Sales and use tax nexus in a post-Wayfair world
Editor's note: Updated August 29, 2018
In its historic opinion in South Dakota v. Wayfair, Inc. et al.,1 a case challenging South Dakota's anti-Quill sales tax nexus law, the U.S. Supreme Court (Court) overturned the decades-old physical presence nexus standard2 required for a state or locality to impose sales or use tax collection upon a remote seller. This article discusses the Court's reasoning in overturning Quill and the potential sales and use tax implications for companies.
"Third time's a charm"
In a 5-4 decision3 written by Justice Anthony Kennedy, the Court overruled its 1967 decision in National Bellas Hess, Inc. and its 1992 decision in Quill,4 finding the physical presence rule promulgated under these decisions was "unsound and incorrect."5 The majority decision rested on three key reasons under the Court's modern commerce clause jurisprudence: 1) The application of a physical presence requirement in an increasingly digital marketplace is an "incorrect interpretation of the Commerce Clause,"6 2) Stare decisis cannot justify reliance on physical presence as it cannot provide a clear and applicable standard upon which retailers can rely, and 3) South Dakota's law does not violate substantial nexus requirements as the law applies to retailers that maintain a significant virtual presence in the state.7
The Commerce Clause doctrine in a digital economy
The Court criticized the Quill decision as flawed, finding not only that physical presence was an unnecessary interpretation of "substantial nexus,"8 but that the requirement deprives a "case-by-case analysis of purposes and effects"9 creating "market distortion."10 The Court noted that even the Quill court recognized that under Due Process physical presence was not required, but nevertheless established an unnecessary distinction between Due Process and Commerce Clause standards.11
The Court clarified that "Due Process and Commerce Clause standards may not be identical or coterminous, but there are significant parallels,"12 and found that under such standards, "[p]hysical presence is not necessary to create a substantial nexus."13 The Court further stated that a physical presence requirement for nexus puts retailers with an actual physical presence in the state at a disadvantage to solely online or remote retailers,14 and treats "economically identical actors differently, and for arbitrary reasons."15 Additionally, the Court found the physical presence requirement to be arbitrary and an impediment on a state's ability to collect lawful taxes by ignoring "substantial virtual connections to the [s]tate."16 Noting that its own Commerce Clause jurisprudence is "grounded in functional, marketplace dynamics,"17 the Court indicated that states should also take those "realities" in consideration for their state tax laws and courts should "not rely on anachronistic formalisms to invalidate it."18
Stare decisis should not promulgate an incorrect constitutional interpretation
The Court recognized the power of stare decisis, but acknowledged that it "is not an inexorable command,"19 providing numerous reasons to reverse Quill. The Court opined that when one of its decisions impedes a state's ability from lawfully exercising their sovereignty, "the Court should be vigilant in correcting the error."20 Acknowledging that, while Congress can act and overturn Quill with legislation, it was not Congress' duty "to address a false constitutional premise of this Court's own creation."21 The changing tide of our traditional economy to one moored in technology and the "present realities of the interstate marketplace"22 necessitates a more updated nexus requirement than provided in Quill.23 The antiquated physical presence rule cannot keep up with the evolved "dynamics of the national economy"24 spurred by the "internet's prevalence and power."25 Because of this, it has "increased the revenue shortfall faced by States seeking to collect their sales and use taxes."26 Further, stare decisis "accommodates only 'legitimate reliance interest[s]'."27 The expanse of the e-Commerce and virtual marketplace caused the physical presence standard to become unclear and inapplicable, thus "arguments for reliance based on [Quill's] clarity are misplaced."28
Virtual presence can be enough
Absent Quill's physical presence standard, a state taxing statute must not offend the principles of the Complete Auto test. The first requirement of Complete Auto requires that a tax "applies to an activity with a substantial nexus with the taxing State."29 While the Court found that something less than physical presence is enough, it did not propose what constitutes an appropriate constitutional minimum. The Court provided, however, that "such a nexus is established when the taxpayer [or collector] 'avails itself of the substantial privilege of carrying on business' in that jurisdiction."30 and that the remote sellers' "extensive virtual presence" met the substantial nexus requirement under Complete Auto.31
Other features of South Dakota's law potentially avoid discrimination and undue burden on interstate commerce
Turning from nexus to the other elements of the Commerce Clause test of the constitutionality of a state tax, the Court noted that the South Dakota law has "several features that appear designed to prevent discrimination against or undue burdens to interstate commerce."32
