Taxes and the internet are not two things typically lumped together. However, last week, the Supreme Court addressed those two issues in the case of South Dakota v. Wayfair, when it re-evaluated the question from a 1992 Supreme Court case as to whether state taxes must be collected if the seller isn’t physically located within the state. Twenty-six years ago, the Supreme Court ruled in Quill Corp. v. North Dakota that a state can’t require a business – without any physical presence in the state – to collect sales tax from residents of that state. Now, with the explosion of online business transactions across state lines, the Supreme Court has taken another look at that question, and it does not bode well for online companies.
Although the Court takes its time with analysis of the Due Process and Commerce Clause standards in order to give the necessary constitutional interpretation to its ruling, at the end of the day, Wayfair abrogates the previous “physical presence” rule on the basis that it gives out-of-state sellers an advantage. The Court expressed concern that Quill “is a judicially created tax shelter for businesses.” The Court explained that “[e]ach year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States.” This argument is bolstered by the argument of South Dakota, whose Department of Revenue estimated revenue losses at $48 to $58 million annually for unrecovered sales tax on goods sold by online retailers to South Dakota residents.
What the Court really did with Wayfair was hit Amazon and other online retailers right where it hurts – their pocketbooks. Unfortunately, that has significant other ramifications as well, many of which remain unresolved by this ruling. For example, the South Dakota law that was at issue in this decision only imposes state tax on “certain remote sellers” that either deliver more than $100,000 goods or services to South Dakota each year or engage in 200 or more separate transactions into South Dakota. But it remains unclear how this will apply, for example, to people who sell on Amazon or Etsy. Will they all be included under the “umbrella” of the larger company as the “remote seller,” in that they are using the Amazon or Etsy platform to sell products? Or will those independent third-party sellers be their own “remote seller” for purposes of this tax rule? It is entirely unclear how these businesses will be characterized.
The Court also disregards the administrative complexities of collecting taxes in literally thousands of different taxing jurisdictions. It figuratively waves its hand at this stated concern, noting that those costs of compliance, “especially in the modern economy with its Internet technology,” is “unrelated” to any potential burden on the retailer and the need to impose the taxation obligations. The complexity is a real problem. There are over 10,000 jurisdictions that levy sales taxes, with different rules not only in the rate imposed but also in the categories of goods that are taxed and, sometimes, the relevant date of purchase.[i] This decision will also lead to separate rules in each state as to whether the online reseller is taxed at all. The Court expressly acknowledges that this decision is designed to eliminate the perceived competitive advantage that remote sellers have by being able to offer lower prices.
Oddly enough, the Court also relies on the idea that “[m]odern e-commerce does not align analytically” with the Quill “physical presence” test, premised on the theory that a website accessible in South Dakota “may be said to have a physical presence in the State” due to the existence of cookies left on the South Dakota resident’s computer after visiting that website. This reflects a tenuous understanding of how the internet actually works and indicates that future internet-based rulings from this Court may contain similar distortions of the process of ecommerce, and what actually constitutes a physical presence within any particular state.
The four dissenting judges recognize these problems, but their voices were not loud enough to shift the majority. Justice Roberts notes in his dissent that “E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule. Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.” For the long-term, it appears that this new ruling will dramatically impact how remote sellers can, and will, operate their business from a taxation perspective. While we can hope that new software will emerge to address the complexities of the collection, in the meantime it is up to the retailers to figure it out. It must also be presumed that without rulings from each state clarifying who is subject to the remote seller taxation rules, sellers should err on the side of caution and begin collecting taxes in those states which have enacted rules similar to South Dakota.
[i] One example given by the dissent of this absurdity is how Illinois categorizes Twix and Snickers bars, usually displayed side-by-side in the candy aisle, as food and candy, respectively (Twix have flour; Snickers don’t), and taxes them differently