In 1967’s Bellas Hess decision, the Supreme Court first held that in order for a state to require a remote seller to collect sales tax on its behalf, the remote seller must have physical presence in that state. Bellas Hess found that both due process and the dormant Commerce Clause required this physical presence.1
In 1992’s Quill decision, the Court was called upon to revisit the wisdom of the physical presence rule. While the Court decided to uphold Bellas Hess’ physical presence rule, it modified the reasoning: it held that only the dormant Commerce Clause, and not due process, requires a physical presence. This modification was not merely semantic. Congress has the power to modify judicial interpretations arising under the dormant Commerce Clause, but cannot deprive a person of their rights under the Due Process Clause. In essence, in Quill, the Court empowered Congress to decide whether physical presence would continue to be required for sales tax nexus.
Over the years, state taxing authorities became increasingly frustrated by Congress’ failure to act to set a standard for sales tax nexus amid growing online sales that were going untaxed. Eventually, the arguments raised by these taxing authorities caught Justice Anthony Kennedy’s attention. In a concurrence to the Court’s decision in Direct Marketing Association v. Brohl, Justice Kennedy stated that due to the rise of the Internet, “Quill now harms States to a degree far greater than could have been anticipated earlier.”2 Without mincing words, Justice Kennedy requested that someone present the Court with “an appropriate case . . . to reexamine Quill and Bellas Hess.”3
South Dakota responded to Justice Kennedy’s request. In 2016, South Dakota’s legislature enacted SB 106, which was designed as a vehicle to challenge Quill and Bellas Hess.4 This statute required a remote seller to collect sales tax on sales made to South Dakota purchasers if the seller’s annual gross revenue from sales to South Dakota purchasers exceeded $100,000 or, alternatively, if the seller made 200 or more separate transactions for delivery to South Dakota on an annual basis. SB 106 did not apply retroactively. South Dakota brought a declaratory judgment action in South Dakota state court under SB 106 against several remote sellers;5 this case ultimately ended up before the Supreme Court in Wayfair.
Justice Kennedy did not squander the opportunity provided by South Dakota: Justice Kennedy authored the Court’s majority opinion overruling Quill’s physical presence rule, joined by Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel Alito, and Neil Gorsuch.6
The Court’s opinion begins by describing the historical role of the Court in adjudicating Commerce Clause disputes—from Gibbons v. Ogden7 to Granhold v. Heald.8 The Court described its role as ensuring the “necessary balance between state and federal power.”9 On the one hand, Congress has broad authority to regulate interstate commerce. On the other hand, when Congress does not act, states can, in certain circumstances, regulate interstate commerce. Accordingly, “the power to regulate commerce in some circumstances [is] held by the States and Congress concurrently.”10
The Court’s historical discussion laid the foundation for overruling Quill. After explaining that the federal government and state governments share the power to regulate interstate commerce, the Court then pivoted to an analysis of its role in balancing state sovereignty and taxing power against the need for a national economy, free trade, and cross-border commerce. When Congress has not acted, a state can tax to the extent it does not violate the four-prongs of Complete Auto Transit v. Brady.11 The “prong” of Complete Auto at issue in Wayfair—and in National Bellas Hess and Quill—is the “substantial nexus” prong. Although states had the authority to regulate interstate commerce absent federal legislation, the Court adopted the physical presence rule as a limit on state power—at the time, the Court believed that the physical presence rule was integral to the existence of free trade and development of the national economy.
But in the Court’s view, times have changed since the decisions in National Bellas Hess and Quill, and with the rise of the Internet, the physical presence rule no longer fulfills its intended purpose. In fact, it now serves to limit states’ ability to raise revenue, a critical feature of state sovereignty. In essence, the Court’s physical presence rule was intended to protect interstate commerce, but now only serves to infringe on state taxing power. And according to the Court, “[i]f 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.”12 National Bellas Hess and Quill infringed on state taxing power and therefore must be overruled: “the Court concludes that the physical presence rule of Quill is unsound and incorrect. The Court’s decisions in Quill Corp. v. North Dakota . . . and National Bellas Hess, Inc. v. Department of Revenue of Ill. . . . should be, and now are, overruled.”13
In the final section of its decision, the Court concluded that “nexus is clearly sufficient based on both the economic and virtual contacts” that the remote sellers in this case had with South Dakota. The Court’s decision implied that South Dakota’s sales threshold for nexus and the size of the specific remote sellers in this case justified nexus, but the Court did not provide guidance on how this holding could be applied to other fact patterns. Additionally, the Court expressly declined to address “whether some other principle in the Court’s Commerce Clause doctrine” could present additional restrictions on a state’s ability to require a seller to collect tax.
Justice Clarence Thomas joined the Court’s opinion and concurred separately. Justice Thomas stated regret that he had joined the majority in Quill rather than overruling Bellas Hess at that time. He also restated his objection to the “Court’s entire negative Commerce Clause jurisprudence.”14
Justice Neil Gorsuch also joined the Court’s opinion and concurred separately. Justice Gorsuch argued that the physical presence rule constituted a “judicially created tax break.”15 Justice Gorsuch suggested that he disagreed with at least some aspects of the Court’s dormant Commerce Clause jurisprudence, and suggested that the Privileges and Immunities Clause may be a better source of law for constitutional restrictions on discriminatory state taxes.
Chief Justice John Roberts dissented in an opinion joined by Justices Stephen Breyer, Sonia Sotomayor, and Elena Kagan. Chief Justice Roberts conceded that Bellas Hess was incorrectly decided in the first instance, but stated that he would have affirmed on stare decisis grounds.
Possible state reactions
The decision is likely to prompt new action by state tax administrators and legislatures around the country. States that previously declined to adopt economic nexus provisions out of respect for Supreme Court precedent may swiftly change positions. For example:
- In North Carolina, an economic nexus bill was proposed last year but did not pass. Secretary Ron Penny said at the time that “that bill was one that our General Assembly felt passionate about, or at least some of the members did, because they want to position us to be ready to collect taxes once Quill is overturned.” We could see a new economic nexus bill in the Tar Heel State, as those that opposed the bill last year begin to support the effort.16
- Peter Franchot, the Comptroller of Maryland, told Reed Smith last month that he is “totally in favor of a Maryland sales tax on remote sellers.”17 At a meeting with taxpayer representatives on June 21, 2018, Samuel Buo, Assistant Director of Compliance, suggested that a working group would be established immediately to consider options in Maryland.
- Kevin Lyons, a spokesperson for the Texas Comptroller of Public Accounts, told Reed Smith hours after Wayfair was decided that the Comptroller’s office “welcome[s] the [C]ourt’s ruling in this case and [is] currently assessing any potential revenue impacts as a result of this decision, as well as whether any rule changes or legislation … might be required to achieve the benefits of the decision.”
The Court’s decision answers one important question, but many other questions still remain open. For instance:
- Will the Wayfair decision be applied retroactively?
- What is the dormant Commerce Clause nexus standard for sales tax collection after Wayfair?
- What other restrictions does the dormant Commerce Clause place on state and local sales tax collection obligations?
- What does Wayfair mean for taxpayers who previously had nexus with a state based on physical presence but only have limited contacts with the state?
- What limitations do the Court’s personal jurisdiction cases place on sales tax collection?
- How will state taxing authorities and state legislatures react to the Wayfair decision?
- How will lower courts interpret Wayfair?
- What can and will Congress do?