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Implications of the Supreme Court’s Historic Decision in Wayfair

Posted on July 9, 2018
William J. Kolarik II
William J. Kolarik II
Jaye Calhoun
Jaye Calhoun

Jaye Calhoun is a partner at the New Orleans office of Kean Miller LLP, and William J. Kolarik II is special counsel at the firm’s Baton Rouge, Louisiana, office.

In this viewpoint, the authors discuss the U.S. Supreme Court’s adoption of an undefined uniform substantial nexus standard in Wayfair, overturning Quill and fundamentally altering the state tax landscape.

On June 21 the U.S. Supreme Court issued its opinion in Wayfair.1 In addition to overturning the physical presence substantial nexus standard applicable to use tax collection requirements articulated by the Court in Quill 2 and Bellas Hess,3 the Court’s far-reaching opinion in Wayfair created an undefined sufficiency test for determining whether substantial nexus is satisfied under the dormant commerce clause. The new sufficiency test appears to apply to all state tax regimes — including income, franchise, sales and use, gross receipts, and property taxes — and may have substantial and significant implications for taxpayers and other parties subject to those regimes. The Court’s decision may also signal that it intends to provide significantly more deference to state tax regimes and may alter the relationship of states to the federal government and the relationship of states to each other. This article explores the questions raised by the Wayfair decision and potential ramifications of Wayfair for state and local taxation and, indirectly, our system of federalism.

I. The Wayfair Decision

A. Background and Procedural History

The issue in Wayfair was whether South Dakota could impose a use tax collection obligation on out-of-state companies4 with no in-state physical presence that sold taxable goods or services delivered into the state. South Dakota and many other states and localities impose tax on sales of tangible personal property and taxable services that occur in the taxing jurisdiction. In most states that impose a sales tax, the tax is imposed on the purchaser and collected and remitted by the seller as an agent of the state.

To prevent an in-state customer (that is, a taxpayer) from avoiding the sales tax by purchasing a good outside the state for use in the state, jurisdictions that impose sales taxes typically impose a complementary use tax on the purchaser’s use of the property in the state.5 However, states have historically struggled to enforce the use tax against individual purchasers.6 Thus, states have enacted various laws to impose a use tax collection obligation on sellers.7 Remote vendors with no in-state physical presence have challenged attempts to impose a use tax collection obligation on them. The law applicable before today, the Supreme Court’s decisions in Bellas Hess (1967) and later in Quill (1992), held that a state may not impose a use tax collection obligation on an out-of-state vendor unless that vendor had more than a de minimis in-state physical presence.

In 1977, between its decisions in Quill and Bellas Hess, the Court in Complete Auto 8 created a four-prong test to determine whether a state tax on interstate activity satisfied the dormant commerce clause. According to the Court, to withstand dormant commerce clause scrutiny, a state tax must apply to an activity with a substantial nexus with the taxing state, be fairly apportioned, not discriminate against interstate commerce, and be fairly related to the services provided by the state.9

With one exception, before Wayfair the Court never articulated a standard for what type of contacts satisfy the substantial nexus prong. In Quill the Court explored the substantial nexus requirement, differentiated that standard from the minimum contacts standard for the 14th Amendment due process clause (which a state tax must also satisfy), and held that substantial nexus required an out-of-state vendor to have more than a de minimis in-state physical presence before it could be subject to a use tax collection obligation.10

Since Quill was decided, the substantial increase in electronic commerce has changed how goods and services are provided. And states have been increasingly concerned about revenue they perceive to be lost because of their inability to enforce their use tax laws against their own residents. Also, merchants with in-state physical presence have been concerned about their ability to compete with out-of-state vendors that were not required to collect use tax on sales to in-state customers. As a result, for use tax purposes, states have enacted laws designed to circumvent the physical presence standard by broadening the definition of physical presence to include the presence of in-state affiliates or commission agents, cookies on an in-state customer’s computer, and similar items. In the context of other taxes, because the Court never articulated any substantial nexus standard, states have adopted increasingly aggressive standards for income, franchise, and property taxes, such as economic presence and factor presence standards for state income taxes, neither of which require an in-state physical presence.

In 2016 South Dakota enacted a law that directly challenged the Court’s decision in Quill, to force the Court to revisit the physical presence test in Quill and Bellas Hess.11 South Dakota’s law required an out-of-state seller to collect and remit use tax as if the seller had an in-state physical presence if the seller annually either delivered more than $100,000 of goods or services into the state or engaged in 200 or more transactions for the delivery of goods or services into the state.12 South Dakota’s law was tailored to foreclose the possibility of retroactive application and specifically provided that enforcement be stayed until its constitutionality was established.

Wayfair Inc., Overstock.com Inc., and Newegg Inc. (collectively, “remote sellers”), large online retailers with no physical presence in South Dakota but whose business volumes satisfied the minimum sales or transactions requirements of the law, refused to collect the tax. South Dakota filed a declaratory judgment action against them in state court. The remote sellers moved for summary judgment, arguing that the law was unconstitutional. The trial court agreed with the remote sellers and granted summary judgment in their favor. The South Dakota Supreme Court affirmed.

