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Picture this: A Miami trial lawyer invites a few friends to buy refrigerators from an internet retailer during a holiday weekend sale.
They add in manufacturer coupons to complicate the transaction. The retailer—let’s say Wayfair Inc., hypothetically—collects more sales tax than the lawyer thinks appropriate, and voila, you have the beginnings of a class action against the retailer for sales tax over-collection.
That’s the kind of scenario Florida tax attorney James Sutton Jr. sees becoming a potential niche market for plaintiff lawyers if the U.S. Supreme Court allows states to require out-of-state retailers to collect sales taxes.
The high court is currently weighing a decision in South Dakota v. Wayfair , the long-awaited direct challenge to the 1992 decision in Quill Corp. v. North Dakota. Quill, which states for years have tried to “kill” through lawsuits and legislation, prohibits states from imposing sales tax collection obligations on vendors lacking an in-state physical presence. The case was argued April 17, and practitioners expect a decision by late June.
If South Dakota wins, “you’re not just opening up sales tax nexus. You’re opening up the courts to have jurisdiction over these companies,” Sutton told Bloomberg Tax. This means plaintiffs lawyers could cherry-pick which states might be most friendly to a class action over sales tax, he said.
Sutton, of Moffa, Sutton & Donnini P.A. in Tampa, Fla., routinely represents businesses in sales tax disputes and wrote a friend-of-the-court brief for the American Academy of Attorney-CPAs arguing that the court shouldn’t overturn Quill.
The arguments for and against striking down the physical-presence standard are many, according to the 40 friend-of-the-court briefs filed since the Supreme Court agreed in January to review Wayfair.
Physical nexus is an outdated standard in an era of increasingly electronic commerce, the states argue.
But the compliance burdens remain high for a retailer trying to collect sales tax in thousands of cities, counties, and states, the industry counters.
Sutton, in the AAA-CPA brief, offers another, under-the-radar argument against striking down Quill: the potentially higher risk of lawsuits in the many states that haven’t protected businesses from tax refund claims in the form of class actions. Collecting sales tax properly, he writes, isn’t as simple as South Dakota wants the court to believe.
Businesses, including grocery stores, wholesale clubs, and pizza restaurant chains, have become all too familiar with class actions for over-collecting sales tax. Sometimes the confusion results from whether and how to apply tax on a discounted price or purchase made with a coupon, and other times a restaurant draws criticism for applying tax to its delivery fee.
Either way, business-side attorneys such as Sutton say the lawsuits aren’t productive because customers have other avenues for getting a refund of overpaid tax. Styling such a claim as a class action only runs up the legal costs for businesses and, when successful, makes money for the plaintiff lawyers, he said.
“Some of the biggest states—New York, Illinois—have left taxpayers out to dry on this,” said Clark Calhoun, a tax attorney with Alston & Bird LLP. In those states, businesses face the catch-22 of aggressive enforcement actions if they under-collect and the threat of customer lawsuits if they over-collect, he said. Calhoun also wrote a friend-of-the-court brief in Wayfair, urging the court not to overturn Quill on behalf of Americans for Tax Reform.
Joseph Bishop-Henchman, executive vice president of the Washington-based Tax Foundation, agreed that businesses find themselves in a tight spot when collecting. “Sales tax has to be exactly right,” he told Bloomberg Tax May 22.
“It’s why I think there will still be interest in a federal law despite what the court does: the court can’t immunize good-faith collection from enforcement or class actions,” he said. The lawsuits are “fundamentally unfair for the retailer,” he said, adding that any dispute about overpaid sales tax should be between customers and the state.
Bishop-Henchman’s friend-of-the-court brief for the Tax Foundation urged the court to find South Dakota’s law constitutional but also provide greater clarity on the proper scope of sales tax nexus.
It isn’t uncommon for class actions over sales tax to be dismissed or settled before trial, Sutton said. But he is also concerned that more courts are beginning to certify a class and let the cases move forward. For example, a Florida trial court recently approved a class action to move forward against BJ’s Wholesale Club Inc. over the way the retailer applied tax to a sale of televisions bought with coupons. An appeal of the trial court’s decision is pending in Florida’s Third District Court of Appeal as BJ’s Wholesale Club v. Bugliaro.
While they generally agree that lawsuits over sales tax collection are bad for business, industry-side tax lawyers differ over whether Wayfair might help, hurt, or not really affect the situation.
For example, if the Supreme Court makes clear it is “changing” the constitutional standard for sales tax nexus, the ruling could help fend off lawsuits for under-collection by shielding claims for prior years, said Jeffrey Friedman, a tax partner at Eversheds Sutherland (US) LLP in Washington.
“And if the court were to uphold the physical presence nexus standard, that decision also should help fend off suits related to under-collection,” he told Bloomberg Tax May 22. “I see a lot of upside here.”
“I guess one could come down on either side,” said Harley Duncan, managing director and leader of the state and local tax group of the Washington National Tax practice of KPMG LLP. “If Quill is overturned, there will be more collection, which will mean more opportunities for error. On the other hand, there could be a decrease in class-action lawsuits that sprung up because a seller was voluntarily collecting in jurisdictions in which it was not required by law to do so.”
A number of states have protected companies from class actions related to tax refunds, said Stephen Kranz, an attorney at McDermott Will & Emery in Washington. In particular, members of the Streamlined Sales and Use Tax Agreement have adopted laws that require consumers to go through a seller notification or refund request process before they can pursue legal action against the business for over-collected sales tax.
“I agree that it’s a legitimate concern,” Kranz said of the potential for increased class actions. “I don’t think it’s the bogeyman that some are characterizing it to be.”
His firm has defended companies against class actions related to sales tax, but in all cases the plaintiffs were alleging over-collection on a large number of transactions, usually involving millions of customers, Kranz said. The risk to small businesses in particular seems small, he added.
Twenty-four states have signed onto the Streamlined Sales and Use Tax Agreement, but notably absent are California, Texas, Florida, New York, Illinois, and Pennsylvania.
The Multistate Tax Commission also has urged states to block class-action litigation related to sales tax refunds. The commission has formally adopted the American Bar Association’s model legislation that would restrict these kinds of class actions, said Helen Hecht, the MTC’s general counsel.
Nevertheless, she questioned whether the expansion of sales tax nexus through overturning Quill would worsen the problem of class actions against businesses.
“I obviously can’t speak for any particular state, but I think the risk is very small,” she told Bloomberg Tax May 22. Hecht and MTC colleagues filed a friend-of-the-court brief in Wayfair urging the Supreme Court to revise or overturn the Quill standard.
While the issue of over-collection lawsuits is up for debate, sellers could see a multitude of new state tax regimes if the high court reaffirms Quill, according to Matthew Melinson, a partner and National SALT Practice Indirect Tax Services Leader at Grant Thornton LLP in Philadelphia.
“In this situation, states are going to do everything in their power to assert seller physical presence,” Melinson said during a May 22 webinar. “We can expect many states to take on a Colorado-style reporting and notification statute in the hopes that companies will just throw in the towel and agree to collect.”
Internet sellers must comply with a variety of state tax collection regimes, which have proliferated in recent years, including:
Speakers on the webinar predicted a 40 percent chance that the court reaffirms Quill.
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