Disregarding 26 years of precedent barring states from taxing out-of-state sellers unless they had a “physical presence” within the state seeking to impose such an obligation, the United States Supreme Court on Thursday overturned its 1992 decision in Quill Corp. v. North Dakota, finding the rationale employed in Quill to be faulty and outdated. The case is South Dakota v. Wayfair, Inc., and was decided by a 5-4 vote.

The Court noted that while due process and commerce clause restrictions continue to exist on the authority of a state to impose sales and use taxes, the so-called “physical presence rule” gave an undue advantage to out-of-state sellers. With each passing year, that rule was becoming further removed from “economic reality” and resulted in significant revenue losses to the states. The Court was critical of Quill's results and noted that Quill “created rather than resolved market distortions” and found it to be a “judicially created tax shelter” for businesses that limit their physical presence in a state but sell their goods and services to the state's consumers, “something that has become easier and more prevalent as technology has advanced.” The Court also faulted Quill for the result of producing an artificial incentive, on the part of retailers, to avoid physical presence in multiple states, affecting economic development in a negative fashion.

Modern e-commerce, said the Court, “does not align analytically” with the test that relies on the sort of physical presence defined in Quill, and the Court should not maintain a rule that ignores substantial virtual connections to the state. Further, the Court was critical of the physical presence rule because it is an “extraordinary imposition by the judiciary on States' authority to collect taxes and perform critical public functions.” The Court noted that 41 states, two territories, and the District of Columbia have asked the Court to reject the Quill test.

Quill, according to the majority, had the result of basically allowing customers to evade a lawful tax and unfairly shifted an increased share of the taxes to those consumers who buy from competitors with a physical presence in the state. The Court noted that public confidence in the tax system also was a factor in its decision because public confidence would be diminished by a system which is perceived as creating “inequitable exceptions.”

While stare decisis (the legal doctrine that prior court opinions should generally be binding on future similar issues) remains an important component of the Court's jurisprudence, stare decisis, standing alone, was not sufficient to overcome the “internet revolution” which has made Quill's original result all the more egregious and harmful. The Quill Court lacked, in 1992, the “present realities of the interstate marketplace,” where the “internet's prevalence and power have changed the dynamics of the national economy.” Further, the expansion of e-commerce has also increased the revenue shortfall faced by the states seeking to collect their sales and use taxes, leading to drastic measures in many states.

The Supreme Court's about-face on the right of states to tax internet retailers will have long-standing impacts on both large and small internet retailers nationwide. We can expect to see many states and businesses adjust their current models to account for the Supreme Court's decision.