It was a precedent-setting ruling two years in the making, but in June the Supreme Court of the United States handed down its decision in Wayfair v. South Dakota—a ruling that will now allow states to charge sales tax for online purchases.
The Supreme Court’s decision in Wayfair reverses a longstanding precedent governing a states’ ability to collect sales tax for online purchases, changing the national standard on when an online business must collect and remit taxes under the states’ respective tax laws. Specifically, in Wayfair, the court decided that an out-of-state seller’s “physical presence” isn’t necessary for the state to compel an online retailer to collect and remit sales tax—reversing its 1992 decision in Quill Corp. v. North Dakota.
The ruling is extremely significant to all retailers. As many consumers shop online to avoid paying the additional cost sales tax adds to purchases, the Wayfair decision essentially levels the competitive playing field between brick-and-mortar shops and online-only businesses.
During a typical retail transaction, states will charge in-state retailers sales taxes on any goods and services those retailers sell within that state. The state then requires sellers to collect and remit the sales taxes to that state. However, when retailers fail to do that, the onus falls on the in-state customer to pay the taxes (referred to as a “use tax”) to the state themselves. However, the rate of consumers complying with this requirement has traditionally been very low—ultimately causing states to lose billions of dollars in taxes.
Historically, this model did not apply to retail businesses that operated entirely out of that particular state. If a retail business had no physical
presence—such as an office, warehouse or employees—within a given state, it was exempt from collecting and remitting sales taxes on any of its online sales in that state.
In 2016, South Dakota sought to challenge the present taxing standard and passed a legislative measure titled “An Act to provide for the collection of sales tax from certain remote sellers…and to declare an emergency.” The Act only applied to remote online sellers who deliver more than $100,000 worth of goods or services into the state each year or engage in 200 or more separate transactions to deliver goods or services into the state.
Taxes on Trial
The state then looked for large online retailers that had billions of dollars in revenues, no employees or real estate in South Dakota, did not collect and remit sales tax in the state, and regularly shipped goods to consumers within the state. Wayfair Inc., Overstock.com Inc. and Newegg Inc. all fit the bill—meeting the Act’s minimum revenue or transactions requirements. So, to test its new statute, the South Dakota Department of Revenue filed suit against the three online retailers for violating the Act.
The trial court granted summary judgment for Wayfair, Overstock and Newegg under the Quill physical presence test, and the Supreme Court affirmed that ruling—noting that Quill remained the controlling precedent on interstate collection and use taxes. But the Supreme Court agreed to re-examine the case under the Commerce Clause when an out-of-state seller can be required to collect and remit a sales tax for a consumer’s purchase of goods or services within the state
In making its ruling, the Supreme Court applied a test set forth in Complete Auto Transit, Inc. v. Brady. In that 1977 case, the court found that taxes should be collected and remitted if it “(1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides.”
The court ultimately ruled 5-4 in favor of South Dakota—setting forth a new and less restrictive standard for collecting and remitting sales tax. In its ruling, the Supreme Court noted that every year, “the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States.”
The court also noted that today’s economic realities aren’t in line with the sales tax standard developed a quarter of a century ago, when less than 2% of American households had access to the Internet. In contrast, last year, consumers spent $453 billion on retail purchases online—a substantial 16% increase over 2016. And e-commerce is continuing to grow significantly year over year.
The Supreme Court said that, as a result of e-commerce growth, states could expect to lose an estimated $8 billion to $33 billion annually if they are unable to collect sales taxes. The court also said that the requirement of a retailer to have a physical presence in a state is practically unworkable. For example, Massachusetts proposed a law, which defined physical presence to include mobile apps available for download by residents and cookies on the in-state residents’ web browsers.
Some retailers already charge consumer sales tax in states that require it to. But many major online retailers only charge the tax when selling its own inventory—not when its acting as a marketplace for third-party sellers. These retailers may need to re-evaluate this model under the Wayfair ruling. Small online-only retailers may also face additional challenges. This ruling means they will need to navigate states’ tax laws or engage software or services to ensure they are in full compliance.
Not surprisingly, states have long criticized the previous standard set in place in 1992 and it’s fair to say, they may be quick to take advantage of the new revenue stream. In fact, 12 states have already developed such laws in advance of the court’s decision.
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