Before it issued its Wayfair decision, the Court had established the physical presence standard in several landmark state tax cases. In 1967, the Court decided National Bellas Hess v. Department of Revenue of Ill.,3 in which it held that both the Due Process Clause and the Commerce Clause prevented the state of Illinois from requiring a mail-order seller of tangible personal property to collect and remit sales tax on purchases made by customers in Illinois when the seller did not have a physical presence in the state. The Court noted it "has never held that a State may impose the duty of use tax collection and payment upon a seller whose only connection with customers in the State is by common carrier or the United States mail."4
The Court again encountered the topic of state taxation in 1977, when it issued a decision in Complete Auto Transit, Inc. v. Brady.5 In this case, the Court had to decide whether Mississippi's privilege tax could be imposed on a Michigan company that transported cars for General Motors to car dealerships in Mississippi via motor carrier. The Court ruled in favor of the state, holding that the imposition of the privilege tax did not violate the Commerce Clause, and noted that "the Court has rejected the proposition that interstate commerce is immune from state taxation."6 The Court enunciated four criteria that a tax must meet to survive a Commerce Clause challenge:
[T]he tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state.7
In 1992, the Court's holding in Bellas Hess was challenged in Quill Corp. v. North Dakota. Quill Corp., incorporated in Delaware with offices and warehouses in California, Georgia, and Illinois, sold office equipment and supplies through catalogs, flyers, advertisements in national periodicals, and telephone calls. The company fulfilled orders using common carriers. In 1987, the North Dakota Office of State Tax Commissioner sent a notice to Quill Corp. informing the company that purchases made by North Dakota residents through Quill's catalog were subject to tax and that Quill had an obligation to collect and remit tax on behalf of its customers. Quill challenged the notice, and the case ultimately went to the Supreme Court.
In its decision, the Court carefully analyzed the Commerce Clause and found that the "substantial nexus" requirement enunciated in Complete Auto necessitates a physical presence to be satisfied. Somewhat ironically, considering the recent Wayfair decision, the Court noted that "the continuing value of a bright line rule in this area and the doctrine and principles of stare decisis indicate that the Bellas Hess rule remains good law."8 The Court also found that different standards exist for the Due Process and Commerce Clause requirements. Specifically, a physical presence standard was not required under the Due Process Clause, but it was under the Commerce Clause.9Evolution of and challenges to Quill
While the Court may have affirmed the physical presence "bright line rule" in Quill, the Court also made it known that the "underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve."10 However, Congress never enacted legislation governing the imposition of state sales and use taxes. As such, Quill was the law of the land until June 21, 2018.
That is not to say that the physical presence requirement has not been tested or its boundaries stretched in the intervening years. The rapid expansion of the digital economy, coupled with the limitation on the power of states to impose sales tax under Quill and the low level of consumer compliance with use tax laws, has resulted in the loss of billions of dollars of revenue to the states, though opinions differ on the extent of those losses. Consequently, in recent years states have developed a number of laws that have expanded what constitutes physical presence.
In 2008, New York enacted click-through nexus legislation that requires out-of-state internet retailers to collect and remit state sales tax on tangible personal property or taxable services sold through links on websites owned by in-state residents, referred to as "affiliates."11 The law applied a threshold requirement of at least $10,000 in gross receipts from referred sales. Since 2008, approximately 22 additional states have enacted similar legislation or issued guidance interpreting current state laws to allow comparable treatment.
In 2010, Colorado took a different approach to taxing out-of-state sellers and enacted controlled group nexus. Under this law, out-of-state sellers must collect Colorado tax if they are part of a "controlled group," defined by reference to the Internal Revenue Code, that has a "component member" that is a retailer with a physical presence in the state.12 The statute permits the nexus presumption to be rebutted under certain conditions. Since Colorado enacted its law, over 20 states have enacted some form of controlled-group nexus.