South Dakota petitioned the U.S. Supreme Court for certiorari, which the Court granted to reconsider the scope and validity of the physical presence rules mandated by Quill and Bellas Hess.

B. The Court’s Rejection of the Physical Presence Rule in Quill

Justice Anthony M. Kennedy delivered the opinion of the Court, writing for a majority that included justices Clarence Thomas, Ruth Bader Ginsburg, Samuel A. Alito Jr., and Neil M. Gorsuch.13 Chief Justice John G. Roberts Jr. filed a dissenting opinion in which justices Stephen G. Breyer, Sonia Sotomayor, and Elena Kagan joined.

The majority began by explaining the history of the Court’s dormant commence clause jurisprudence. And they concluded that modern precedents rest on two primary principles that mark the boundaries of a state authority to regulate interstate commerce. “First, State regulations may not discriminate against interstate commerce; and second, States may not impose undue burdens on interstate commerce.”14 A state law that discriminates against interstate commerce is per se invalid, but a state law that regulates evenhandedly to effectuate a legitimate local interest will be upheld unless the burden imposed on interstate commerce is clearly excessive in relation to the putative local benefits.15 According to the majority, those two principles guide the courts in all cases challenging state law under the commerce clause, including the validity of state taxes.

After articulating the guiding principles of the commerce clause analysis, the majority then explained the history of the Court’s state tax dormant commerce clause jurisprudence in Bellas Hess, Complete Auto, and Quill. They noted that three justices based their decision to uphold the physical presence standard for a use tax collection obligation in Quill on stare decisis alone. The majority then noted that economic changes had occurred since Quill and stated that the physical presence rule, both as first formulated and as applied today, was an incorrect interpretation of the commerce clause. The majority then explained why the physical presence rule was incorrect.

Quill is flawed on its own terms, the majority said, because (1) the physical presence rule was not a necessary interpretation of the substantial nexus requirement, (2) the rule creates rather than resolves market distortions, and (3) the rule imposes an arbitrary, formalistic distinction that modern commerce clause precedents disavow.

Regarding the first point, the majority explained that the question in Wayfair was whether a state may require a remote seller to collect and remit use tax and not whether the state has jurisdiction to tax the underlying sale of the good or service. According to the majority, the substantial nexus requirement is closely related to the 14th Amendment due process minimum contacts requirement, and it is well settled that a business need not have a physical presence to satisfy that requirement. Thus, according to the majority, even though the due process or commerce clause standards may not be identical or coterminous, when considering whether a state may levy a tax, there are significant parallels between the two standards. Therefore, according to the majority, the reasons given in Quill for rejecting the physical presence rule for due process purposes also apply to the question of whether physical presence is required to force an out-of-state seller to collect and remit use taxes. As a result, physical presence is not necessary to create substantial nexus.

The majority also rejected the idea that without the physical presence rule the administrative costs of complying with thousands of sales tax jurisdictions’ tax laws created an undue burden on interstate commerce. The majority rationalized this conclusion by noting that with the physical presence standard, a small company with a diverse physical presence still might face equal or higher burdens than a large remote seller. Thus, according to the majority, the physical presence rule was a “poor proxy for the compliance costs faced by companies that do business in multiple states.”

The majority then explained that the physical presence rule creates rather than resolves market distortions and that these distortions were in direct conflict with the purpose of the commerce clause — that is, to prevent states from engaging in economic discrimination. According to the majority, local businesses and businesses with a physical presence are at an economic disadvantage because a remote seller can offer “de facto lower prices,” since states have difficulty enforcing their own use tax laws directly against the taxpayers (in-state purchasers). Thus, according to the majority, the physical presence rule served as a “judicially created tax shelter” and guaranteed a competitive benefit to some businesses based solely on the organizational form they chose. Moreover, according to the majority, the physical presence rule caused harm to local markets and may have resulted in those markets lacking storefronts, distribution points, or employment centers. Therefore, rejecting the rule was necessary to ensure that the Court’s precedents did not create artificial competitive advantages. And the Court “should not prevent States from collecting lawful taxes” through a physical presence rule.

The majority then explained that the Court’s commerce clause jurisprudence has “eschewed formalism” in favor of a fact-sensitive case-by-case analysis, but that Quill treats “economically identical actors” differently for “arbitrary reasons.” The majority justified this conclusion by explaining that the physical presence rule would tax an online sale by an in-state retailer differently from an online sale of the same item to the same customer by an out-of-state retailer, solely because of the location of each company’s warehouse, and even if neither sale was related to the business’s warehouse. According to the majority, a state is free to consider functional marketplace realities in enacting and enforcing its laws, and courts should not rely on “anachronistic formalisms” to invalidate a state’s law under the commerce clause if the law avoids an effect forbidden by the commerce clause.

