Last Tuesday the U.S. Supreme Court heard oral arguments in South Dakota v. Wayfair, Inc., billed as the most important case in decades concerning sales tax.
Going into Tuesday’s session, the prevailing mood was that the Court would rule in favor of the state; at issue was how much change to previous doctrine would the Court permit. Following the oral arguments, however, the scuttlebutt was much less sanguine as several Justices voiced their concerns about overturning decades of sales tax jurisprudence.
Join the Sovos team on Friday, April 28 as our Director of Regulatory Analysis, Chuck Maniace, takes a deep dive into what happened in the Wayfair oral arguments and where the Court may go from here.
How Did We Get Here?
The beating heart of Wayfair is the principle that states cannot impose legal duties and obligations on persons with whom the state does not have a substantial connection — a “nexus.” For decades, “physical presence” has been the standard for what constitutes nexus when it comes to from whom states can obligate sales tax collections.
The Supreme Court cemented physical presence as the standard in the 1992 case Quill v. North Dakota. However, things have changed since 1992, most notably the rise of the Internet and the eCommerce marketplace.
Because online sellers often don’t have physical presence in the purchaser’s state, the state couldn’t require the seller to collect sales tax (sales taxes are assessed in the state where the purchaser takes possession). This led to the perception that online sales were tax free, which in turn naturally led to charges of unfairness — why didn’t online sellers have to deal with the same tax obligation as small brick-and-mortar stores? Such charges have come to the foreground as eCommerce now constitutes nearly 10 percent of the total U.S. retail market, with states claiming tens of billions of dollars in missing sales tax revenue every year.
Courts are well aware times have changed. Two Supreme Court Justices, Anthony Kennedy and Neil Gorsuch, both commented in the last few years that the physical presence standard may have lost its usefulness in light of the modern eCommerce market (Justice Gorsuch was still on the 10th Circuit Court at the time of his remarks).
Then, in 2017, South Dakota passed a bill requiring all businesses, regardless of their physical presence, that make more than $100,000 in annual sales, or more than 200 yearly transactions, to the state to collect and remit sales tax. In its conception, the bill was a direct challenge to Quill, designed to be argued before the U.S. Supreme Court.
What Did the Oral Arguments Reveal?
For an hour last Tuesday, the nine Justices heard from attorneys representing Wayfair, South Dakota, and the U.S. Department of Justice who argued in support of South Dakota.
The prevailing sense from these arguments is that the Justices are overwhelmingly concerned with ensuring a fair outcome and protecting small businesses from an overbearing regulatory environment. However, it became clear that the driving question is, which small businesses should be protected, brick-and-mortar retailers or someone selling online from their garage?
Both South Dakota and Wayfair claimed to be champions of small businesses, arguing that if the Court ruled against them, there would be dire consequences. South Dakota asserted that it needs to protect its local brick-and-mortar establishments, who can’t compete against remote sellers who seemingly get an automatic discount by not charging sales tax.
Conversely, Wayfair argued that if online sellers had sales tax obligations everywhere they make sales, they’d be crushed by the cost of complying with sales tax regulations. There are nearly 12,000 different sales tax jurisdictions in the U.S., all with different rates and reporting requirements; for someone selling out of their garage, that’s an impossible burden to meet.
Even though there are several software services available to help remote sellers with nationwide sales tax compliance, including the overwhelming diversity of tax rates and product definitions, these services can get expensive. And even with such services, businesses would still need to deal with the often complicated and costly process of getting registered in every state they sell to. Past efforts to simplify state sales tax regulations, such as the Streamlined Sales Tax Project, have not had their intended results, especially as many of the largest states never signed up.
Justices seemed very responsive to both claims, repeatedly hinting that their decisions would hinge on finding an equitable result for small businesses, though the Justices seemed unsettled on whether to privilege small brick-and-mortar stores or small online sellers.
How Might The Court Rule?
The Court’s choice appears binary — either uphold South Dakota’s law and overturn decades of Quill doctrine, or rule against South Dakota and maintain the status quo. Each choice will have consequences and the potential to drastically affect the future of retail in the U.S.