Massachusetts took a different position than other states on how to require sales tax collection from internet sellers. The commonwealth, through issuance of Directive 17-1, stated that it was adopting an administrative bright-line rule for internet vendors based on a dollar and transaction threshold, as long as they had physical presence in the state. While at first blush the interpretation seems similar to other economic nexus standards, Directive 17-1 went on to explain that physical presence is invariably satisfied for internet vendors by the presence of in-state internet "cookies" (which identify the user) or content delivery networks such as in-state computer servers. The directive was immediately challenged on procedural grounds and withdrawn, but new regulations were issued on Sept. 22, 2017, that provide substantially the same requirements.13
Marketplace provider nexus
Yet another strategy to increase sales tax collection has been to enact "marketplace provider" provisions.14 The provisions generally require marketplace providers to either (1) collect or remit on behalf of their sellers, or (2) comply with certain notice and reporting requirements.15
While several states saw the expanded nexus provisions described above as the path forward, other states made note of Justice Anthony Kennedy's concurrence in Direct Marketing Association v. Brohl.16 In March 2016, in direct opposition to the holding in Quill, South Dakota enacted a law that required out-of-state sellers to collect and remit sales tax based on economic nexus, not on physical presence.17 The law requires a remote seller with no physical location in South Dakota to collect and remit sales tax on transactions with South Dakota customers if the remote seller, in the previous calendar year or the current calendar year, has either sales of over $100,000 a year or 200 separate transactions with South Dakota customers.18 The law contains additional provisions, one of which enabled the state to bring a declaratory judgment action "against any person the state believes meets the criteria of section 1 of this Act to establish that the obligation to remit sales tax is applicable and valid under state and federal law." Another provision of the law states that "[t]he filing of the declaratory judgment action established in this Act by the state operates as an injunction during the pendency of the action."19
South Dakota was not alone in challenging Quill. Several states followed South Dakota's lead and enacted similar bills with the hope of having the Supreme Court revisit and, ultimately, overturn, the physical presence requirement for sales-and-use-tax collection inQuill.Notice and reporting
In addition to states' expanding the definition of physical presence, in 2010 Colorado enacted the nation's first use tax notice and reporting requirement for out-of-state sellers. The law was enacted in 2010, but an immediate challenge by the Direct Marketing Association resulted in the law not being implemented until July 2017. The law requires out-of-state sellers that do not collect sales tax on sales made to customers within Colorado and that have gross receipts in excess of $100,000 during the previous calendar year to report information about Colorado customers to the Colorado Department of Revenue.20 Several states have followed Colorado's lead, enacting similar notice and reporting requirements in an effort to increase use tax compliance by individuals.
Many have argued that these notice and reporting requirements are more onerous and costly than collecting the sales tax, but the ultimate failure of the challenge brought by the Direct Marketing Association meant that these requirements were here to stay — at least until the states had better options available. Perhaps forebodingly, Kennedy noted in his concurring opinion on the Direct Marketing challenge that "it is unwise to delay any longer a reconsideration of the Court's holding in Quill."21 It remains to be seen how the notice and reporting provisions will be employed after the Wayfair holding.South Dakota v. Wayfair
Shortly after South Dakota enacted its economic presence law, the South Dakota Department of Revenue began issuing written notices to sellers it believed met the threshold. The notices informed the sellers about the law, explained its requirements, advised the sellers to register for South Dakota sales tax, and warned that the failure to register could result in a declaratory judgment action as authorized by the law.22 The state then sued four of the sellers that failed to comply with the notices, Wayfair, Newegg, Overstock.com, and Systemax, seeking a declaratory judgment affirming the legality of the state's law. Three of the sellers that were sued chose to proceed with the suit, while Systemax was dropped after agreeing to register for a sales tax license and immediately begin collecting and remitting sales tax as required under the law. The state's trial court and South Dakota Supreme Court reached the same result, ruling for the sellers, as "Quill remains the controlling precedent on the issue of Commerce Clause limitations on interstate collection of sales and use taxes."23