The majority next addressed the role of the physical presence requirement in the modern e-commerce economy and concluded that the rule was “artificial in its entirety.” According to the majority, it was not clear why a single employee or a single warehouse should create substantial nexus but the physical aspects of pervasive modern technology, including a cookie saved on a customer’s hard drive, a mobile app downloaded on a customer’s phone, or data storage leased in a state, should not. According to the majority, “between targeted advertising and instant access to most consumers via any internet-enabled device” a business may have a meaningful in-state presence without having an in-state physical presence. “The continuous and pervasive virtual presence of retailers today is, under Quill, simply irrelevant,” and the “Court should not maintain a rule that ignores these substantial virtual connections to the State.”

Next, the majority explained that the physical presence rule was an “extraordinary imposition by the Judiciary on States’ authority to collect taxes and perform critical public functions.” According to the majority, the rule intruded on states’ reasonable choices in enacting their tax systems and allowed remote sellers to escape an obligation to remit a lawful tax. And the rule was unjust because it allows a remote seller’s customers “to escape payment of sales taxes — taxes that are essential to create and secure the active market they supply with goods and services.” According to the majority, “There is nothing unfair about requiring companies that avail themselves of the States’ benefits to bear an equal share of the burden of tax collection.” Helping a remote seller’s customer “evade a lawful tax” unfairly shifts an increased share of taxes to customers who buy from a business with an in-state physical presence. According to the majority, the Court should avoid undermining public confidence in a state’s tax system by creating inequitable exceptions. The majority also stated that Quill harms both federalism and free markets by limiting a state’s ability to seek long-term prosperity and preventing market participants from competing on an even playing field.

Before issuing its holding in Wayfair, the majority also rejected upholding Quill based on stare decisis because a commerce clause decision may not “prohibit the States from exercising their lawful sovereign powers in our federal system.” The majority also noted that it was inappropriate to ask Congress to resolve the matter because, although Congress could change the physical presence rule, it was not proper for the Court to ask Congress to address a false constitutional premise of the Court’s own creation. The majority dismissed the theory that the physical presence rule was easy to apply by noting Massachusetts’s and Ohio’s recent attempts to expand the rule to placing cookies on an in-state resident’s computer, and similar technical and arbitrary rules that would likely result in a substantial amount of litigation. Because Quill was not easily applied, the majority noted that arguments for reliance based on the physical presence rule’s clarity were misplaced. Finally, the majority observed that Congress could resolve any problems associated with the increased administrative burden on businesses caused by its rejection of Quill, and that other aspects of the commerce clause can protect against any undue burden on interstate commerce that may be placed on small business or others that engage in interstate commerce.

The majority thus concluded that the physical presence rule of Quill was “unsound and incorrect” and that Quill and Bellas Hess are now overruled.

C. Creation of a Substantial Nexus Sufficiency Test

The majority in Wayfair was not content to merely overrule Quill and Bellas Hess. It created a new sufficiency test to determine whether substantial nexus exists and, in so doing, changed the entire landscape of state and local taxation in the United States.

According to the majority, substantial nexus is established “when the taxpayer [or collector] ‘avails itself of the substantial privilege of carrying on business’ in that jurisdiction.”16 This new sufficiency standard was satisfied in Wayfair “based on both the economic and virtual contacts” the remote sellers had with South Dakota. The majority’s reasoning was that the remote sellers at issue are “large, national companies that undoubtedly maintain an extensive virtual presence.” The justices said, “Thus, the substantial nexus requirement of Complete Auto is satisfied in this case.”

D. Remand to Determine Constitutionality

Because the Quill physical presence rule was the only issue before the Court in Wayfair, the majority was unable to conclude that South Dakota’s law was constitutional under the commerce clause. As a result, the majority remanded the case to the South Dakota Supreme Court to determine whether the law violated “some other principle of the Court’s commerce clause doctrine.”

The Court noted that the law contained the following attributes that appeared to be designed to prevent discrimination or an undue burden on interstate commerce:

1. the law contained a safe harbor for those who transact only limited business in South Dakota;

2. the law ensured that no obligation to remit the sales tax may be applied retroactively; and

3. South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement, which standardizes taxes to reduce administrative and compliance costs by:

a. requiring single, state-level tax administration;

b. requiring uniform definitions of products and services;

c. requiring simplified tax rate structures and other uniform rules;

d. providing sellers access to sales tax administration software paid for by the state; and

e. providing sellers that choose to use that software immunity from audit liability.

E. The Concurring and Dissenting Opinions

Thomas and Gorsuch both filed brief concurring opinions. Thomas explained that in hindsight, he should have joined Justice Byron R. White’s dissenting opinion in Quill and reiterated his long-held position that the Court’s entire dormant commerce clause jurisprudence cannot be rationally justified. Gorsuch emphasized his view that the physical presence rule was a “judicially created tax break” that the Court lacked the authority to create, and indicated that his agreement with the majority’s discussion of the Court’s past dormant commerce clause jurisprudence should not be interpreted as his agreement with all aspects of the dormant commerce clause doctrine.

