For over 50 years, retailers engaging in interstate sales have been able to rely on a bright-line standard that meant they did not have to collect destination state sales taxes unless they had a physical presence in that state. The standard was founded in U.S. Supreme Court constitutional cases, most prominently, National Bellas Hess, Inc. v. Department of Revenue of Ill., decided back in 1967, and Quill Corp. v. North Dakota, decided 25 years later, in 1992. While the Supreme Court's basis for establishing and upholding that standard has changed somewhat over the years, the basic standard remained the same in its application for decades, right up to last Thursday, June 21, 2018, when the standard was eliminated by the Court. All vendors selling product across state lines that could potentially be subject to state sales taxes need to be aware of this new decision. It will likely affect many vendors and require significantly increased compliance.
The latest case, South Dakota v. Wayfair, Inc. et al., involved South Dakota sales tax. The South Dakota Legislature had enacted a law requiring out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the State.” The South Dakota act in question covered only sellers that, on an annual basis, delivered more than $100,000 of goods or services into the state or engaged in 200 or more separate transactions for the delivery of goods or services into the state. The taxpayers in the suit were established online retailers with large sales that met these requirements but did not collect and remit South Dakota's sales tax, relying on established U.S. Supreme Court precedents. The taxpayers won the case in the lower courts, including the South Dakota Supreme Court, which ruled that it was bound by the U.S. Supreme Court decision in Quill and its predecessors. Well, the U.S. Supreme overturned the lower court rulings and went against the previous Quill ruling. The Court determined Wayfair would indeed need to pay the South Dakota state sales tax.
The Wayfair case can be seen as part of an onslaught over the years by states challenging the physical presence standard, and businesses and trade association groups pushing back, resulting in significant litigation at the state level. Many states had joined in an amicus brief in support of South Dakota in Wayfair. In recent years, several states have enacted laws or passed regulations attempting to skirt the physical presence standard, arguing that times had changed, and that the old standard was devised before the internet changed the world of sales and distribution. They also argued, as did South Dakota in Wayfair, that the status quo was causing large revenue losses because of the difficulty in collecting use taxes from purchasers of products and services (South Dakota argued it was losing up to $58 million annually). Justice Kennedy in Wayfair cited evidence that states could be losing up to $33 billion of sales taxes in total annually. Tennessee, which relies heavily on sales taxes, is a case in point: it had promulgated regulations with a quite significant $500,000 in-state sales threshold. Those regulations were put on hold by a consent order in American Catalog Mailers Association and Netchoice v. Tennessee Department of Revenue and David Gerregano, Commissioner pending the outcome of litigation. Tennessee expects to recover an additional $450 million annually as a result of the abandonment of the physical presence rule.
Could states apply Wayfair retroactively? This raises an interesting question. Many states enacted statutes counter to the physical presence standard shortly after the National Bellas Hess case, and while those statutes conflicted with Supreme Court constitutional interpretation, that interpretation is now radically altered. As many of those statutes were never repealed, can states now assess cross-border sellers for unpaid taxes spanning decades? While the risk might at first blush seem to be remote, it is impossible to say so at this time, especially as Wayfair apparently held that the physical presence test was flawed from its inception.
There will be winners, and there will be losers as a result of the change. It is hard to predict the precise outcome of all this. The states and states' rights clearly win. On the consumer economy side, if the estimates mentioned above are accurate, one may expect, in the words of Ross Perot, to hear a “giant sucking sound” as $33 billion is taken from the pockets of consumers, leaving them with less cash to buy products and services. Conventional wisdom suggests that brick-and-mortar stores will be winners because the sales tax playing field has now been leveled. How that plays out in reality, though, likely depends on many factors. One is whether the increased tax burden on consumers, above, mitigates any benefit. Furthermore, it is probably inaccurate to assume that consumers have gravitated to online shopping solely because of sales tax savings. Many other factors increase the attractiveness of online shopping, including broader product availability, reduced retailer costs being passed on to consumers, and convenience. The internet revolution did not happen just because of sales tax elimination.
The very largest online retailers, such as Amazon, Walmart, Apple, or Macy's, will unlikely be significantly affected in respect of their own inventory sales, as Amazon collects sales tax on such sales already, and the other largest players are brick-and-mortar as well as online and also collect taxes anyway. However, some companies such as Amazon and Walmart do not collect sales taxes from smaller companies that are marketplace sellers on their online platforms.
The biggest losers, as usual, are likely to be small businesses engaging in interstate sales. It's likely compliance costs will ultimately burden small businesses much more drastically than larger ones. The Wayfair case was brought against Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc. From a compliance standpoint, one would expect additional costs to businesses of such magnitude not to be problematic (for example, Wayfair's and Overstock's net revenues are in the billions). It could be argued that any retailer that exceeded the in-state sales minimums in states like South Dakota or Tennessee should not have to gripe about compliance costs – they're making substantial revenue. However, a big problem is that the Supreme Court did not implement a new standard to replace the physical presence standard. The states that established minimum sales thresholds did so as part of an attempt to end-run around the old physical presence standard. Now that the standard has been removed, it is not crazy to think that money-hungry states may impose lower and lower thresholds, burdening even very small businesses with the need to comply with sales tax rules (state, county, municipal) in multiple jurisdictions.
Other unknowns include whether U.S. vendors now risk ceding ground to foreign vendors, some of which may be bold enough to ignore the change in the law, as they are beyond U.S. jurisdiction; and whether it is only a matter of time before similar changes occur in the sphere of state income taxation in respect of interstate sales.
We are at the very beginning of a sea change. It is possible that Congress may ultimately have to intervene, as it has authority to do under the U.S. Constitution's Commerce Clause. Perhaps a sensible outcome would be a national per-state minimum threshold before the states may require a vendor to collect destination state sales taxes. Meanwhile, it's wait and see.
What should interstate vendors do while we wait? Pending further clarification, vendors should take actions to mitigate risk and exposure in states in which they sell but have not traditionally collected sales tax. These actions could include the following:
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Analyze applicable tax laws in such states
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Consider the magnitude of the retroactivity issue mentioned above in such states
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Consider other defenses to taxation which may be available in such states
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Monitor future legislation that may be enacted in such states in light of Wayfair
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Consider voluntary disclosure procedures available in such states
