In a digital age, what circumstances should be considered to create sales tax nexus between a state and an online retailer? Is physical presence a proper baseline for determining whether a state can require a nonresident retailer to collect sales tax?
In the 21st century, people often prefer shopping online to shopping at a local store. States argue that they are losing tax revenues when their residents shop online with out-of-state retailers.
In a case coming out of South Dakota, the U.S. Supreme Court will be considering these issues.
“Physical Presence” and Quill
On April 17, 2018, the Court will hear oral arguments on whether its “physical presence” rule for sales tax nexus still makes sense. The justices are expected to rule on the case by late June.
The case before the court is South Dakota v. Wayfair, Inc., Docket No. 17-494. South Dakota is asking the Supreme Court to overturn its physical presence rule as applied in Quill Corp. v. North Dakota (91-0194), 504 U.S. 298 (1992).
Remote Seller Laws and Taxing Online Sales
In an attempt to capture sales tax revenue from online sales, states have passed new laws to work around the physical presence rule. A popular remote seller law enacted by many states was click-through nexus. Under click-through nexus laws, an out-of-state seller has nexus with the state if the seller has a referral agreement with an in-state resident that results in online sales. Some states also recognize nexus with a remote seller when it has affiliates in the state, under so-called affiliate nexus rules.
South Dakota’s Remote Seller Law
South Dakota v. Wayfair involves remote seller legislation enacted in South Dakota. Generally, the law applies to out-of-state retailers that:
- had annual gross revenue of more than $100,000 from sales in South Dakota; or
- completed more than 200 sales annually in South Dakota.
South Dakota has fast-tracked this question to the Supreme Court by way of its own law. With no income tax, the state relies on sales taxes for funding. From the state’s perspective, it loses massive tax revenue to online sales. Therefore, South Dakota included an expedited appeals process for any challenges to the constitutionality of the law in its remote seller legislation. The law, enacted two years ago, is about to be considered by the U.S. Supreme Court.
The Dormant Commerce Clause
The issue in South Dakota v. Wayfair requires another look at the limits of state taxing authority under the U.S. Constitution. The Court decided Quill relying on the Commerce Clause. Under the dormant Commerce Clause, states cannot impose rules that put an undue burden on interstate commerce. The underlying question in South Dakota v. Wayfair is whether states put an undue burden on interstate commerce if they make out-of-state retailers collect tax on sales to the state’s residents.
Arguments in briefs filed with the Court address the relative ease and costs involved for online retailers to register and collect tax in many states. Meeting sales tax compliance requirements in up to 50 states looms as a daunting task for small and mid-size online retailers. However, technology similar to that which has allowed online shopping to eat away at brick-and-mortar sales may make multistate-filing doable.
If the Court Follows Quill
Overturning South Dakota vs. Wayfair will invalidate many remote seller laws. Retailers that have registered with states to avoid use notice requirements might consider whether the use notice requirements are an undue burden on interstate commerce. Should retailers be required to notify a state’s residents of the state’s tax laws in order to sell to those residents?
If the Court Shelves Quill
The Supreme Court could overturn its holding in Quill. This will likely cause states to rethink what creates nexus for sales tax in their state. If they do not have to follow a strict physical presence standard, they, too, may look at what level of economic activities create nexus.
As a result, online retailers and their tax advisors should be prepared for the retailers to:
- register in all states where they make sales;
- collect sales tax; and
- comply with filing and other requirements.
If a retailer sells into a state with existing remote seller laws, it will have to determine whether its sales into the state meet the state’s thresholds.