Writing for the minority, Roberts in his dissent said he agreed Bellas Hess was wrongly decided for many reasons articulated by the majority. But according to Roberts, in Wayfair the Court should not have departed from its doctrine of stare decisis because Congress had plenary authority in the field of state and local taxation and could override the decisions in Bellas Hess and Quill with contrary legislation. Roberts was particularly concerned that the majority’s decision may have “waylaid Congress’s consideration of the issue.” But he was also troubled that the majority’s focus on unfairness and injustice did not embrace the public policy concerns of the Wayfair decision’s effect on the economy — for example, that it might alter the marketplace itself and that it would impose significant compliance costs on market participants. According to Roberts, Congress was better suited to balance those competing interests.

II. Implications of the Wayfair Decision

Much has been written about the sales and use tax consequences of the Wayfair decision. But those consequences may represent only a small subset of the changes ushered in by Wayfair. The decision appears to signal a fundamental change in the relationship of the states to each other and to the federal government. And it may signal a new era in which the courts provide a tremendous amount of deference to state tax regimes.

A. The Sufficiency Test for Determining Whether Substantial Nexus Exists

With the exception of Quill and Bellas Hess, until Wayfair, the Court had never articulated a test for determining whether the substantial nexus prong of the Complete Auto test was satisfied. As a result, states have developed a wide variety of nexus standards. Although those standards are still constitutional to the extent they exceed the sufficiency test articulated in Wayfair, post-Wayfair the substantial nexus analysis is dramatically altered for all state and local tax regimes, arguably including income, franchise, sales and use, gross receipts, and property taxes.

Post-Wayfair, the new substantial nexus test turns on whether a taxpayer has availed itself of the substantial privilege of carrying on business in the taxing jurisdiction at issue. In keeping with tradition, the Court left the minimum threshold of this sufficiency test undefined, for lower courts to determine. Because the substantial nexus analysis is fact-specific, the only existing guidance for determining the sufficiency of the economic and virtual contacts that satisfy this test are the particular South Dakota contacts of the businesses involved in the Wayfair litigation.

Complicating matters further, the Court, contradicting its own opinion, did not analyze those businesses’ contacts with the state; rather, it merely concluded that each business, by virtue of being a large national company, “undoubtedly maintain[ed] an extensive virtual presence.” As a result, the only conclusion that can be drawn with certainty is that a business with an “extensive virtual presence” (whatever that means17) has availed itself of the substantial privilege of carrying on business in a taxing jurisdiction. The Court left the question of whether something less than an extensive virtual presence is also sufficient to establish substantial nexus.

The Supreme Court in Wayfair, similar to the approach of lower courts in non-use-tax cases creating economic nexus for income tax purposes, also muddies the distinction (or arguably removes it) between the due process and commerce clause analysis articulated in Quill by stating: “The reasons given in Quill for rejecting the physical presence rule for due process purposes apply as well to the question whether physical presence is a requisite for an out-of-state seller’s liability to remit sales taxes.”18 The “reasons given in Quill” appears to be a reference to the “purposeful direction” language used by the Court in Burger King.19 That language has since evolved in other due process cases, so it is unclear whether the Court also believes a similar standard should apply to the Wayfair test and, if so, what standard should apply.

The reference to the due process analysis in Quill could indicate that the Court intends the substantial nexus analysis to be like the due process analysis developed in International Shoe 20 and its progeny. International Shoe is a cornerstone of modern due process jurisprudence because it established the minimum contacts and purposeful availment due process standard for in personam jurisdiction.21 In International Shoe, the Court abandoned the territorial jurisdiction approach of Pennoyer 22 and held that personal jurisdiction was proper if a nonresident defendant was shown to “have certain minimum contacts with [the taxing state] such that the maintenance of the suit does not offend ‘traditional notions of fair play and substantial justice.’”23 Further, “to the extent that a corporation exercises the privilege of conducting activities within a state, it enjoys the benefits and protections of the laws of that state.”24

Over the past several years, post-International Shoe due process cases have explored the extent to which a court may exercise personal jurisdiction over the operator of a website. For example, in Zippo,25 the U.S. District Court for the Western District of Pennsylvania differentiated between a passive website that does little more than make information available to those who are interested and an interactive website intentionally designed to facilitate business with a foreign state’s residents. Post-Wayfair, this type of analysis may now be relevant in determining whether a person’s virtual contacts establish substantial nexus with a taxing jurisdiction.

From this perspective, the Court appears to have followed the lead of lower courts, which have considered constitutional challenges brought under the commerce clause in income and franchise tax cases and tended to find in favor of taxable nexus while relying on due process language in pre-Quill Supreme Court decisions, most notably Tyler Pipe.26 When the Supreme Court declined to grant certiorari in Geoffrey,27 many states began to press the theory that was successful in that case — namely, that mere presence of intangibles in a state could create nexus for tax types other than use taxes. This approach for income tax purposes has come to be called “economic nexus.”

