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07.09.2018 | Legal Advisory

South Dakota v. Wayfair, Inc., decided on June 21, 2018, required the Supreme Court to assess how its own precedent fit in the era of online commerce. Buyers and sellers in the United States are familiar with the sales tax imposed by most states. What they may be unfamiliar with is that, until the Wayfair decision, out-of-state sellers—those without a physical presence in the state—are not required to collect and remit sales tax to the states in which they conduct business. While states have the authority to compel in-state sellers to collect and remit sales tax, the longstanding Supreme Court decision Quill Corp. v. North Dakota proclaimed that states did not have that same authority with regard to out-of-state sellers. The Supreme Court addressed this discrepancy in Wayfair and paved the way for states to treat all sales similarly. The practical effects of this decision could alter the way small online retailers and start-ups target consumers.

Many states utilize a complementary system to collect the tax from retail transactions. The seller can collect a sales tax from the buyer at the time of purchase and then remit it to the state where the purchase was made. This method is the most reliable and the one that states can require in-state sellers to adopt. Yet Quill prevented states from compelling out-of-state sellers to adopt this method, even though they were conducting in-state sales. In these situations, states were reliant upon the in-state consumer paying a use tax, the alternative and less dependable method. It is not uncommon for consumers to avoid paying the use tax and, as a result, South Dakota allegedly lost between $48 and $58 million in annual revenue. In an attempt to recover these losses, South Dakota enacted a law requiring out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the state.”  This enactment prompted major online retailers who had no physical presence in South Dakota to challenge the law’s validity.

Under Quill, a seller had to have a physical presence in the state before that state could subject it to its tax jurisdiction. This physical presence requirement was an interpretation of the controlling test promulgated under Complete Auto Transit, Inc. v. Brady, which required the business to have a “substantial nexus” to the state. South Dakota conceded that its law failed Quill’s physical presence requirement and instead used the litigation as an opportunity to stress the importance of reversing Quill. The Supreme Court, in a 5-4 decision, was receptive to this plea and agreed that Quill gave out-of-state sellers an advantage to the detriment of in-state sellers and the states themselves. Specifically, the Court stated that Quill’s result was a “judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State’s consumers.” Justice Kennedy elaborated, “a business with one salesperson in each State must collect sales taxes in every jurisdiction in which goods are delivered; but a business with 500 salespersons in one central location and a website accessible in every State need not collect sales taxes on otherwise identical nationwide sales.” As a result, it was estimated that the physical presence requirement cost the states between $8 and $33 billion in annual revenue. The Court felt strongly enough about this implication to go against its own precedent and overrule Quill.

The Wayfair decision and underlying rationale indicate that only certain out-of-state sellers could be subjected to a state’s sales tax laws. While Quill is no more, the Complete Auto substantial nexus test lives on. Quill’s reversal means that “[p]hysical presence is not necessary to create a substantial nexus” but does not give states free reign to subject out-of-state sellers to its tax laws. As to what constitutes a substantial nexus, the best guidance now is that “large-scale, systematic, continuous solicitation and exploitation of [a foreign state’s] consumer market is a sufficient nexus.” South Dakota’s law, for example, applies only to sellers that deliver “more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State.” This volume can be used as a benchmark to establish a substantial nexus, which may shield smaller-scale operations from shouldering increased compliance costs.

Twenty-three states currently have legislation, or pending legislation, that must now be analyzed under Wayfair. It can be expected that more states will follow South Dakota’s lead, so out-of-state sellers should be aware of the tax laws of each state prior to making significant sales there.

This advisory was prepared by Nutter’s Tax Department. For more information, please contact Melissa Sampson McMorrow, or your Nutter attorney at 617.439.2000.

This advisory is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.