Challenge To Sales Tax “Physical Presence Test” To Be Heard By The Supreme Court

The Supreme Court has agreed to hear a case that stands to change sales tax collection and remittance laws for out-of-state and online retailers.

Rapid growth and an outdated law

In 1992, the U.S. Supreme Court ruled in Quill Corp. v. North Dakota that states may not collect sales tax from retailers that do not have a “nexus” (a physical presence) in the state. Physical presence varies from state to state, but usually involves the presence of property, inventory, sales agents or other employees within or coming to the state for a particular business purpose.

As reasonable as this may have been during the era of mail order catalogs, the Supreme Court in 1992 could not have anticipated the impact that Quill would have on state tax revenue in the internet age. In the years since, the rapid growth of the E-commerce industry and inability of states to collect what otherwise would be billions of dollars in sales taxes has turned the Quill decision into major source of contention.

Following Justice Kennedy’s commentary in the 2015 Direct Marketing Association v. Brohl case (in which he referred to the physical presence rule as “a serious continuing injustice” that was “inflicting extreme harm and unfairness on states”), more than 20 states passed so-called “kill Quill” legislation for the express purpose of taking Quill back to the Supreme Court. South Dakota is the first to get there.

Wayfair and S.B. 106

South Dakota’s “kill Quill” law came in the form of Senate Bill 106 (effective date May 1, 2016), which imposes state sales taxes on any business with: (1) annual sales exceeding $100,000 or (2) 200 or more transactions in South Dakota. After the bill passed, the state filed a declaratory judgment action in the Sixth Judicial Circuit Court, seeking a court determination that would permit it to collect sales tax from remote sellers, including Wayfair Inc., an online home furnishings company.

The Circuit Court did not rule in the state’s favor and granted the sellers’ motion for summary judgement. The court invoked the Dormant Commerce Clause, which prohibits a state from passing laws that discriminate against interstate commerce, and stated that South Dakota could not impose sales taxes on Wayfair or any seller that does not have a physical presence in the state. The South Dakota Supreme Court affirmed the lower court’s decision.

The State appealed to the U.S. Supreme Court, and on January 12, 2018 the Supreme Court granted certiorari. In April 2018 it will hear arguments challenging the constitutionality of S.B. 106’s economic nexus for sales tax and whether Quill should remain controlling precedent for interstate sales. A ruling is expected by the end of the current term.

Impact of South Dakota v. Wayfair

If the Supreme Court rules in favor of South Dakota, this will pave the way for a replacement of physical presence rules with economic nexus standards throughout the country. Many states have already passed laws stating that economic nexus rules will take effect as soon as the Supreme Court overrules Quill – companies with extensive internet sales should therefore be prepared to implement compliance strategies for the collection and remittance of sales tax in multiple jurisdictions.