It is interesting that the language of the new sufficiency test was culled from pre-International Shoe 14th Amendment due process jurisprudence. The language of the Wayfair test appears to have originated inJ.C. Penney 28 and initially stood for the proposition that a tax on a foreign corporation registered to do business in a state satisfied the 14th Amendment due process clause. But in Wayfair the new sufficiency test was satisfied by economic and virtual contacts with a state. So the Wayfair test should not be read as applying only to foreign corporations registered to do business in a state.

To make matters even worse, the Court also raises the possibility that several, also undefined, types of contacts may be considered when determining whether the new sufficiency test is satisfied. Those contacts might include “substantial virtual connections,” targeted advertising, or “instant access to most consumers via any internet-enabled device.”29 (Does the fact that the Court mentions targeted advertising imply that that a taxpayer must affirmatively target a state’s market before a relevant contact can occur?) Relevant contacts might also include what the Court appears to acknowledge as physical contacts, such as a cookie on an in-state customer’s computer, a mobile app installed on an in-state customer’s phone, or leased data storage.

The extent to which the relationship between economic, virtual, and physical contacts will now be determined under due process analysis is also unclear. For example, for the sufficiency test, are only virtual and physical contacts that are also economic contacts at issue, or may a court look to a noneconomic physical or virtual contact to determine whether a taxpayer has availed itself of the substantial privilege of carrying on business in a taxing jurisdiction?

Because of the conflicting language in the Court’s opinion, it is not entirely clear how the Court intends lower courts to apply the new sufficiency test. It is certainly possible that they will apply the test with reference to the due process analysis. But it’s also possible that lower courts could create a new analysis that is different from or wholly unrelated to the minimum contacts necessary to satisfy the due process clause. As a result, other than the specific facts of Wayfair, there appears to be no clear guidance that a taxpayer (or use tax collector), tax administrator, or lower court can rely on to determine whether substantial nexus exists.

B. Other Principles of the Court’s Commerce Clause Doctrine

As noted above, the Court remanded Wayfair to the South Dakota Supreme Court to determine whether the state’s law runs afoul of some other principle of the Court’s commerce clause doctrine. In so doing, the Court implied that the lower court should review South Dakota’s law to determine whether it either discriminates against interstate commerce and is per se invalid or imposes a burden on interstate commerce that is clearly excessive in relation to the putative local benefits.

Notably, the Court did not reference the other prongs of the Complete Auto test (one of which is discrimination). Because the Wayfair decision directly addressed the substantial nexus prong of Complete Auto, it is clear that the Complete Auto test remains relevant. But interestingly, the Court seems to imply that satisfying the Complete Auto test, which was traditionally sufficient to uphold the constitutionality of a tax under the dormant commerce clause, is no longer sufficient. And it indicates that the undue burden analysis in Pike 30 (a state law that regulates evenhandedly to effectuate a legitimate local interest will be upheld unless the burden imposed on interstate commerce is clearly excessive in relation to the putative local benefits) must also be performed on state tax laws.

Some language in the Wayfair decision seems to imply that the Court is trying to distinguish the tax collection obligation at issue in Wayfair (a state regulation to which Pike would apply) from tax laws imposing a levy (a tax law to which both Complete Auto and Pike would apply).31 But the language in the Court’s holding makes clear that a use tax collection obligation must also be scrutinized to determine whether substantial nexus exists. So it appears that any state tax law must be evaluated under, and survive, both a Complete Auto analysis and a Pike undue burden analysis. But post-Wayfair, it is not entirely clear how those two tests interact. For example, does a tax that survives Complete Auto also survive Pike by default?

C. Retroactivity and Financial Reporting Consequences

Of concern for remote vendors is that in general, a constitutional decision of the Court may be applied retroactively.32 As a result, the new sufficiency test in Wayfair should be considered not only in connection with a taxpayer’s post-Wayfair contacts with a taxing jurisdiction but also its pre-Wayfair contacts. Therefore, each vendor that now arguably has a use tax collection obligation must consider not only whether the business has substantial nexus with a taxing jurisdiction in the future but also whether it has tax exposure in the jurisdiction for all open tax periods because of having failed to collect the jurisdiction’s taxes. Because the statute of limitations for a tax period does not begin to run until a return is filed, a vendor could have significant exposure for past-due uncollected taxes, penalties, and interest. A similar analysis may be required for all other tax regimes.

This exposure could have broad economic implications because for financial statement purposes, it could significantly affect a business’s earnings. And because Wayfair was decided late in the second quarter of the calendar year, businesses may be required to quantify and report that exposure in their second quarter filings (or year-end filings if the taxpayer’s fiscal year ends June 30). Unless the SEC provides relief, a business could be faced with preparing accurate financial statements in an extremely compressed time frame, which is further complicated by the uncertainty regarding application of the Wayfair sufficiency test.

