus should exist, and requires out-of-state sellers making at least 200 individual sales of taxable goods or services in the state or more than $100,000 in total sales in South Dakota to collect and remit state and local sales and use tax.
In crafting the law, South Dakota claimed an “urgent need for the Supreme Court of the United States to reconsider” the physical presence precedent. As with the Quill decision, South Dakota sued an online retailer, in this case Wayfair Inc., eventually setting up the current Supreme Court showdown.
As the Supreme Court clearly said in the Quill decision, it's important to note that Congress has always had the option to act. While Congress hasn’t taken much action, in 2013, the Senate approved the Marketplace Fairness Act (MFA), which sought to grant states with simplified sales tax laws the right to tax certain remote sales. Congress, however, has not been able to agree on an approach, and the measure stalled in the House Judiciary Committee. Later iterations of the MFA and at least two versions of a similar measure, the Remote Transactions Parity Act, have never made it to the floor of the House.
It's also important to recognize that not all retailers agree on an approach. Large online retailers tend to oppose sales taxes on remote sales because they believe the taxes could hurt sales. Small brick-and-mortar retailers typically want to see sales taxes imposed because they believe it will level the playing field if everyone is required to collect and pay sales tax. Many retailers, however, fall in the middle, having brick-and-mortar stores but also selling online.
The Impact of the Court’s Decision
If the court decides in favor of Wayfair, the South Dakota law will be nullified, but the issue certainly won’t go away. Other states, such as Wyoming, Indiana and Tennessee, already have similar laws, and these will likely lead to their own court challenges. Some states are also trying a different approach. Some are requiring noncollecting sellers to comply with complex use tax notice and reporting requirements, hoping that complexity will lead retailers to register and collect tax. Others are implementing new laws targeting marketplace sellers. A decision in favor of Wayfair could also increase the pressure on Congress to act.
If the court decides in favor of South Dakota and overturns Quill, the decision could take a couple of different forms. If the court simply rules that South Dakota’s law doesn't impose an undue burden on interstate commerce, there would still be a number of unanswered questions. For example, what should the number or amount of sales be in California or Texas in order to trigger nexus? States would then still have to pass their own similar regulations, which could continue to face court challenges.
The court could also decide to include specific requirements for nexus in its decision. If this happens, it could simplify what other states need to do in their legislation and eliminate or at least reduce future court challenges.
What Should Retailers Do?
No matter what the Court decides, it’s imperative that retailers track the evolution of sales tax regulation and understand what they will need to do if sales tax collection on remote sales becomes a reality. How likely is this to happen? The last time the U.S. Supreme Court issued a related opinion in March 2015 (Direct Marketing Association v. Brohl), Justice Kennedy argued, “Given these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill. A case questionable even when decided, Quill now harms states to a degree far greater than could have been anticipated earlier … It should be left in place only if a powerful showing can be made that its rationale is still correct.”
Retailers that don’t currently collect and remit tax everywhere they sell should stay tuned!
Scott Peterson is the vice president of U.S. tax policy and government relations for Avalara, a software provider for automated tax compliance.
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