The immediate consequence if the Court rules in favor of South Dakota is that South Dakota’s economic nexus bill will become valid law. However, there will follow a much wider effect, as other states then move to impose sales tax obligations on remote sellers.
If the Court overturns Quill, the question becomes, what standard replaces it? South Dakota’s bill seems mostly harmless — there’s a fairly high threshold of sales that a business needs to reach before it’s required to collect sales tax, and the bill specifically prohibits the state from forcing retroactive tax collection on sales made before the bill’s passage, an issue that sparked debate between some Justices and the litigants.
However, just because South Dakota crafted a reasonable law, doesn’t mean that other states necessarily would do the same. If economic presence becomes the nexus standard, what would stop a state form saying that a single sale created a sufficient connection. (Indeed, the Deputy U.S. Solicitor General argued this exact point, a position that was not met favorably by several Justices.) The risk, then, is that over turning Quill could potentially lead to a wild west scenario, where, without clear standards, states will do whatever they want.
For Justices keen to protect small online sellers from an overwhelming array of sales tax regulations, opening the floodgates like this is troublesome. Potentially, the Court could determine exactly how South Dakota’s specific law was acceptable, and create standards that other states would have to follow. But the Court is historically loath to establish specific thresholds.
Whether $100,000 in annual revenue is the appropriate threshold, or if instead $10,000 is acceptable, is a decision fraught with policy consequences, which the Court prefers Congress to make. If, instead, the Court comes up with more amorphous standards (requiring, say, a “reasonable” amount of annual revenue), that will just lead to years of more litigation of hammering out the details. Even more so, Congress is in a better situation to balance the interests of both brick-and-mortar and online small businesses.
It may end up being better, then, to maintain the status quo; if there really is a problem, then Congress, not the Court, should settle things.
That point was repeatedly made by several Justices. The physical presence standard has been in place for decades. Under the principle of stare decisis, the Court should honor past decisions, and only change the established order when conditions have substantially changed. If the political winds shift, laws can certain change tack, but the new direction should come from politicians — that is, Congress — not the courts.
Indeed, Justice Sonia Sotomayor noted, perhaps that Congress has not acted to change Quill signals that the physical presence standard is correct; were the Court to decide otherwise could be an improper assumption of legislative responsibility. Of course that would mean that South Dakota’s concerns (such as vast amounts of missing tax revenue and unfair competitive advantage for remote sellers) would remain unsettled.
This leads to a third possibility: the Court could remand the case for a full trial. Normally cases before the Supreme Court have an extensive trial history, with a complete record of facts determined by lower courts. In Wayfair, however, the details of the case were never litigated. Instead the lower courts noted that South Dakota’s law was invalid on its face under Quill; only if the Quill standard was invalidated could South Dakota have any chance of prevailing; and only the U.S. Supreme Court could rule whether Quill was still valid.
By telling lower courts to retry Wayfair and consider the South Dakota law, its effects and rationales, as if Quill weren’t a complete bar, the Supreme Court could end up with a more complete record on exactly how much tax revenue is being lost and actually how costly it would be for small online retailers to comply with nationwide sales tax obligations. In addition, remanding would mean postponing the Court’s decision by at least months, if not years, which would give Congress more time to act.
The Court’s decision likely won’t be published until June at the earliest. Until then, all we can do is read the tea leaves. It is a fool’s errand to predict how the Court will rule on anything. Still, from the oral arguments, it appears that the Justices are fairly split, with several arguing that sales tax doctrine needs to be updated, and an equal number instead claiming that overturning Quill will cause too much upset. Chief Justice John Roberts, though, seemed fairly torn from his questions; all appearances are that he will be the deciding vote.
If the Court rules for South Dakota, then a brave new world of sales tax regulation will open up as states move to collect revenue from online sellers. But, even if the Court upholds Quill, that won’t stop the wave of extended-nexus rules that states are passing, including Massachusetts’ recent “cookie” nexus law or the notice-and-reporting requirements first passed in Colorado, which numerous other states are adopting.
In this unsettled climate, eCommerce businesses need to ensure they stay on top of any new sales tax regulations that emerge. See how Taxify by Sovos can help your business by signing up for a free trial.