D. Future SALT Jurisprudence

One theme of the Wayfair decision was that Quill represented an intrusion by the Court on the states’ reasonable choice in enacting their tax systems. Throughout its decision in Wayfair, the Court repeatedly noted that the Quill physical presence rule was an inappropriate intrusion by the Court on a state’s authority to make tax laws, collect taxes, and perform critical functions. This language may indicate that the Court is reevaluating the role of the judiciary in reviewing state tax laws and that it intends to give substantial deference to state tax regimes. It may also be that the Court is indirectly hinting to Congress that it expects congressional action in the field and intends to limit its forays into SALT.

It is not clear whether states will interpret this language as a mandate to enact increasingly aggressive tax laws that further export the state’s tax burden (and the burden of enforcing the state’s tax laws) to out-of-state businesses and nonresidents. Nor is it clear whether lower courts will interpret this language as meaning that increased deference should be given to a state’s tax laws. Tax administrators could also try to rely on this language to rationalize more aggressive tax enforcement actions.

The significance of the Court’s language on this issue is unclear. But the fact that the Court repeatedly emphasizes the inappropriateness of intruding on the states in this field indicates that this language should not be considered dicta. Rather, it is at least some indication, however vague, that the Court is reevaluating the role of the judiciary in SALT cases.

E. The Prospect for Post-Wayfair Congressional Action

Because Wayfair creates a sufficiency test for substantial nexus that likely will be found to be favorable to states and localities, and because Wayfair indicates that the Court will probably give significant deference to states and localities in the future, there is little incentive for subnational governments to pressure Congress to clarify the Wayfair decision. And since future congressional action in the field would likely limit this new-found freedom to act, state and local governments might have an incentive to lobby against it.

In contrast, potential taxpayers (now tax collectors for up to 10,000 subnational jurisdictions) have a significant incentive to lobby for congressional action to mitigate the significant administrative compliance and tax burdens and economic consequences they will probably incur because of Wayfair. And as the economic consequences become clear — for example, the stock market effect of the reduction in earnings — Congress may also face additional pressure from investors and other parties. In today’s political environment, it is not clear whether, and to what extent, Congress will choose to place additional federal limitations on the states’ abilities to levy and collect taxes. While we would like to believe congressional action is forthcoming, the lack of pressure by states makes it less likely.

F. Wither Due Process

The only certainty created by Wayfair is that its sufficiency test will be litigated for years for all manner of taxes. But it is also likely that the 14th Amendment due process clause will assume a greater role in state tax litigation, particularly if the lower courts begin to conclude that the floor of the sufficiency test in Wayfair is below (or unrelated to) the minimum contacts necessary for due process. Among other things, the authors expect future due process litigation to explore whether a taxpayer must target some states or markets before the due process minimum contact test is satisfied.33 Taxpayers may also consider limiting appearances in a state’s courts to the sole purpose of contesting the state’s jurisdiction over them, as opposed to voluntarily consenting to jurisdiction.

The Court’s characterization of the physical presence rule as a tax shelter, and its suggestion that remote vendors potentially were helping in-state non-taxpaying customers skirt the law, also has implications to the extent the Court has previously suggested due process jurisdiction is appropriate because of some perceived complicity of the remote vendor in the consumer’s failure to pay tax. As the Court stated in McIntyre, “In some cases . . . the defendant might well fall within the State’s authority by reason of his attempt to obstruct its laws.”34

G. The Sales and Use Tax Implications

Generally, federal and state courts give deference to the validity of state laws, typically though the presumption of constitutionality or though similar judicial canons. Tax administrators are aware of this. As a result, states and localities will likely assert that the obvious implication of Wayfair is that a remote seller with economic or virtual contacts with the state is, as early as June 21, required to collect and remit use taxes (and is subject to assessment for past due taxes) until the state or locality’s sales and use tax regime is otherwise held to violate the commerce clause as applied to a particular taxpayer.

Even though the Court did not determine the validity of South Dakota’s law, it indicated that the law is probably constitutional (at least concerning the commerce clause). And assuming the lower court finds South Dakota’s law constitutional, which is likely, the Supreme Court probably would not grant certiorari to review the lower court’s decision. Thus, we expect the 20 or so states with laws similar to South Dakota’s to soon begin requiring remote sellers to collect and remit use tax from sales delivered to in-state purchasers.

Some states that have passed use tax economic nexus legislation have premised that legislation on either federal law enacted by Congress or a final judgment by the U.S. Supreme Court authorizing states to require remote sellers to collect and remit state and local use taxes on their sales delivered into the state.35 A remote seller that may have nexus with one of those states should review the specific language of the state law to determine if or when it takes effect. For example, in Louisiana the economic nexus safe harbor law is premised on a final decision by the U.S. Supreme Court on the constitutionality of South Dakota’s law in Wayfair.36 Because Wayfair was not such a final decision, Louisiana’s safe harbor law is inoperative unless amended. In Louisiana and any other state with an inoperative economic nexus threshold (that is, safe harbor), any nonresident with the requisite contacts with the state may be subject to tax if the state’s sales and use tax regime does not otherwise violate the commerce clause as applied to that nonresident.

