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By Ryan Prete
In a post-Wayfair world, a state that disobeys the recommendations of U.S. Supreme Court Justice Anthony Kennedy could find itself in the crosshairs of future litigation, according to several state tax lawyers.
A pivotal section of the groundbreaking U.S. Supreme Court’s ruling in South Dakota v. Wayfair—which tossed out Quill Corp. v. North Dakota, the Supreme Court’s 1992 physical presence threshold for when states could tax remote sales—included suggestions that could strengthen the potential constitutionality of a state’s economic nexus model.
In the Wayfair opinion, Kennedy suggested a state’s law could pass constitutional muster if:
If states don’t follow these suggestions, they could be ripe for further lawsuits, according to Jennifer Karpchuk, a state tax attorney at Chamberlain Hrdlicka in Philadelphia.
“Wayfair was decided based upon the specific facts of that case—large online retailers with substantial economic presence in a state that was a member of the Streamlined Sales and Use Tax Agreement, and a statute that provided for minimum thresholds and explicitly stated non-retroactive application of the law. States that fall outside of that fact pattern are certainly opening themselves up for litigation,” Karpchuk told Bloomberg Tax.
In Wayfair, the court stopped short of formally declaring South Dakota’s law valid in the absence of Quill. A South Dakota circuit court still has to bless the state’s economic nexus model—unless a bill lifting the injunction blocking the state from enforcing its law passes during an upcoming special session, and the parties settle.
So which states are most vulnerable to further litigation?
South Dakota is the only state that currently aligns with all three of Kennedy’s suggestions, and therefore is the only state that receives a green light. Five states—Alabama, Connecticut, Massachusetts, Mississippi, and Pennsylvania—received a red light, meaning they could be the most vulnerable to future litigation. All other states received a yellow light, meaning they might need to use caution moving forward.
Nine of the 25 states with an economic nexus model aren’t members of the SSUTA.
Of the 25 states that have enacted an economic nexus model, only two—South Dakota and Maine—prohibit the state from applying retroactive back taxes. This doesn’t mean all other states are guaranteed to pursue retroactivity; it just means that all other states haven’t legally barred themselves from the activity.
South Dakota’s economic nexus threshold is 200 transactions or $100,000 in in-state sales. A state that enacts a threshold lower than South Dakota’s could potentially find itself in legal hot water. Some states have also enacted thresholds that exceed South Dakota’s, and 10 states have thresholds other than 200 transactions/$100,000 in in-state sales.
Karpchuk said that each of the three suggestions could be the most crucial depending on the taxpayer surveyed, but she shined a light on the SSUTA.
“Arguably the most important for the small online businesses is the third recommendation, SSUTA membership,” Karpchuk said. “There is no doubt that the companies most affected by the decision in Wayfair were not the “Wayfairs” of the world, but the small mom-and-pop online retailers. A state’s membership in SSUTA guarantees those small businesses some help and relief; namely simplification of the vast and varied states’ sales and use tax administration systems and free software to aid with compliance.”
Jamie Yesnowitz, a principal and state and local tax practice and national tax office leader at Grant Thornton LLP in Washington, told Bloomberg Tax that a state might feel confident in meeting two of the three Kennedy recommendations.
“To the extent that a state is not a Streamlined member, such state may decide that meeting the other two thresholds is enough if it has a relatively simple sales tax system, or can implement relatively simple solutions for the remote sellers that will be subject to the sales tax,” Yesnowitz said.
“Alternatively, a state lacking Streamlined membership could raise the economic nexus thresholds to a much higher level than the South Dakota standards as a means to minimize impact on small sellers, and claim that while it only meets two of the Kennedy conditions, it goes well beyond the economic nexus thresholds endorsed in Wayfair,” Yesnowitz said.
Over time, Karpchuk said she expects most states to follow the suggestions.
“I expect a majority of the states to align with these recommendations, and I expect others to continue to try to push the boundaries as they historically have,” she said.
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