Legal Backdrop:

In 1992, the U.S. Supreme Court determined in Quill Corporation v. North Dakota that the Constitution (specifically the Commerce Clause) barred states from mandating that businesses collect state sales taxes unless the business had a substantial connection to the state and established the “physical presence” rule.  On June 21, 2018, the Court in South Dakota v. Wayfair, Inc. et al. overruled Quill in a 5-4 decision, thus removing the physical presence rule and allowing states to collect sales tax from e-commerce.  Justice Kennedy, writing for the majority (joined by Justices Thomas, Ginsberg, Alito, and Gorsuch) said that states were losing upward of $33 billion annually in tax revenues as a result of Quill and the “physical presence rule as defined by Quill is no longer a clear and easily applicable standard.”

In the time of Quill, less than 2 percent of Americans had internet access and mail-order sales totaled roughly $180 billion annually. Today, nearly 90 percent of Americans have internet access and mail-order sales have progressed to e-commerce and annual sales tallied a staggering $453.5 billion in 2017.  With more at stake, states like South Dakota that do not have an income tax and rely heavily on sales tax were bound to act.

Procedural History:

In 2016, South Dakota implemented a law which requires remote sellers with no physical presence in the state to remit sales tax if; (1) they had more than $100,000 in annual sales from personal tangible property or services transferred into the state or (2) 200 or more separate transactions for any tangible property, products, or services transferred into the state. Shortly thereafter, South Dakota brought action against Wayfair, Overstock.com and Newegg in State Court.  The trial court granted Wayfair’s motion for summary judgment under Quill and in September  2017, the Supreme Court of South Dakota affirmed the trial court’s ruling.

The U.S. Supreme Court Decision in Favor of South Dakota:

A share of the majority’s rationale was based upon (1) the recent incredible growth of online sales and (2) the complexities of applying the physical presence rule in the cyber age.  Justice Kennedy, writing for the Court, likened the “physical presence” requirement of Quill to a “judicially created tax shelter” operating to the detriment of state and local governments’ ability to fund “ . . . police and fire departments . . . maintain public roads and municipal services . . . [and] support [of] sound local banking institutions [and] courts . . ..” With more at stake than at the time of the Quill decision (“nearly half a trillion dollars”) the Court found the application of the physical presence rule to be “unsound and incorrect.”

The decision in Wayfair not only benefits states, but also levels the playing field between traditional brick-and-mortar stores and online-exclusive retailers.

What’s Next:

Though the opinion eliminates the physical-presence rule, it does not outline a clear rule on how a state’s sales-tax law might become an impermissible encumbrance on interstate commerce.  In this regard, the Wayfair case has been remanded to South Dakota for additional determinations in accordance with the analytical framework found in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).  Complete Auto provides that a state tax will be upheld if it “(1) applies to an activity with substantial nexus with the taxing state, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the state provides.”  There is a strong presumption that the South Dakota law will be upheld as the Court specifically called out favorable provisions:

First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively. Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement [Author’s note – NYS has not adopted the SSUTA]. This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state-level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State  . . .

A remarkably absent party was Amazon.  Amazon currently charges tax on consumers in states that have a sales tax but only on products from its own inventory.  Approximately half of its sales are of goods owned by third-party merchants.  It is yet to be determined how the ruling will affect the steep growth of e-commerce or the sharp decline in traditional retailers, but for the first time in nearly three decades, remote sales and brick-and-mortar retailers will be on equal footing.

The author would like to thank Joshua Caron, a 2018 Harris Beach summer associate who is attending  the Syracuse University College of Law, for his invaluable assistance in the preparation of this Legal Alert.