Appeals Court Upholds Colorado Use Tax Reporting Law

By James A. Beavers, J.D., LL.M., CPA, CGMA

The Tenth Circuit held that Colorado's sales and use tax notice and reporting law, designed to force noncollecting out-of-state retailers to report sales to Colorado customers and the state, does not violate the dormant Commerce Clause because it does not discriminate against or unduly burden interstate commerce.

The Facts

Colorado, like many other states with an unslakable thirst for tax revenue, was dissatisfied with its citizens' unwillingness to comply with its use tax laws and decided to try something new. In 2010, it passed a new notice and reporting law designed to dragoon retailers into its use tax enforcement efforts.

Colorado's notice and reporting law (Colo. Rev. Stat. §39-21-112.3.5) was designed to improve the collection of use taxes when out-of-state sellers with no physical presence in the state sell to customers located in Colorado. The law requires retailers selling to Colorado customers that do not collect sales tax on the sales to (1) send a "transactional notice" to purchasers informing them that they may be subject to Colorado use tax; (2) send an "annual purchase summary" to customers who purchase more than $500 worth of goods in a year, with dates, amounts, and categories and another reminder that they may be subject to use tax; and (3) file an annual customer information report with the Colorado Department of Revenue. The law exempts from the reporting requirement retailers that made less than $100,000 of gross sales to Colorado customers in the previous year and that reasonably expect to make less than that amount in the current year.

Quite expectedly, out-of-state retailers were not thrilled with the new law, which they thought was unreasonable, burdensome, and unconstitutional. Thus, the Direct Marketing Association (DMA), a group of businesses and organizations that market products via catalogs, advertisements, broadcast media, and the internet, challenged the law in federal court, arguing, among other things, that the law violated the dormant Commerce Clause because it discriminated against and imposed an undue burden on interstate commerce. In 2012, the district court permanently enjoined the law, finding it unconstitutional (Direct Marketing Ass'n v. Huber, No. 1:10-CV-01546-REB-CBS (D. Colo. 3/30/12)).

The Tenth Circuit then reversed that decision on the basis that the lower court lacked jurisdiction to decide the case because of the Tax Injunction Act (28 U.S.C. §1341), which requires that "district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State" (Direct Marketing Ass'n v. Brohl, 735 F.3d 904 (10th Cir. 2013)). That decision was appealed to the U.S. Supreme Court, which granted certiorari. The Court held that the law was not a tax and therefore could not be subject to the Tax Injunction Act (Direct Marketing Ass'n v. Brohl, 135 S. Ct. 1124 (2015) (Brohl II). The case was remanded to the Tenth Circuit for a decision on the substantive issues.

The Tenth Circuit's Decision

The Tenth Circuit held that Colorado's notice and reporting requirements law does not violate the dormant Commerce Clause because it does not discriminate against or unduly burden interstate commerce. The court broke the discussion of its decision into three parts: an overview of the dormant Commerce Clause doctrine; an analysis of the effect of the bright-line rule from Quill Corp. v. North Dakota, 504 U.S. 298 (1992); and a review of DMA's dormant Commerce Clause claims.

Overview of the dormant Commerce Clause: As the Tenth Circuit explained, the Constitution does not contain a provision called the "dormant Commerce Clause," rather it grants Congress the power to regulate commerce in the Commerce Clause. However, where Congress does not explicitly exercise its powers under the Commerce Clause, the Supreme Court has inferred a negative implication in the Commerce Clause that limits states' ability to regulate or interfere with interstate commerce. This is known as the dormant Commerce Clause.

The primary concern addressed in dormant Commerce Clause jurisprudence is state regulation of interstate commerce that is a form of economic protectionism. The Supreme Court has held that state regulation that discriminates against interstate commerce will generally not survive a constitutional challenge if the state cannot show a legitimate local purpose for the regulation that cannot be adequately served by reasonable nondiscriminatory alternatives. In addition, a court may invalidate nondiscriminatory laws when they impose an undue burden on interstate commerce. A special test for state taxes on interstate commerce was adopted in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), but the Tenth Circuit found that this did not apply to the Colorado notice and reporting law because, as it discussed later in its opinion, the law was not a tax.

Quill bright-line rule analysis: The DMA argued that the bright-line physical presence test in Quill, which requires a retailer's physical presence in a state for the state to require a retailer to collect sales and use tax for the state, applied to the notice and reporting law. The Tenth Circuit found that it did not. It noted that the Supreme Court, as discussed below, had not extended the Quill physical presence rule beyond tax collection and that the cases the DMA cited in support of its position "merely describe points of law in Quill and do not actually extend its holding to other contexts."

