Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...
By Ryan Prete
So now what?
After decades spent enacting new laws and litigating over those laws, states finally got the legal answer June 21 that most had been seeking from the U.S. Supreme Court for 26 years: gone for good is Quill Corp. v. North Dakota and its rule that barred states from collecting sales tax from out-of-state vendors unless they had a physical presence in-state.
What that means now for states and their ability to tax online sales, and for companies and consumers to avoid tax bills, is uncertain despite the flurry of reaction to what many called the tax case of the millennium. But most predicted that the states’ 5-4 victory in South Dakota v. Wayfair would only mean more numerous, and bolder, online sales tax regimes—even if a lot more litigation is likely before actual tax dollars can roll in.
Steven Wlodychak, a principal with EY’s indirect tax practice, said until and if “Congress acts, every state is free to come up with their own standards. Expect states to respond IMMEDIATELY.”
The lead counsel for the e-retailers in the case Wayfair Inc., Overstock.com Inc., and Newegg Inc., George Isaacson of Brann & Isaacson LLP, said e-commerce companies would face tremendous difficulties in wake of the decision. “Companies engaged in interstate commerce will now be confronted not only with the prospect of collecting sales tax for thousands of state and local tax jurisdictions, but also determining whether those jurisdictions’ laws and regulations satisfy the new factors discussed in the majority opinion,” he said in a statement to Bloomberg Tax.
He urged Congress to act.
“This is obviously huge and validates that physical presence is not a sound standard in the 21st century economy,” Max Behlke, director of budget and tax for the National Conference of State Legislatures, told Bloomberg Tax. “States that implement necessary and sound standards for interstate commerce will finally be able to enforce their tax laws as they intended. Now, it is time to move to the next chapter and states will work to implement a sound tax system that is fair to all retailers.”
Among the burning questions to sort out during that next chapter:
Also: will Congress act? And does this ruling, as many retail groups asserted, hurt smaller retailers especially and consumers? In his dissent on behalf of three other justices, Chief Justice John Roberts wrote: “Armed with today’s decision, state officials can be expected to redirect their attention from working with Congress on a national solution, to securing new tax revenue from remote retailers.”
Wlodychak noted that “foreign retailers have to be especially careful” in the wake of Wayfair. “Nexus is not permanent establishment and US international tax treaties do not protect them from a states assertion of sales tax nexus,” he said in a statement to Bloomberg Tax.
In its 5-4 decision, the high court categorically threw out its divisive rule in Quill, which states like the petitioning South Dakota for years have tried to “kill” through lawsuits and regulation.
The majority in Wayfair declared Quill “unsound and incorrect” and suggested strongly that South Dakota’s law would pass constitutional muster. But the court stopped short of formally declaring that South Dakota’s law, which dozens of states have mimicked, was valid in the absence of Quill. The court just made clear that Quill was no longer part of any commerce clause test for when states may impose taxes.
The majority opinion was authored by Justice Anthony Kennedy, who famously requested a test case to revisit Quill. He was joined by Justices Samuel Alito, Ruth Bader Ginsburg, and two justices who also issued concurrences: Clarence Thomas and Neil Gorsuch. Roberts dissented, and was joined by Justices Stephen Breyer, Sonia Sotomayor, and Elena Kagan.
“The Quill Court did not have before it the present realities of the interstate marketplace, where the Internet’s prevalence and power have changed the dynamics of the national economy,” the court said. “The expansion of e-commerce has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes, leading the South Dakota Legislature to declare an emergency. The argument, moreover, that the physical presence rule is clear and easy to apply is unsound, as attempts to apply the physical presence rule to online retail sales have proved unworkable.”
The ruling is expected to open the floodgates for states to do even more to tax online sales, an area in which they have been prolific in recent years, citing a desire to adapt to an evolving economy and to level the playing field with brick-and-mortar retailers. Kennedy cited both reasons in rejecting the Quill rule.
According to the U.S. Census Bureau, e-commerce sales in the first quarter of 2018 accounted for 9.3 percent of total sales. In 2016, Amazon third-party sellers sold $346 million of goods in South Dakota alone. At South Dakota’s 4.5 percent sales tax, this would equal $20.2 million in uncollected sales tax revenue.
The ruling likely means that e-commerce companies and sellers using platforms like Amazon.com Inc. at least soon will have to comply with South Dakota’s law, which requires vendors without a physical presence to collect and remit sales and use taxes if they meet certain sales thresholds.
Practitioners, however, expect that all other states that administer a sales tax will at least copy South Dakota’s model, and those laws likely would pass constitutional muster under the reasoning of the Wayfair decision. However, the high court didn’t address whether any of those other 17 state economic nexus models are constitutionally valid, merely suggesting that South Dakota’s law would be (with its threshold of 200 transactions and $100,000).
Shortly after the ruling, e-retailer giant Ebay Inc. released a statement urging “Congress to step in and provide clear tax rules, with a strong small business exemption, to help small businesses take advantage of the Internet to grow and create local jobs.”
