On June 21, 2018 Sobel & Co. distributed a memo regarding the landmark decision handed down that day by the U.S. Supreme Court in South Dakota v. Wayfair. Now that some time has passed since that important announcement out of Washington DC, we can take a deeper dive into the decision and its influence on commerce across and within the states.

What was the most obvious effect of the decision?

With this vote the Court overturned the “physical presence standard” that was at the core of previous decisions presented in Quill v. North Dakota and National Bellas Hess v. Department of Revenue of Ill.  The standard for whether a state can require an out-of-state retailer to collect and remit sales tax based on a physical presence is no longer recognized as law.

As we mentioned in our previous email, the Supreme Court justices used this opportunity to express their strong feelings that the decades-old ruling was no longer relevant.

Since the U.S. Supreme Court's 1992 decision in Quill v. North Dakota, the standard for whether a state can require an out-of-state retailer to collect and remit sales tax has been physical presence.  But given the rapid changes taking place regarding the way commerce is conducted today through technology advances, the Court held that reliance on the physical presence rule in Quill is an "unsound and incorrect."  They disagreed with the previous interpretation of the Commerce Clause which favored out-of-state sellers and resulted in the states losing out on significant amounts of tax revenue.

In summary, the Court has determined that physical presence is no longer required to meet the "substantial nexus" requirement and instead determined that the respondents had established substantial nexus in this case through "extensive virtual presence."

In the years since the Quill decision, the Court has been encouraged to revisit the physical presence standard, contending that the evolution of the impact of Internet on the economy has negated the ruling in that case.  

Writing for the majority, Justice Kennedy's commentary on Quill likened the physical presence requirement to a "judicially created tax shelter that has created marketplace distortions and unfair and unjust incentives to avoid physical presence in various states."

Dissenting opinions

The ruling was not unanimous and the voice of dissenting justices must be acknowledged. In overturning both National Bellas Hess and Quill, the Court has effectively overturned half a century of precedent. Dissenting Chief Justice Roberts, joined by Justices Breyer, Sotomayor, and Kagan, took particular note of this fact, observing that departing from the doctrine of stare decisis is "an exceptional action" requiring a “special justification,” even more so when the Court is ruling in matters where Congress has "primary authority.”

What are other states doing?

According to a article published by Checkpoint Catalyst, although Wayfair clearly overturns the physical presence requirement, it does not provide states carte blanche to enact or enforce all forms of economic nexus laws. Here is what they report:

In recent years, a growing number of states have followed South Dakota and enacted economic nexus laws that intentionally spurn the physical presence requirement by asserting nexus based on the number and/or dollar amount of sales into the state.

A number of states have laws asserting nexus to the greatest extent permitted by the U.S. Constitution and federal law. It is anticipated that businesses can expect to see rapid expansion of nexus assertions in light of the new Wayfair standard. Barring legislative action, taxing agencies in states like these will undoubtedly face challenges if they expand their assertions of nexus to include contacts that do not meet the physical presence rule.

Out-of-state retailers lacking physical contacts could successfully argue, under the new Wayfair standard, that the burden of compliance is too high in states that do not conform to the SSUTA. Whether those challenges would succeed is uncertain but far from unlikely.

What else is a stake?

Given the Court's conclusion that "physical presence is not necessary to create substantial nexus," this decision will impact other state taxes, such as corporate income taxes, which could apply to the income of an entity conducting significant business activities in a state without having a physical presence there.

Final observations

Chief Justice Roberts pointed out that many of the "behemoth" online retailers, such as Amazon, have already begun collecting and remitting the tax (regardless of whether they have a physical presence in a state) and that the revenue loss to states is "receding with time."