Bob Dylan wrote a song back in the 1960’s, “The times, they are a changin”. The title of that song can apply to the current times in the matter of sales and use tax and the seemingly increasing reaches of the states to encourage or require companies to collect their tax. The word “encourage” is used loosely here as states are implementing laws and regulations that establish nexus for companies they previously were not able to reach. In essence, states are making it so difficult on taxpayers to comply with the new laws that they choose to register voluntarily to collect the tax, as it can be less cumbersome than complying with the new law the state has established. This brings up the constitutional question whether these state laws violate the constitution as it relates to the Commerce Clause, thereby placing an unconstitutional burden on interstate commerce.
Background on the Commerce Clause
Let’s establish some groundwork before diving into the case before the Court in South Dakota v. Wayfair. In 1967, the US Supreme Court determined that under the Commerce Clause, States cannot require an out of state seller to collect its use tax (the equivalent of the sales tax for an out of state purchaser) if the business does not have a physical presence in that State[1]. It is incumbent upon the purchaser to pay the proper use tax to their own state.
In 1992, the US Supreme Court was confronted with the nexus question once again in Quill v. North Dakota[2], the Court held that the Commerce Clause barred enforcement of a use tax collection on an out of state mail order business whose only contacts with the state were by mail or common carrier. In essence, the Court ruled this activity lacks the “substantial nexus” required by the Commerce Clause of the Constitution, so the State’s enforcement of the use tax against Quill placed an unconstitutional burden on interstate commerce. The Court relied on stare decisis to rule that the physical presence requirement still stands.
Tax on Internet Sales
Over the years, the internet has grown tremendously, leading to more and more sales made via the internet. The internet companies, along with other mail order businesses, may only have nexus with the state in which they reside and are not obligated to collect other state’s use taxes based on the decisions in National Bellas Hess and Quill. Since it is incumbent upon the purchaser to pay the use tax on their purchase, many either choose not to, or do not know how to do so. They don’t realize the use tax return that used to arrive in the mail with our annual state income tax return should be filled out for all those transactions on which no tax was charged from an out of state company. The states have no avenue to collect that tax outside of auditing individuals and companies. Auditing is an expensive endeavor for many states and there has to be some cost-benefit analysis. This leads to a loss of tax revenue for the states. It would be very costly to audit individuals or small businesses to collect the tax owed by them via their purchases from out of state vendors. The revenue may be hundreds of dollars on average. Hardly, worth the state’s time. It would be more beneficial for the states if they could enforce a collection obligation on the Sellers. So, the states are trying to challenge Quill and National Bellas Hess by establishing laws that are contrary to those decisions.
In Direct Marketing Association v. Brohl, the Court addressed Colorado’s attempt to do just that by enacting legislation imposing a notice and reporting requirement on out of state sellers whom have no nexus with Colorado, but have gross sales in excess of $100,000[3]. The case was remanded to the United States Court of Appeals, where the Court ruled that this law did not violate the commerce clause as it does not unconstitutionally discriminate against and unduly burden interstate commerce[4]. Therefore, the Colorado notice and reporting requirements on out of state retailers is constitutional and thereby enforceable. This was partially due to the fact Colorado was enforcing a “reporting” requirement, not a “collection” requirement.
However, in his concurrence to the US Supreme Court’s opinion in Direct Marketing Association, Justice Kennedy made the following statement, “Given [the] changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill….The legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess”[5]. Therefore, the states have been trying to bring such a case. That case is South Dakota v. Wayfair[6], which was heard by the US Supreme Court on April 17, 2018.
Specifics on South Dakota v. Wayfair
South Dakota is one of the states that enacted legislation that forces a collection requirement on a seller if their sales into South Dakota exceed $100,000 OR consist of 200 or more transactions. In the hearing, Justice Sotomayor suggested it was the state’s inability to find a mechanism to collect from consumers that is the real problem. It was also discussed whether it is the Court’s role to find the solution to this problem or if it is Congress’ duty to determine a solution and they have chosen not to do so. We all know that may be a bit too ambitious to expect of Congress as we can see how difficult it is to get anything passed in Congress, and many times what starts out as a good law and idea morphs into something altogether different by the time it is passed.
Another concern of the Court is the retroactivity that could be applied. When the Supreme Court decides a case such as this and overrules their prior decision, they are, in essence, saying that the prior case was wrongly decided and the correction today is what the law actually is. This means the Court’s decision today is what the law is today, was yesterday, and will be tomorrow, or in this case, 1992 when Quill was decided. Then, the question is “will the states apply the decision retroactively?” This is a valid concern for the Justices in this case.
The State’s counsel stated that 38 states cannot apply an overruling of Quill retroactively and that South Dakota does not wish to do so, while Wayfair’s counsel pointed out that one particular state had already notified retailers without a physical presence that they intend to pursue them for back taxes. This is a significant issue that the Court appears very concerned about and no real answer has been provided. Should Congress address the issue, they can do so prospectively.
Should the Court overrule Quill, as many expect they may, we can be sure many, if not all, states will enact similar laws as South Dakota. As a result, out of state sellers who have no physical presence in other states, may now have nexus in those jurisdictions.
The Anders State and Local Tax Services Group is happy to discuss the ramifications of this decision and help you remain compliant in all jurisdictions in which you have nexus. Contact an Anders advisor with questions specific to your business.
Read how the Supreme Court’s decision on South Dakota v. Wayfair will impact online and multi-state businesses.
Court Case References:
[1] National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967).
[2] Quill v. North Dakota, 504 U.S. 298; 112 S Ct 1904; 119 L Ed 2d 91 (1992).
[3] Direct Marketing Association v. Brohl, 575 U.S. ___; 135 S. Ct. 1124; Docket No. 13-1032 (2015).
[4] Direct Marketing Association v. Brohl, No. 12-1175, US Court of Appeals, 10th Circuit (2016).
[5] Direct Marketing Association v. Brohl, 575 U.S. ___; 135 S. Ct. 1124; Docket No. 13-1032 (2015).
[6] South Dakota v. Wayfair, No. 17-494, case heard 4/17/18, yet to be decided.