After exhausting all options at the state court level, South Dakota petitioned the Supreme Court to grant certiorari in the case, hoping the Court would take the opportunity to reconsider Quill's physical presence requirement. The State listed three main reasons it believed the Court should grant review: (1) The Quill decision is unusually and increasingly harmful given the rapid expansion of the digital economy; (2) Quill was decided incorrectly and should not be reinforced through the doctrine of stare decisis; and (3) the issue itself cannot wait any longer.24
The Court granted review on Jan. 12, 2018, and many parties, including over 40 states, filed amicus briefs. Oral arguments were held on April 17, 2018, during which both sides were tested thoroughly. Justice Sonia Sotomayor, when asking S.D. Attorney General Marty Jackley what the minimum number of sales would be for requiring collection and remission of sales tax, stated, "I know what [South Dakota's minimum] was set at. It still doesn't answer the question. What's the minimum everywhere else?," to which Jackley replied, "[t]he minimum would be one sale."25
It is probably fair to say that the oral arguments did not reveal a significant inclination one way or the other. This notion would be borne out when the decision was released. On June 21, 2018, the Court released its decision in Wayfair, overruling Quill with a slim 5-4 majority. Kennedy, who, as noted, had previously called for revisiting the decision in Quill, delivered the opinion of the Court. While noting that the Court's Commerce Clause doctrine has evolved over time, Kennedy referred to the framework established in Complete Auto as "the now-accepted framework for state taxation."26 Kennedy wrote that the decision in Quill was flawed for three fundamental reasons:
First, the physical presence rule is not a necessary interpretation of the requirement that a state tax must be "applied to an activity with a substantial nexus with the taxing State." Second, Quill creates rather than resolves market distortions. And third, Quill imposes the sort of arbitrary, formalistic distinction that the Court's modern Commerce Clause precedents disavow.27
Further, while discussing how Quill was incorrectly decided at the time, a decision for which he wrote a concurring opinion, Kennedy noted that the Due Process Clause "minimum contacts" requirement is closely related to the Commerce Clause nexus requirement, and that "Due Process and Commerce Clause standards may not be identical or coterminous, but there are significant parallels."28 If Kennedy's thinking on Quill's physical presence requirement was not clear before, he crystalized his view when stating, "[t]he physical presence rule as defined and enforced in Bellas Hess and Quill is not just a technical legal problem — it is an extraordinary imposition by the Judiciary on States' authority to collect taxes and perform critical public functions."29
The dissenting justices were led by Chief Justice John Roberts, echoing strongly the sentiment that the issue, at this point, should be left to Congress, noting that "[a]ny alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress."30 Further, Roberts thought the precedents established by the Court should be respected through the doctrine of stare decisis, stating:
This is neither the first, nor the second, but the third time this Court has been asked whether a State may obligate sellers with no physical presence within its borders to collect tax on sales to residents. Whatever salience the adage "third time's a charm" has in daily life, it is a poor guide to Supreme Court decisionmaking.31Implications of the Wayfair decision
The Court's decision in Wayfair will have lasting effects, with both immediate and long-term effects on companies, many of which will only reveal themselves in time.
States that enacted the "kill Quill" type of bills likely will quickly begin enforcing sales tax collection on remote sellers. While the Court noted that South Dakota's law does not allow for its economic nexus standard to be applied retroactively to remote sellers, other states may not follow South Dakota's restraint. If states retroactively require collection based on economic presence only, vendors could be liable for periods of uncollected taxes if their customers had not themselves remitted the use tax. (Gathering proof of that can be challenging in itself.) For these vendors, it is not feasible to go back and collect the taxes from customers.
For those states that do not currently have specific economic nexus provisions, the response may be to enact legislation mirroring South Dakota's bill. Some states may question whether newly enacted legislation is even needed if their statutes allow for entities to be considered to have nexus to the fullest extent allowed by the Constitution of the United States.