As noted earlier, only about 20 states have enacted laws with safe harbors similar to South Dakota’s law, and some of those laws may not take effect at all (or may not have taken effect on June 21). Moreover, some of those laws may not have provisions that limit retroactivity. As a result, on June 21, a seller that satisfies the sufficiency test in Wayfair may have tax exposure, including retroactive tax exposure, in any state without a safe harbor in effect on that date. Because the floor of the sufficiency test in Wayfair is not clear, in theory, a seller could have tax exposure for any open period in any state where the seller shipped a single taxable good or service until that state’s law is otherwise ruled unconstitutional for that specific seller’s facts. In other words, a nonresident seller should evaluate its sales and use exposure in light of Wayfair, but it is premature to conclude that states and localities have free reign to impose a use tax collection obligation on the nonresident seller.

The Wayfair test also creates an additional problem for the many online sellers that use a marketplace facilitator. Some states have enacted laws requiring a facilitator to collect and remit use tax for remote sellers that use the facilitator’s services. But the Wayfair test does not address whether a remote seller’s indirect virtual contacts with a state through a marketplace facilitator are sufficient to satisfy the substantial nexus prong of the Complete Auto test. So it is not yet clear whether a state may compel a remote seller with only indirect virtual contacts to collect and remit use tax. Nor is it clear whether a state may compel the marketplace facilitator to collect and remit use tax for its client, the remote seller.37 As a result, both a remote seller that does business through a marketplace facilitator and a facilitator that has virtual contacts with the state should carefully evaluate their state tax exposure.

It is also important to note that Wayfair does not alter state notice and reporting requirements. And states that are aggressively enforcing those requirements (for example, Connecticut and Washington) and the associated penalties may no longer be willing to negotiate the waiver of penalties in exchange for a remote seller’s commitment to prospectively collect and remit use tax on sales to in-state customers, unless the state’s sales and use tax regime is unlikely to survive commerce clause scrutiny as applied to a remote seller after Wayfair.

Further note that even though the Court laments the litigation that will arise from the expansion of the definition of physical presence to include cookies on in-state computers and similar items by states like Massachusetts and Ohio, the Wayfair decision could be read by states as tacitly endorsing those laws as correct. Depending how lower courts define the Wayfair test, a state or locality could rely on Wayfair to support a physical presence nexus theory below the (yet-to-be-defined) economic and virtual contact threshold in Wayfair. More important, Massachusetts and Ohio may interpret the Wayfair decision as endorsing their approach and issue retroactive assessments based on their expanded physical presence standards.

Finally, a business considering restructuring its operations to fall below a state’s economic nexus threshold should note that the Wayfair test may set a low bar. And a state could thwart any such restructuring by repealing any existing safe harbor (assuming its sales and use tax regime is otherwise constitutional).

H. Income, Franchise, Gross Receipts, and Property Tax Implications

The commerce clause and the Court’s dormant commerce clause jurisprudence are constitutional law. As a result, a holding that changes the Court’s commerce clause doctrine, such as Wayfair, applies to all states and localities and all SALT regimes. Wayfair makes this clear by linking the new sufficiency test to the substantial nexus prong of Complete Auto. Thus, the Wayfair sufficiency test appears to apply when determining whether substantial nexus exists for all SALT regimes, including income, franchise, gross receipts, and property tax.

Regarding income and franchise taxes, many states may impose a higher nexus standard than the Constitution requires. For example, some states have imposed factor presence standards that effectively set a safe harbor for a taxpayer whose in-state sales or payroll are below a defined threshold. In other states with economic nexus standards, those standards may also contain a de facto safe harbor, such as by requiring more than de minimis economic activity. For example, Louisiana’s judicially created economic nexus standard applies to a taxpayer with “significant royalty income from the use of its trademarks in Louisiana.”38

Although the threshold or floor of the Wayfair sufficiency test is not clear, it will likely fall below many existing nexus safe harbors in use by states. And it appears that the contacts necessary to satisfy the Wayfair test may be of an entirely different nature than the contacts for existing nexus safe harbors. As a result, many taxpayers that rely on a state’s nexus safe harbor will, through the application of the Wayfair test, probably have broader nexus with that state and may have both prospective and retroactive tax exposure in that state as of June 21. Any nonresident with an economic or virtual presence (for example, any business with a website that can be accessed remotely) should evaluate the scope of its economic and virtual contacts with all other states to determine whether those contacts are sufficient for purposes of the Wayfair test. That analysis should be conducted for any jurisdiction that levies any tax that the taxpayer may be subject to.

The Wayfair test may also have implications for limitations on the states’ taxing powers imposed by federal law. For example, one can expect controversy over the application of the Interstate Income Tax Act (P.L. 86-272), which prohibits states from levying an income tax on taxpayers whose in-state business activity is limited to the solicitation of sales orders of tangible personal property sent outside the state for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the state.39 The types of virtual and economic contacts contemplated in the Wayfair decision might inadvertently undermine P.L. 86-272 if those contacts are considered to exceed solicitation. For example, a state could construe a tracking cookie on an in-state customer’s computer as a business activity that exceeds solicitation. As a result, a person that relied on P.L. 86-272 for protection from a state’s income tax regime should reevaluate its contacts with the state.