DMA's first argument—notice and reporting law is discriminatory: The DMA made two arguments that the notice and reporting law violated the dormant Commerce clause. The first of these was that the law discriminated against interstate commerce.

A law can discriminate against interstate commerce either on its face or in its direct effects. With regard to facial discrimination, the Tenth Circuit stated that the Supreme Court had only found a law to facially discriminate when the statutory language explicitly identified geographical distinctions between otherwise similarly situated taxpayers. The Tenth Circuit observed that, although the notice and reporting law's title specifically mentioned out-of-state retailers, the law actually applied to all retailers that do not collect sales tax, regardless of their location. Thus, it was not facially discriminatory.

With regard to discrimination in effects, the court stated that under Tenth Circuit precedent, the party claiming discrimination must show that the state law in question benefits local actors and burdens out-of-state actors, and the result must alter the competitive balance between in-state and out-of-state entities. DMA argued that any differential treatment between in-state and out-of-state entities would establish discrimination and that the notice and reporting law should be viewed in isolation in determining whether discrimination occurred.

The Tenth Circuit first found that not just any differential treatment, but only differential treatment that is detrimental to out-of-state economic interests, is discrimination. It also found that equal treatment requires that similarly situated parties be treated alike. It further found that whether discrimination occurred should be viewed in the broader context of the entire sales and use tax regulatory system, including both the sales and use tax collection laws and the notice and reporting law. The court determined that taking the whole regulatory system into account, the DMA had failed to prove that the notice and reporting law imposed a discriminatory burden on out-of-state retailers versus in-state retailers.

The court also analyzed whether the result would be the same if only the notice and reporting law were taken into account, and determined that it would be. The Colorado Department of Revenue argued that the law is not discriminatory because out-of-state retailers can either comply with the notice and reporting requirements or collect and remit taxes as in-state retailers do. The DMA contended that this argument failed because Quill protects out-of-state retailers from having to collect and remit taxes, making the Colorado law's only function to impose new notice and reporting responsibilities on out-of-state retailers that in-state retailers need not perform.

However, as the court had already decided, Quill did not apply to the notice and reporting law. In the absence of the application of Quill, the court found that the law did not affect the competitive balance between in-state and out-of-state entities and thus the DMA had failed to prove the law was discriminatory.

DMA's second argument—undue burden: Having determined that the notice and reporting law was not discriminatory, the Tenth Circuit was required to address whether, as the DMA claimed, the law imposed an undue burden on interstate commerce, i.e., whether the law protected a legitimate state interest and whether the burden the law placed on interstate commerce clearly exceeded the local benefits the law provided. Because the DMA relied exclusively on Quill to support its undue burden argument, the court's determination rested on the scope of Quill, so it was not required to inquire into whether the burdens the law imposed impermissibly exceeded the benefits it conferred.

The Tenth Circuit concluded that Quill did not apply based on its own decisions and, more importantly, on the Supreme Court's decision in Brohl II. In that case, the Court characterized Quill as being limited to the narrow context of sales and use tax collection and, describing notice and reporting requirements as preceding the steps of tax assessment and collection, had held that the notice and reporting law requirements were not a form of tax collection. The Tenth Circuit, having found that Quill did not apply, and unable to identify any good reason on its own to extend the bright-line rule of Quill to the notice and reporting law, concluded that the law did not impose an undue burden without performing any benefits-and-burdens analysis.


In the notice and reporting law, Colorado has come up with a costly and inefficient way to try to collect more use tax. Presumably, it will use the information collected to target out-of-state purchases of big-ticket items, and enjoy the side benefit that the law may strong-arm some out-of-state retailers into collecting sales tax to avoid the onerous reporting rules. However, the Tenth Circuit correctly holds that the reporting requirements, whatever they actually are intended to accomplish, are not taxes.

Many other states are likely as interested as Colorado in increasing tax revenue but face the same legal obstacle in the form of a decision rendered 24 years ago before the advent of online commerce.Unless Congress enacts (or possibly the Supreme Court decides on) new rules on when out-of-state retailers are required to collect sales taxes, it would be reasonable to expect those other states to follow Colorado's lead.

Direct Marketing Ass'n v. Brohl, No. 12-1175 (10th Cir. 2/22/16)   

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.