Another important consideration that will arise, likely sooner rather than later, is what minimum standards will allow a state to enforce collection and remittance requirements on remote vendors without discriminating against or creating an undue burden upon interstate commerce? When questioned in oral arguments, Jackley, South Dakota's attorney general, stated that one sale would be the minimum. However, setting the minimum standard at one transaction surely would be challenged. In the decision, the Court cited South Dakota's threshold as one of the features of its law designed to prevent discrimination against and undue burdens upon interstate commerce. Despite this, if the potential increase in tax revenue is as large as the states suggested in their briefs, then it may not be long until one or two states try to decrease their thresholds below the level of South Dakota's to bring in yet greater revenues.
As many companies grapple with the rapid expansion in their sales tax profile, these companies will be forced to learn the intricacies of each jurisdiction to be compliant. Though the Streamlined Sales and Use Tax Agreement sought to simplify sales tax laws across the states, the truth is that the complexity still exists as states differ in tax bases, definitions, and application. Companies will need to know what goods and services are taxable in which jurisdictions, how they are sourced, and which rates apply. This will not be an easy task.
Additionally, this decision potentially will have an impact in the income tax sphere, an area where economic nexus has been in play for a while. For companies that have relied on Quill as a standard to protect them from states' imposing income tax, the Wayfair decision will require companies to rethink their income tax filing positions.
Ultimately, while the Court may have put to bed Quill's physical presence standard, the decision in Wayfair brings forth many new questions, the answers to which will have lasting impact. From retroactivity to the minimum level of sales into a state, the Court may find itself confronted by more state tax cases in the near future.
Taxpayers are encouraged to discuss Wayfair's impact (including the lower South Dakota court's decision on remand when it is released) on their businesses with their tax advisers. Given the number of decisions to be made and processes to be implemented, taxpayers will need as much lead time as possible to become sales tax compliant.
1Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
2South Dakota v. Wayfair, Inc., No. 17-494 (U.S. 6/21/18), slip op. at 10.
3National Bellas Hess v. Department of Rev. of Ill.,386 U.S. 753 (1967).
4Id. at 758.
5Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).
6Id. at 288.
7Id. at 279.
8Quill, 504 U.S. at 317.
9Id. at 308, 317.
10Id. at 318.
11N.Y. Tax Law §1101(b)(8)(vi).
12Colo. Rev. Stat. §39-26-102(3)(b).
13830 Mass. Code Regs. 64H.1.7.
14A marketplace provider is defined in general as any person who facilitates a retail sale/sale by a retailer when the provider both (a) lists or advertises tangible personal property and services for sale in any forum, including a catalog or internet website, and (b) either directly or indirectly through agreements or arrangements with third parties, collects receipts from the customer and transmits those receipts to the marketplace seller.
15See, e.g., 72 Pa. Stat. §7213.1.
16Direct Marketing Ass'n v. Brohl, 135 S. Ct. 1124 (2015) (Kennedy, J., dissenting).
17See S.D. S.B. 106.
20See 39 Colo. Code Regs. §21-112(3.5).
21Direct Marketing Ass'n v. Brohl, 135 S. Ct. 1124 (2015) (Kennedy, J., dissenting at 1134-35).
22South Dakota v. Wayfair, Inc., 901 N.W.2d 754, 759 (2017).
23Id. at 761.
24South Dakota v. Wayfair Inc., No. 17-494, petition for writ of certiorari at 12 (10/2/17).
25South Dakota v. Wayfair Inc., No. 17-494, transcript of oral argument at 6 (4/17/18).
26South Dakota v. Wayfair, Inc., No. 17-494, slip op at 7.
27Id., slip op. at 10, quoting Complete Auto, 430 U.S. at 279.
28Id., slip op. at 11.
29Id., slip op. at 16.
30Id., dissenting op. at 1.
31Id., dissenting op. at 3.