“The Court was very clear about the importance of protecting small businesses from unfair burdens,” the company said. “If state tax authorities attempt to subject remote small businesses to audits and lawsuits, there will be increased litigation across the country to protect small business from unfair burdens.”
The majority said, however, that the court shouldn’t wait for Congress “to address a false constitutional premise of this Court’s own creation.” The court in Quill had suggested that Congress was the proper authority to resolve these issues of interstate taxation.
“If it becomes apparent that the Court’s Commerce Clause decisions prohibit the States from exercising their lawful sovereign powers in our federal system, the Court should be vigilant in correcting the error,” Kennedy wrote. “While it can be conceded that Congress has the authority to change the physical presence rule, Congress cannot change the constitutional default rule.”
On the other hand, Roberts in his dissent strongly asserted that Congress would be the proper body to act in this space. “Nothing in today’s decision precludes Congress from continuing to seek a legislative solution,” the chief justice wrote. “But by suddenly changing the ground rules, the Court may have waylaid Congress’s consideration of the issue.”
And Sen. Dick Durbin (D-Ill.) told Bloomberg Tax after the ruling that he and other lawmakers are deciding whether they should act to bolster the court’s decision with legislation.
“Our bill would have taken care of the administration of this, and I want to read the opinion closely to see if we need to” build on the court’s decision with “enabling legislation,” Durbin said. Durbin, along with Mike Enzi (R-Wyo.), Lamar Alexander (R-Tenn.), and Heidi Heitkamp (D-N.D.), sponsored the Marketplace Fairness Act of 2017 (S.976) (MFA), which sought to kill Quill. And Durbin told Bloomberg Tax “we’re ready to take the field again if we need to to make sure that this decision is implemented fairly.”
The MFA never moved in this year’s Congress, nor in recent sessions, much like Rep. Kristi Noem’s (R-S.D.) Remote Transactions Parity Act of 2017 (H.R. 2193) (RTPA),which also sought to undo Quill. Both Enzi and Noem also lauded the high court’s ruling.
Representatives of Wayfair Inc. said the company didn’t expect the decision to impact business because the company “already collects and remits sales tax on approximately 80% of our orders in the United States.”
“Wayfair has long supported a legislative solution that would establish a level playing field for brick-and-mortar and online retailers by permitting states to collect sales tax on online sales,” the company said in a press release. “While we believe the Court was not the ideal venue for creating this level playing field, we expect that today’s decision will bring clarity and certainty to this issue.”
South Dakota Gov. Dennis Daugaard (R) called the ruling “a great day for South Dakota.”
“We have long fought the battle to defend Main Street businesses and now with today’s ruling, all businesses will compete on a level playing field,” he said in a news release.
South Dakota Department of Revenue Secretary Andy Gerlach said the state will issue guidance in the coming days about how and when it will seek to enforce its law.
“We intend to do all we can to ensure compliance. Once we have thoroughly reviewed the opinion, the Department will offer specific guidance on how out-of-state online retailers that meet the threshold can comply,” he said. “The Department of Revenue will also continue to be a resource for in-state businesses that may be affected by the court’s decision.”
Illinois Revenue Director Connie Beard said the ruling would bring in an additional $200 million in state revenue for the state annually.
“With this decision, we level the playing field for Illinois brick and mortar retailers,” she said in a statement provided to Bloomberg Tax.
Iowa’s Revenue Department expects its South Dakota-style provisions will generate $66 million annually beginning in 2020.
“It’s a great day for the states,” Joe W. Garrett Jr., deputy commissioner for the Alabama Department of Revenue, told Bloomberg Tax. “Not often do plans this involved work out exactly the way you anticipate, especially when you are talking about state tax. But here it has.”
Alabama was among the frontrunners of the “kill Quill” movement and has a regulation that imposes a similar taxing structure to South Dakota’s law.
On the other hand, internet-trade companies like NetChoice were among those representing especially smaller retailers who expressed their distaste with the high court’s decision.
“While a fraction of online commerce was free of sales tax before this ruling, the Supreme Court has now created an even greater imbalance by placing far greater burdens on Internet shopping compared to its ‘offline’ counterparts,” Steve DelBianco, president and CEO of NetChoice said in a statement. “A brick-and-mortar business won’t have to comply with the differing rules of over 12,000 tax jurisdictions, or integrate costly and complex tax software into its operations. But small web businesses will, eating away at their already razor-thin profit margins. When these businesses disappear, consumers will be the biggest losers.”
Carl Szabo, vice president and general counsel at NetChoice, told Bloomberg Tax that while some are celebrating the billions in revenue that soon will end up with states, those at NetChoice were upset about the billions coming out of the pockets of U.S. citizens.
Quill is gone, but the other takeaways from the high court’s Wayfair ruling were more-nuanced.
