In a blow to online retailers, and welcome news to state tax authorities as well as brick and mortar retail stores, the US Supreme Court overturned nearly 50 years of precedent and ruled late last month in South Dakota v. Wayfair Inc., et al, No. 17-494 (2018) (“Wayfair”) that a state can impose sales tax on a transaction even when the seller does not have a physical presence in that state.
The Wayfair ruling overturned the Court’s rulings in two prior cases -- National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1968) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992), -- that held that a seller must have a physical presence in a state, such as a store, office, or warehouse, in order for that state to impose an obligation on the seller to collect sales tax on a sale to a customer in that state. As a result of the Quill decision, online and other remote retailers, such as catalog companies, were able to sell products to customers throughout the United States and collect sales tax only in those jurisdictions where they had a physical presence.
As online sales exploded, criticism of the Quill decision increased, led by state taxing authorities, who claimed substantial lost sales tax revenue, and by brick and mortar retailers, who claimed they were placed at a competitive disadvantage because the absence of a sales tax resulted in consumers paying less for a product purchased online or through a catalog. In fact, many online retailers expressly marketed this cost savings advantage as a reason for purchasing goods via the Internet, rather than at the local store. Over the years, several attempts were made to overturn Quill legislatively, but the proposed legislation never made much headway in Congress, leading states, such as South Dakota, to creatively draft language that would consider certain activity as constituting a physical presence.
Change in the law
The Wayfair case involved three large online retailers – Wayfair, Inc., Overstock.com, Inc. and Newegg, Inc. All were merchants without any employees or real estate in South Dakota who shipped products to customers in South Dakota without collecting sales tax. South Dakota law imposed an obligation to collect sales tax on all sellers, whether or not they had a physical presence in the state, if the sellers conducted more than 200 transactions a year in South Dakota or had more than $100,000 in annual sales to customers in South Dakota.
The Supreme Court, in a 5-4 decision, held that the physical presence rule of Quill is unsound and incorrect. The majority opinion, written by Justice Kennedy, states that each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the states. Thus, the Court should not maintain a rule that ignores substantial virtual connections to the state.
What does this mean for those retailers that sell products through the Internet, catalogs or other remote means?
The Wayfair ruling does not mean that every online or remote sale is now automatically subject to sales tax, since not all states impose sales tax on these types of sales. Additionally, the Wayfair decision still requires the seller to have a substantial nexus to the taxing state. The Supreme Court considered South Dakota’s modest threshold of $100,000 in annual sales or 200 transactions a year to have satisfied this nexus test. How minimal the nexus may be is still open to interpretation.
A number of states do impose sales tax on certain remote sales, but the requirements differ from state to state. However, the ruling does pave the way for those states to amend their laws. In fact, two states – Kentucky and Vermont – have already amended their sales tax laws, adopting the threshold limits employed by South Dakota.
For large online retailers, the Wayfair decision evens the retail playing field, at least from a cost perspective. They no longer can advertise consumer sales tax savings. But the ruling does not overcome the other issues facing brick and mortar retailers in their battle with online retailers, such as disparity in overhead costs and shopping convenience.
A bigger obstacle now faced by online retailers is compliance. All but a couple of states, as well as a countless number of local municipalities, impose some form of a sales tax. Knowing what sales tax to charge, what and when sales tax returns must be filed, and what requirements for remitting sales tax collections exist, can be a time-consuming matter, especially onerous for smaller retailers and those just beginning to sell products on the Internet. For many, the cost of compliance will be a significant expense. A number of tax programs are available to help retailers deal with their sales tax obligations. While we do not recommend any particular tax program, a listing of some of the numerous programs available can be found at www.capterra.com/sales-tax-software/