Although the U.S. Supreme Court handed states a victory in South Dakota v. Wayfair Inc., experts warn that the ruling also shows they must tread cautiously in their remote sales tax compliance efforts.
The Court’s June 21 majority overturned the long-standing requirement that a seller must be physically present in a state to have “substantial nexus,” and further implied support for South Dakota’s law, which asserts sellers have such nexus when they make annual sales numbering over 200, or worth over $100,000, into the state.
Although the Court remanded the case to the South Dakota Supreme Court, some experts said they anticipate the law will be upheld, establishing South Dakota’s statute as a model for states seeking to enforce remote sales taxes post- Wayfair.
“My advice to a state would of course be to hew as closely as possible to South Dakota’s law,” in passing their own, said Darien Shanske of the University of California, Davis.
But as monumental as Wayfair is, it still leaves uncertainty that could be challenging for states that don’t want to simply replicate South Dakota’s rules, or don’t share some of that state’s particular circumstances.
“One of the problems here is we know now that a sales tax regime like South Dakota’s is constitutional” in its efforts to tax sales with no physical presence, “but we don’t know what would make one unconstitutional,” said Andrew Yates of Alston & Bird LLP. He said the ruling doesn’t specify what level of economic nexus is necessary for a remote sales tax compliance law to stand, and indicates excessive complexity and burden for retailers might be grounds for overturning a given statute.
The Wayfair ruling “is more of a safe harbor than a bright-line rule,” Yates said.
Christopher Lutz of Horwood Marcus & Berk Chtd. said that unless states “follow what South Dakota does to a tee,” there’s no guarantee they’ll be in the clear regarding legal challenges. Experts predict at least some states won’t simply copy South Dakota’s law, despite the protection it might provide, which will result in further litigation.
“I don’t think states are just going to abide by South Dakota’s model,” said Andrew Moylan of the National Taxpayers Union Foundation.
Commerce Clause Challenges
Wayfair provides some clues for how a taxpayer or seller could now construct — or a state could avoid — a challenge to remote sales tax laws. According to Shirley Sicilian of KPMG LLP’s Washington National Tax practice, “there’s still a dormant commerce clause, and there’s still an undue burden prohibition.”
Complicating the matter, according to Andrew Pincus of Mayer Brown, who authored an amicus brief on behalf of eBay Inc., is that a given law could represent a much higher burden for smaller entities than major businesses. Tax experts “don’t know how the undue burden test will apply to small companies,” Pincus said.
Experts said Wayfair’s positive analysis of features of South Dakota’s law and sales tax regime serves as a roadmap for what protections courts may look for in deciding whether to uphold or overturn states’ remote sales tax compliance laws. The majority praised South Dakota’s relatively uniform state and local rules and its membership in the Streamlined Sales and Use Tax Agreement, which the majority noted “provides sellers access to sales tax administration software paid for by the State” and indemnifies sellers if there’s a good-faith error in their tax compliance.
States would be well advised to emulate those accommodations and protections to avoid the risk of their remote sales tax laws being overturned as too burdensome.
For example, “say Colorado passes the exact same law” as South Dakota, “but it doesn’t simplify its tax system” or make accommodations similar to those of SSUTA states, Shanske said. Potentially, it could still be determined that the overall burden the state is putting on remote retailers violates the commerce clause. Rather than risk such an outcome in court, the state could mirror South Dakota, including joining the SSUTA — or, if unwilling or unable to do that, provide free software and protections for sellers.
Another policy states could adopt to protect their remote sales tax compliance laws is something like South Dakota’s small-seller exemption, which the majority opinion praised.
“Look for litigants to challenge state sales tax regimes that don’t have” those protections, said Daniel Hemel of the University of Chicago.
A key issue will be whether states apply laws retroactively and seek back taxes from sellers — a risky move, given that the justices’ praise of South Dakota’s avoidance of retroactivity in its law might cause courts to look unfavorably on states that seek back taxes on remote sales, observers said.
“The Court doesn’t say that you can’t [seek retroactive enforcement], but it observes that South Dakota does have that feature . . . and notes there would be challenges to the retroactive application” of sales tax collection obligations, Shanske said.
