If Online Sellers, South Dakota Settle Tax Beef, Who Wins?

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

Wayfair, Newegg, Overstock, and South Dakota certainly have felt the most direct impact from the U.S. Supreme Court in June lifting a major obstacle to when states can tax online sales.

Those parties in the “tax case of the millennium” are actively looking to settle their ongoing dispute over South Dakota’s online sales tax regime, which is poised to become the new normal across the U.S. states.

But what would a settlement mean for states and for e-retailers as governments (including Congress) threaten to take increasing action in this space?

Would taxpayers finally have a level of certainty? Would more litigation arise? Answers to these questions vary, but most tax lawyers asked about it believe a settlement is ultimately in each party’s best interest.

As so many await the outcome in South Dakota, Bloomberg Tax analyzed the pros and cons at play for each party if they do settle the closely watched case, which the state lower courts are expected to take back up later this month if the parties don’t settle first.

Pros for South Dakota

Jennifer Karpchuk, a state tax attorney at Chamberlain Hrdlicka in Philadelphia, told Bloomberg Tax that a settlement would lift the injunction that is currently prohibiting the state from enforcing its economic nexus law.

“While that would likely be the outcome if the case stayed with the state courts, it may be a more costly and drawn out process and the settlement could give South Dakota the ability to, if it so chooses, immediately begin implementing its law or, at least have a set date at which the state knows for certain it could begin implementing its collection requirements,” Karpchuk said in an email.

A number of states have already began enforcing their South Dakota-modeled laws since the ruling (Vermont, Hawaii, Kentucky, and Oklahoma started on July 1). Many more are eyeing Oct. 1, including the home state of Amazon.com, Inc.: Washington state.

In the groundbreaking June 21 ruling in South Dakota v. Wayfair, Inc., the U.S. Supreme Court tossed out Quill Corp. v. North Dakota, the high court’s disputed 1992 physical presence threshold for when states could tax remote sales, and suggested strongly that South Dakota’s law would pass constitutional muster. The statute imposes a tax collection threshold at 200 transactions or $100,000 in in-state sales. But the court stopped short of formally validating South Dakota’s law, which dozens of states have mimicked already, in the absence of Quill.

That means the South Dakota Supreme Court still has to bless the state’s economic nexus model before it can become effective.

Steven Wlodychak, a principal with Ernst & Young LLP’s indirect tax practice, agreed that a settlement would expedite South Dakota’s collection pursuit and save the state money.

“The state has limited resources, and there’s no real reason to keep spending money on lawyers fees outside of the state’s attorney general,” Wlodychak said. “I’m 90 percent certain that this case will end in a settlement.”

Jamie Yesnowitz, a principal and state and local tax practice and national tax office leader at Grant Thornton LLP, told Bloomberg Tax that a settlement could offer the parties a chance to work together.

“Settling might provide the parties an opportunity to work together moving forward to minimize the administrative burden in transitioning to a system in which remote sellers meeting the transactional or market threshold are required to collect and remit sales tax,” Yesnowitz said in an email.

A majority of the lawyers agreed that a settlement is a smart move for both parties, but the benefits to the companies may outmatch those of South Dakota.

Pros for E-Retailers

Karpchuk told Bloomberg Tax that a settlement would economically benefit the e-retailers and allow them a chance to negotiate terms.

“E-Retailers may gain a limited look-back period, or potentially no look-back period, and instead merely a requirement that they collect on a going forward basis. If there is a look-back period, it could be limited and they could receive a waiver of interest and penalties, or any combination of that,” she said.

Wlodychak called a settlement the best thing for e-retailers, vendors, and George Isaacson—a senior partner at Brann & Isaacson LLP in Lewiston, Maine, who represented Wayfair, Inc., Newegg, Inc., and Overstock.com, Inc. before the high court in Wayfair.

Yesnowitz said a settlement would offer something to e-retailers and sellers that hasn’t yet existed: a level of certainty. Taxpayers would finally have a set date for when to begin collecting in South Dakota, if they surpass the state’s threshold.

Richard D. Pomp, the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law, told Bloomberg Tax that entering a settlement could “save face” for e-retailers, as the outcome would show that e-commerce companies are willing to broker and work with states.

Consequences for South Dakota

Still, Wlodychak said he has “no idea why South Dakota would settle.”

Namely: “a settlement wouldn’t provide a resolution of whether or not South Dakota’s law is constitutional,” he said.

This would impact potential future litigation within South Dakota, but also in the many other state courts (and up the appellate chain) where five disputes are pending and more are expected. Lawsuits remain pending in Indiana, Ohio, Virginia (over a Massachusetts regulation), Tennessee, and Wyoming.

Further, if negotiations push South Dakota to delay its implementation date, the state could lose out on months of revenue, according to Karpchuk.

“One consequence for the state is that the agreement could limit the immediate enforceability of the law; deeming it to be active and enforceable as of a future date, Oct. 1 or Jan. 1, 2019,” she said. “If that were the case, arguably no enforcement actions should be taken or penalties or interest charged in relation to activities prior to that date.”

Slim Consequences for E-Retailers

Karpchuk said that the most serious consequence for e-retailers is also the obvious one—that vendors hitting South Dakota’s threshold must now collect the tax going forward.

Overstock.com Inc. already has announced that it had “started the process to collect sales tax on purchases made by consumers from the more than 12,000 unique U.S. tax jurisdictions” after the high court ruling.

Regardless of the argument for or against a potential settlement, the details of the actual agreement likely will remain a mystery.

Jeffrey Friedman, a tax partner at Eversheds Sutherland (US) LLP in Washington, told Bloomberg Tax that many tax settlements are confidential.

Confidentiality a Boon?

And for e-retailers, a confidential settlement would boost Wayfair’s image, according to Pomp.

“A confidential settlement would preserve some leverage for Wayfair in dealing with other states,” he said.

The high court didn’t state that South Dakota’s law was constitutional, but strongly suggested it was. In the Wayfair opinion, Justice Kennedy suggested a state’s law could pass constitutional muster if:

  • the state installed a threshold that recognizes a “substantial nexus,”
  • the state didn’t push for retroactive back taxes, and
  • the state is a member of the Streamlined Sales and Use Tax Agreement, a program under which sellers collect tax voluntarily and remit it to the 24 state participants.

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