The law applies only to sellers that deliver more than $100,000 of goods or services or engage in 200 or more separate transactions in South Dakota.33
The injunction provided in the law "ensures that no obligation to remit the sales tax may be applied retroactively."34
South Dakota adopted the Streamlined Sales and Use Tax Agreement requiring certain standardization within the sales and use tax statutes "to reduce administrative and compliance costs" for remote sellers.35
The dissent -- Congress may be "better qualified" to resolve
In the dissent, Chief Justice John Roberts asserted that the Court should have "let Congress decide whether to depart from the physical-presence rule."36 The dissent called for the Court to rely on the "special force"37 of stare decisis in dormant Commerce Clause questions because "Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve"38 under its "plenary power to regulate commerce among the States."39 Congress, he noted, "may more directly consider the competing interests" and could draft legislation to "provide a nuanced answer to the troubling question whether any change will have retroactive effect."40
The focus turns to other states
Numerous states have enacted sales-based economic sales and use tax nexus laws or administrative rules in the last two years that provide similar thresholds or supposed protections as South Dakota. Many of these states generally enjoined enforcement (or delayed the effective date) pending the outcome of Wayfair or overturning of Quill. Additionally, states with broadly worded general nexus statutes (e.g., "to the extent permissible under the U.S. Constitution") or with broad definitions of "retailer" or "vendor" may issue regulatory guidance to assert similar sales-based nexus provisions consistent with the South Dakota framework. It is important to note that, while Wayfair concerned a statute with prospective application, potential retroactive application and enforcement to the effective date of other state's applicable statute remains uncertain. Many states have issued guidance informing retailers of future effective or enforcement dates for their sales and use tax obligations;41 however, a few states have remote seller statutes with effective and enforceable dates of July 1, 2018, or earlier.42
Minnesota has enacted two separate provisions encompassing remote sellers. Generally, Minnesota requires all sellers (including the retailers who do not maintain a physical presence in the state)43 to collect and remit sales tax to the extent "allowed by the United States Constitution,"44 with an exception for retailers who have less than $10,000 of Minnesota sales in the previous 12 consecutive months and only sell through marketplace providers. Minnesota also subjects "marketplace providers"46 to collection and remittance obligations for sales made into Minnesota through an internet marketplace.47 The state provides a "Small Seller Exception," meaning the collection obligation is applicable only to remote sellers who, if during the previous 12 consecutive months, had more than a) 100 retail sales shipped into Minnesota or b) has 10 or more retail sales into Minnesota totaling more than $100,000.48 The Wayfair decision made Minnesota remote seller laws effective,49 and the Minnesota Department of Revenue recently issued guidance instructing remote sellers to register and begin collecting and remitting Minnesota sales tax no later than Oct. 1, 2018.50
Another consideration is whether or how Congress may respond, e.g., to consider a small business exclusion, address retroactive application, and/or require certain simplifications before states can require remote sellers to collect and remit sales or use tax. The "Stop Taxing Our Potential of 2018"51 was introduced in the Senate in June 2018 and seeks to codify physical presence as the congressional requirement for state sales and use tax collection. The legislation has been referred to the Senate Committee on Finance, with no further movement at the time of publication.52
Additionally, at the time of publication, more than 10 states have notification statutes; these statutes often require remote sellers to not only provide in-state buyers with information about their use tax obligations, but also require reporting of the remote seller's in-state sales activity directly to the state. While there is no collection or remittance requirement for these notification statutes, many states impose substantial penalties upon remote sellers who do not comply.
Companies of all sizes are coming to terms with the impact of this landmark decision and the potential for expanded sales and use tax collection and remittance obligations. Because of the additional resources and information necessary to meet these potential compliance and reporting requirements, companies should analyze whether their current financial systems and any applicable sales and use tax reporting software are capable of complying with these additional obligations.
Companies are encouraged to consult with their indirect tax advisers to review the many technical and logistical considerations in light of Wayfair.