The court made clear the four-pronged test from its 1977 ruling in Complete Auto Transit, Inc. v. Brady remains the standard for commerce clause disputes over interstate matters like this case. Accordingly, South Dakota’s law will be valid and enforceable on remand, like any similar tax regime affecting interstate commerce, if it:
The majority suggested, without deciding, that the South Dakota law would satisfy the second and third elements. And the high court said the e-retailers that challenged South Dakota’s law, clearly had nexus for purposes of the first element after discarding the Quill physical presence requirement. But the state supreme court will have to resolve the issue officially.
Compliance burdens, which clearly troubled the justices during the April oral arguments, as well as potential retroactivity issues are among the issues the South Dakota court on remand, among others, might evaluate in evaluating the discrimination element of the Complete Auto test. And critics of the Wayfair ruling particularly honed in on the potential burdens for smaller retailers in complying with the dozens of similar state laws to South Dakota’s.
Kennedy’s majority opinion, however, emphasized that South Dakota’s law offers protections to especially smaller merchants because the state is a member of the Streamlined Sales and Use Tax Agreement.
As part of the Streamlined program, sellers collect tax voluntarily and remit it to the 24 state participants, which cover the filing costs and other fees. Kennedy plugged the program as a system that “standardizes taxes to reduce administrative and compliance costs.”
“It’s an endorsement of simplification,” if not the Streamlined and Sales Tax Use Agreement, Phil Horowitz, director of the national state and local tax practice for Moss Adams, told Bloomberg Tax.
“One thing is clear though,” Stephen Kranz, partner and tax attorney at McDermott Will & Emery, told Bloomberg Tax. “The Streamlined Sales and Use Tax Agreement just became more important than ever. States should immediately look to joining that effort if they have not already done so. It, and South Dakota’s small business protection and prohibition on retroactivity, seem to be the roadmap for states that want collection authority.”
Meanwhile, Kennedy emphasized that South Dakota’s law isn’t retroactive, and that the potential for another state to apply their laws retroactively wasn’t a strong enough reason to maintain Quill.
“These issues are not before the Court in the instant case; but their potential to arise in some later case cannot justify retaining this artificial, anachronistic rule that deprives States of vast revenues from major businesses,” Kennedy wrote.
Kranz wasn’t convinced states would enforce their laws retroactively.
“Retroactivity would likely be a death knell to a state that tried it,” he told Bloomberg Tax.
The Wayfair ruling ultimately leaves a lot of unanswered questions on the table, according to Jennifer Karpchuk, state tax attorney at Chamberlain Hrdlicka in Philadelphia.
“One key question is what will be substantial enough,” Karpchuk told Bloomberg Tax. “In South Dakota, it was the $100,000 or 200 transactions threshold. Is an amount less than that still substantial? States will need to decide if and where they want to draw the line, with the understanding that something less may be challenged.”
There’s also the question of when businesses are forced to comply.
“How much time will they give taxpayers to become compliant? Are taxpayers expected to comply as of today, June 21st? Will there be a grace period? An amnesty?” Karpchuk said.
Brian Kirkell, a Washington-based principal at RSM US LLP told Bloomberg Tax that the sales tax in question would “arguably be due today.”
Revenue officials from most states told Bloomberg Tax they were still reviewing the decision to see how their own statutes aligned with South Dakota’s.
In Maine, Alec Porteous Commissioner of the state’s Administrative and Finance Services, said his department would “prepare any changes to Maine law that may be necessary.”
The Washington Department of Revenue said it would be changing its online sales tax laws, but how and when was still up in the air.
“It will definitely change what we are doing in light of the court decision as far as the notice and reporting,” Patti Wilson, marketplace fairness project manager for the Washington DOR, told Bloomberg Tax. “This allows us now to require businesses of a certain threshold—we don’t know what that threshold might be—to collect sales tax.”
Wilson said department staff is unsure whether the state would use South Dakota’s threshold or “something else, we don’t know what that looks like.”
In the wake of Wayfair, all eyes will turn next to the South Dakota Supreme Court, and how it resolves the dispute on remand. But litigation is also expected to continue or to quickly crop up in a number of states.
Similar legal battles over digital sales tax regimes are pending in Indiana, Ohio, Tennessee, Virginia (over a Massachusetts regulation), and Wyoming. Alabama just settled a matter.
In Tennessee, Attorney General Herbert Slatery III said the state will review the ruling and its “impact on the pending case filed against the TN Department of Revenue by the American Catalog Association,” Slatery said.
It wasn’t immediately clear how the Wayfair ruling would impact the other cases, many of which were formally held in abeyance until Wayfair was decided.
The other states didn’t immediately respond to requests for updates on pending litigation.
The Wayfair case traveled to the highest court after the e-retailers challenged South Dakota’s digital sales tax statute, S.B. 106 (S.D. Codified Laws Chapter 10-64), which the South Dakota Supreme Court last year found unconstitutional under Quill. South Dakota’s law imposes a tax on retailers with 200 transactions or annual in-state sales exceeding $100,000.
For years, internet sellers have complied with a variety of state tax collection regimes, which have proliferated recently as the digital economy has displaced traditional brick-and-mortar retailers, including:
The case is South Dakota v. Wayfair, Inc., U.S., No. 17-494, 6/21/18.
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