Supreme Court to hear South Dakota v. Wayfair: Has the twilight of Quill arrived?

By Kent DeBruin, J.D., LL.M., Grand Rapids, Mich., and Scott D. Smith, J.D., LL.M, Nashville, Tenn.

Editor: Kevin D. Anderson, CPA, J.D.
On Jan. 12, 2018, the Supreme Court of the United States agreed to hear South Dakota v. Wayfair, Inc., No. 17-494 (U.S. 1/12/18) (petition for writ of certiorari granted). South Dakota is challenging, and attempting to have overturned, the physical presence nexus standard for the collection of sales and use taxes. The physical presence standard was established by the Court in National Bellas Hess, Inc. v. Illinois Dep't of Revenue, 386 U.S. 753 (1967). It was affirmed 25 years later in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court will decide whether the Quill physical presence standard should be overturned. This case should determine whether states can constitutionally require out-of-state retailers to charge and collect sales and use taxes from in-state consumers when the retailer has no physical presence within a state.
Evolution of nexus

Nexus has evolved over the years. Courts have struggled over the past century to create workable rules for nexus. In particular, the nexus standards for direct taxes and indirect taxes have diverged through the years.

Direct taxes, such as corporate income, gross receipts, and franchise taxes, are paid directly by the taxpayer to the government and are not shifted to others. Conversely, indirect taxes, such as excise or sales and use taxes, can be shifted or passed on to another person. But now, the Supreme Court could be on the brink of establishing similar nexus standards for both direct and indirect taxes. Since Geoffrey, Inc. v. South Carolina Tax Comm'n, 437 S.E.2d 13 (1993), a number of states have allowed economic nexus for income tax purposes.

Nexus, at its core, is the principle that determines when a business's activities are "sufficiently connected" to the state for that state to be able to impose its taxes on that business. National Bellas Hess was the first case that articulated the bright-line physical presence test for a state to be able to impose sales and use taxes on out-of-state retailers. In Bellas Hess, the Court ruled that Illinois's statute violated both the Due Process Clause and the Commerce Clause of the U.S. Constitution.

Twenty-five years later, in Quill, the Supreme Court overruled the first part of Bellas Hess, which required physical presence to meet the requirements of the Due Process Clause. The Court held that Quill Corp.'s mail-order solicitation of North Dakota customers, including the presence of "a few floppy diskettes" of ordering software, was enough to establish a "minimum connection," under the Due Process Clause. However, the Court affirmed the second part of Bellas Hess, requiring physical presence to meet the requirements of the Commerce Clause. Significantly though, a primary reason the majority upheld that requirement in Quill was due to stare decisis. In fact, the Court speculated that if Bellas Hess were being decided at that time, the outcome might not have been the same.

Moreover, Justice Antonin Scalia authored a concurring opinion that has been the Damocles' sword of sales-and-use-tax nexus since 1992. In his concurrence, which was joined by Justices Clarence Thomas and Anthony Kennedy, Scalia indicated that Quill should be upheld only because "the doctrine of stare decisis has 'special force' where 'Congress remains free to alter what we have done.'" Therefore, if the case of Bellas Hess had been first decided in 1992, the result may have differed.

The national economy has changed greatly since 1967. The United States used to be characterized by more brick-and-mortar-based stores that focused on the sale of tangible personal property. But businesses have evolved to more service-based, e-commerce-type industries in the last few decades. In Quill, by removing the Due Process Clause basis for a physical presence requirement, the Court opened the door for Congress to exercise its sole power to regulate interstate commerce and allow states to impose sales and use taxes when a taxpayer does not have a physical presence. However, to date, Congress has not acted.

Nonetheless, and perhaps because of congressional inaction, states have been attempting to overturn Quill by statutes or regulations with increased frequency in recent years. From affiliate nexus to "clickthrough" nexus, and now to economic nexus and other measures, states have pushed the physical presence nexus envelope to the edge and now are directly confronting the Quill precedent. For example, Ohio, Rhode Island, and Massachusetts are attempting to impose nexus on businesses if they place browser "cookies" on their customer's computers ("cookie" nexus) because they consider that to be physical presence.

Another measure is the enactment of use tax notification (to customers) and reporting requirements. For example, Colorado enacted a use tax notification and reporting statute for out-of-state vendors that have no physical presence with Colorado but that sell to Colorado residents. Colorado's statute requires sellers to notify Colorado consumers of their use tax obligation and to report sales to the Department of Revenue. In its 2016 decision in Direct Marketing Ass'n v. Brohl, 814 F.3d 1129 (10th Cir. 2016), cert. denied, 137 S. Ct. 591 (2016) (Brohl II), the Tenth Circuit upheld Colorado's statute. A number of other states have since enacted similar statutes.

Some states, including South Dakota, have gone one step further by enacting economic nexus statutes (or regulations) that impose a sales-and-use-tax collection obligation on out-of-state sellers that have a minimal threshold of sales or number of sales transactions in the state. It is South Dakota's economic nexus for sales-and-use-tax collection that is at issue in South Dakota v. Wayfair, Inc.