However, despite the implicit warning, some experts said some states may feel legally obligated to pursue retroactive enforcement, particularly if they enacted remote sales tax compliance laws before Wayfair. “It’d be an open question how the courts want to react to that,” said David Gamage of Indiana University Maurer School of Law.
Apart from considering features praised in the majority opinion, state lawmakers also need to broadly evaluate the burden imposed by their remote sales tax compliance laws. Notably, the opinion mentions the so-called “Pike balancing test” established by Pike v. Bruce Church Inc., which evaluates whether laws unduly burden commerce.
In addition to ensuring sales tax laws don’t burden remote sellers, another challenge for states is ensuring that the combined effect of their remote sales tax laws don’t create a logjam in the online economy. Experts said many states may wish to avoid intervention by Congress, but a chaotic rollout of various new state laws that combine into a larger compliance headache could hammer online sellers and spur federal legislation.
Opponents of online sales taxation are already calling for such action. In a June 21 press release, NetChoice President and CEO Steve DelBianco argued the Court “lacks the tools Congress has to protect interstate commerce and reduce regulatory complexity.”
“Congress should immediately address this situation by delivering a law that harmonizes the interests of consumers, small businesses, and state government,” DelBianco said.
Sicilian said states could consider coordinating on the legislation they pass to avoid federal intervention. “You’ve got the potential for 10,000 jurisdictions to reach out and require [remote retailers] to collect, and [if] they’ve all got different thresholds, etc., all different audit requirements, and so on,” it could be problematic, she said. “A little uniformity would go a long way there.”
“Congress could do it. [But] the states are probably going to want to do that as much as they can,” Sicilian said.
Shanske said federal lawmakers are unlikely to take quick action, but “it’s quite possible Congress will act if states don’t act responsibly” and if “there are a lot of horror stories — states going after small sellers demanding lots of back taxes” or laws that assert nexus is created by significantly lower sales thresholds than South Dakota’s.
Retroactive enforcement could also lead to calls for federal action.
“Some of the laws are [already] on the books” and could be applied to past transactions, said Alan Morrison, a George Washington University law professor and amici author for four Senate members. “But who is going to enforce them? . . . Do [states] really want to anger Congress and have them come in and create laws?”
Another post- Wayfair risk for states could be political. Legislators eager for higher sales tax revenue might find constituents unsupportive of policy changes that would effectively raise the price of out-of-state purchases.
In “states that don’t already have economic nexus statutes, there will be at least some legislators who view revising sales tax laws to take advantage of this as a tax increase,” Gamage said. “I don’t think it’s a foregone conclusion every state will take action even over the medium term.”
In most states, sales tax is technically paid by consumers. Nonetheless, compliance by buyers is virtually nonexistent, and many aren’t aware they owe the tax on remote purchases.
However, Carl Davis of the Institute on Taxation and Economic Policy said that with the growth of online retailing, and voluntary sales tax compliance by Amazon, political resistance by the public may be less now than in previous years. “I think the public has become used to having to pay sales tax on many of their online purchases,” he said.
Shanske also noted that South Dakota “is not a blue state,” and suggested that support for remote sales taxation — or at least acceptance — may be present “in even traditionally antitax states.”
Sellers on Notice
While Wayfair preserves potential challenges against states’ remote sales tax collection laws, remote vendors are the most immediately affected parties. The floodgates have opened, and Yates said sellers shouldn’t expect “any quarter” from states.
“I’m in Georgia, which has a remote sales tax law,” he said. “When I went on to Wayfair this morning, they were charging sales tax.”
Experts said sellers need to act quickly to figure out where they sell and what the sales tax laws in those states require.
“Remote sellers that have not had a physical presence in a state, and have not had to collect, should take a look and see how much sales are they making in those states,” Sicilian said. “Do they have a law that is triggered by Quill being overturned?”
Also, sellers need to determine how quickly they need to comply in a given state, whether they have the ability to comply, whether there are any exemptions that might affect their sales, and similar questions.
“Foreign retailers have to be especially careful,” said Steve Wlodychak of EY, highlighting the decision’s far reach. Although foreign sellers are often an afterthought in online sales tax discussions, “U.S. international tax treaties do not protect them from a state’s assertion of sales tax nexus,” creating another wrinkle, he said.
State Tax Today reporters Lauren Loricchio and Andrea Muse contributed to this article.