David L. Welliver is a member of Deloitte Tax LLP's Minneapolis indirect tax practice and a director on the MNCPA board. David has extensive experience working with companies on multistate indirect tax matters. You may reach him at email@example.com.
Sara Clear is an MNCPA member and a member of Deloitte Tax LLP's Minneapolis multistate tax practice. You may reach her at firstname.lastname@example.org.
This article contains general information only and Deloitte is not, by means of this article, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte shall not be responsible for any loss sustained by any person who relies on this article. Copyright 2018 Deloitte Development LLC. All rights reserved.
1 South Dakota v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. 2017), cert. granted (U.S. Jan. 12, 2018) (No. 17-494).
2 Quill Corp. v. North Dakota, 504 U.S. 298 (1992);
3 Justices Kennedy with Ginsburg, Alito, Gorsuch, with Justices Gorsuch and Thomas concurring, and Chief Justice Roberts with Justices Breyer, Sotomayor, and Kagan dissenting.
4 Quill Corp., 504 U.S. 298 (1992); National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U. S. 753 (1967), respectively.
5 South Dakota v. Wayfair, Inc., et al., 585 U.S. ___, *22 (2018).
6 Wayfair, Inc. 585 U.S. at 10.
7 Id. at 22-23.
8 Id. at 11-12.
9 Id. at 13.
10 Id. at 13-14
11 Id. at 10-11.
12 Id. at 11.
14 Id. at 12-13.
15 Id. at 13-14.
16 Id. at 14-17.
17 Id. at 14.
18 Id. at 14.
19 Id. at 17, citing Pearson v. Callahan, 555 U. S. 223, 233 (2009) (quoting State Oil Co. v. Khan, 522 U. S. 3, 20 (1997),
21 Id. at 18.
23 Id. at 18-19.
24 Id. at 18.
26 Id. at 19.
27 Id. at 20, citing United States v. Ross, 456 U. S. 798, 824 (1982).
29 Id. at *22, citing Complete Auto, 430 U. S., at 279.
30 Id. at *22, citing Polar Tankers, Inc. v. City of Valdez, 557 U. S. 1, 11 (2009).
31 Id. at 22-23.
32 Id. at 23.
33 Id. at 22-23.
34 Id. at 23.
36 Wayfair, Inc. 585 U.S. at dissent p. 8.
37 Id. at dissent, p. 3.
38 Id. at dissent, p. 3, quoting Quill Corp., 504 U. S., at 318.
39 Id. at dissent, p. 2, quoting Quill Corp., 504 U. S., at 305.
40 Id. at dissent, p. 7.
41 For example, see Alabama, Ala. Reg. 810-6-2-.90.3; Indiana, Ind. Code Ann. §6-2.5-2-1(c); Iowa, Iowa Code Ann. §423.14A(2-3); Kentucky, Ky. Rev. Stat. Ann. §139.340(2)(g); Maryland, Proposed Md. Regs. Code §03.06.01.33.
42 For example, see Arkansas, Ark. Code Ann. §26-53-102(21); Hawaii, Haw. Rev. Stat. §237-24(18); Maine, Me. Rev. Stat. Ann. tit. 36, § 1951-B(3); Massachusetts, 830 CMR 64H.1.7(3); Rhode Island, R.I. Gen. Laws § 44-18.2-3(A).
43 See Minn. Stat. § 297A.66, subds. 2, 3.
44 Minn. Stat. § 297A.66, subd. 3(b).
45 Minn. Stat. § 297A.66, subd. 2(b).
46 Minn. Stat. § 297A.66, subd. 1(c).
47 See H.F. 1, Art 3, Sec. 9-12, Laws 2017 which amended Minn. Stat. § 297A.66, subd. 4b and included a triggering effective date of the earlier of a U.S. Supreme Court decision overturning Quill or July 1, 2019.
48 Minn. Stat. § 297A.66, subd. 3(d).
49 Minn. Stat. § 297A.66, subd. 4b was effective
50 Minnesota Department of Revenue, News Release, July 25, 2018, http://www.revenue.state.mn.us/newsroom/Documents/20180725%20Wayfair%20Update.pdf.
51 115 S. 3180.