Direct Marketing Ass'n v. Brohl, 135 S. Ct. 1124 (2015) (Brohl I), in addition to Quill, is significant with regard to the Court's consideration of Wayfair. Notably, in his concurring opinion in the Court's Brohl I decision (addressing whether a challenge to Colorado's use tax notice and reporting statute in federal court was barred by the Tax Injunction Act), Kennedy stated that it could be time to reconsider the holding in Quill, given changes in the national economy and technology since Quill was decided in 1992.

Kennedy is a strong supporter of the dormant Commerce Clause. If the Commerce Clause is the "sword" that gives Congress the power to regulate interstate commerce, then the dormant Commerce Clause is the "shield" that prevents a state from discriminating against or burdening interstate commerce. According to Kennedy, the time is ripe to determine whether the first prong of the four-prong test set forth in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), requires physical presence to have "substantial nexus" to withstand a Commerce Clause challenge. That prong requires that the tax be applied to an activity with a substantial nexus with the taxing state.

Additionally, Justice Neil Gorsuch, when he was still a judge with the Tenth Circuit, authored a concurring opinion in that court's 2016 Brohl II decision. While Gorsuch opined that Quill may have reached the end of its useful life, he stated that, under the doctrine of stare decisis,the precedent of Quill could not be overturned by the Tenth Circuit. Further, it is reported that Gorsuch is skeptical of the dormant Commerce Clause limitation on state taxes, of which substantial nexus is a part. As a result, there could be some "wild cards" in how the Court will address Wayfair, and it is impossible to predict how it may ultimately decide the case. However, it is reasonable to conclude that the Court would not have taken a case challenging a now 26-year-old precedent if some justices did not intend to overturn that precedent in some manner.

Thomas (like his former colleague, Scalia, who claimed the dormant Commerce Clause was a "judicial fraud") does not believe in the legitimacy of the dormant Commerce Clause (see Maryland v. Wynne, 135 S. Ct. 1787 (2015) (Scalia, J., dissenting)). He may agree that the South Dakota statute should be upheld, not because physical presence is outdated, but because, as long as the South Dakota statute does not discriminate against interstate commerce, it should withstand Commerce Clause scrutiny.

History of South Dakota S.B. 106 and Wayfair

South Dakota enacted S.B. 106 on March 22, 2016. The effective date of the legislation is stayed, pending the resolution of the Wayfair case. Under S.B. 106, a remote seller is required to collect and remit sales tax if (1) South Dakota sales exceed $100,000, or (2) the seller has more than 200 separate sales transactions into South Dakota.

In addition to the economic nexus thresholds, S.B. 106 provided for an expedited appeals process. Shortly after enactment, South Dakota filed a declaratory judgment action against remote sellers in South Dakota. The trial court quickly disposed of the case by granting summary judgment in favor of the sellers, citing Quill as precedent. The case was then appealed to the South Dakota Supreme Court. The South Dakota Supreme Court also ruled in favor of the sellers, again noting that Quill remains controlling and, as a lower court, it could not overturn the U.S. Supreme Court's precedent (South Dakota v. Wayfair Inc., 901 N.W.2d 754 (S.D. 2017), aff'g No. 32CIV16-000092 (S.D. Cir. Ct. 3/6/17)).

On Oct. 2, 2017, South Dakota then filed a petition for a writ of certiorari with the Supreme Court. On Jan. 12, 2018, the Court granted South Dakota's petition. Oral arguments were scheduled for April 17, 2018, and an opinion is likely to be issued by the end of June. (For coverage of the oral arguments, see "Supreme Court Hears Oral Arguments in Sales Tax Nexus Case.")

The road ahead

Online retailers should closely monitor the case, especially if they sell to consumers in states that have enacted economic nexus statutes for sales-and-use-tax collection. If the Court overturns Quill, it is likely that more states will be encouraged to enact similar economic nexus legislation. It is also conceivable that the Court's ultimate decision could take alternative directions.

For example, the Court could uphold Quill and send the message to the states that Brohl II is their "road map" for enforcing sales-and-use-tax compliance. Alternatively, the Court could overturn Quill, but remand Wayfair to the South Dakota Supreme Court for proceedings consistent withthe Court's decision, while leaving it up to state courts to decide which economic nexus thresholds pass constitutional muster. It is uncertain what a decision in Wayfair, whether for or against South Dakota, could mean for the prospects of federal legislation that remains pending in Congress.

Stare decisis is a delicate principle that can produce strange results. The Court upheld the physical presence requirement for the Commerce Clause in Quill simply because that is how the Court ruled back in 1967, even though the justices acknowledged the result may have been different if that had been the first time they encountered the issue. In this case, though, it is likely that the Court will overturn the physical presence requirement for the Commerce Clause. The writing has been on the wall for the last 25 years.

If the Court overturns Quill, the question will become what level of sales constitutes "substantial nexus." Will the Court create a bright-line rule and hold that the $100,000 limit is substantial nexus? Or will it remand the case to the South Dakota Supreme Court to have it determine whether the statute violates the first prong of the Complete Auto four-part test? And if the Court does accept that $100,000 is substantial nexus, what does that mean for states that have enacted lower economic thresholds? Will their statutes be challenged? Thus, even though this case may solve the argument of whether physical presence is required, it is still the beginning of a long and chaotic process to determine what is "substantial nexus."


Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Washington.

For additional information about these items, contact Mr. Anderson at 202-644-5413 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.

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