The Wayfair decision also raises the issue of whether the Court is trying to limit taxpayers’ ability to structure their businesses to minimize their taxes or administrative burdens.40 Specifically, the Court cites the concurring opinion of then-judge Gorsuch in Direct Marketing: “This guarantees a competitive benefit to some firms simply because of the organizational form they choose while the rest of the Court’s jurisprudence is all about preventing discrimination between firms.”41 This language could indicate that the Court is considering providing more deference to state (and federal) challenges to a taxpayer’s choice of entity or business structure. Even though this language is probably dicta, a state or locality may try to rely on Wayfair in contesting a taxpayer’s choice of entity or business structure.

The Wayfair decision may also affect property tax litigation, particularly over whether a state can tax goods traveling in interstate commerce. For example, Texas courts have held that natural gas stored in connection with an interstate common carrier pipeline system is not subject to ad valorem taxation because the owner of the gas lacked substantial nexus with the state under the Complete Auto test.42 But post-Wayfair, a jurisdiction that imposes property taxes could conceivably reevaluate the gas owner’s contacts attempting to find substantial nexus based on virtual or economic contacts.  Perhaps this is not what the Supreme Court had in mind and may create unnecessary issues for taxpayers.

III. Conclusion

The Wayfair decision likely removes many limits that prevented states and localities from exercising nationwide jurisdiction over a nonresident operating in interstate commerce. Despite the Court’s noble intentions to level the playing field, because the new sufficiency test for substantial nexus is undefined, the only thing any player can be certain of post-Wayfair is that a playing field might exist. But no player can be certain of the field’s markings, location, or boundaries. Nor does any player know whether it is on the playing field at all.

FOOTNOTES

1 South Dakota v. Wayfair Inc., Dkt. No. 17-494 (2018) (slip op.).

2 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

3 National Bellas Hess Inc. v. Illinois, 386 U.S. 753 (1967).

4 The taxpayers before the Court were large online sellers Wayfair Inc., Overstock.com Inc., and Newegg Inc.

5 Many localities within states also impose sales and use taxes. The discussion here applies equally to the large number of political subdivisions within states that also impose these types of taxes.

6 Business taxpayers tend to be aware of use tax obligations, but most individual taxpayers are not. Because of the historical lack of enforcement, individual taxpayers tend to view information about those obligations as if the news itself were a tax increase, making elected officials unwilling to be associated with that news.

7 Similar to laws requiring employer withholding of income taxes, laws that require vendors to withhold sales or use tax shift the burden of collection and remittance to the vendor and often result in greater compliance because the vendor is a participant in the transaction.

8 Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977).

9 Id. at 279.

10 Quill, 504 U.S. at 313 and 318.

11 That was most likely the result of Justice Anthony M. Kennedy’s concurrence in Direct Marketing Association v. Brohl, 135 S. Ct. 1124, 1135 (2015) (Kennedy, J., concurring) (“The legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.”). See also Jaye Calhoun, “What’s Next for Nexus After Latest Direct Marketing Opinion?State Tax Notes, Mar. 21, 2016, p. 863.

12 S.D. Codified Laws section 10-64-2.

13 Thomas and Gorsuch also filed concurring opinions.

14 Wayfair, slip op. at 7.

15 Id. (citing Granholm v. Heald, 544 U.S. 460, 476 (2005); and Pike v. Bruce Church Inc., 397 U.S. 137, 142 (1970)).

16 Id. at 22 (citing Polar Tankers Inc. v. City of Valdez, 557 U.S. 1, 11 (2009).

17 What is an “extensive virtual presence,” considering that any website created can be viewed anywhere in the universe at any time by anyone with a computer? Assuming that alone creates a virtual presence, what makes one website more extensive than any other?

18 Wayfair, slip op. at 11.

19 Quill, 504 U.S. at 307-308 (citing Burger King Corp. v. Rudzewicz, 471 U.S. 462, 476 (1985)).

20 International Shoe v. Washington, 326 U.S. 310 (1945).

21 Also, under the due process analysis, a state tax scheme withstands due process scrutiny if the “income attributed to the State for tax purposes [is] rationally related to values within the taxing state.” Moorman Manufacturing Co. v. Bair, 437 U.S. 267, 273 (1978).

22 Pennoyer v. Neff, 95 U.S. 714 (1877).

23 See International Shoe, 326 U.S. at 316.

24 Id. at 318.

25 See generally Zippo Manufacturing Co. v. Zippo Dot Com Inc., 952 F. Supp. 1119 (W.D. Pa. 1997).

26 Tyler Pipe Industries Inc. v. Washington, 483 U.S. 232 (1987). See State v. Quantex Microsystems Inc., 809 So.2d 246 (La. App. 1st Cir. 2001); and State v. Dell International Inc.,Dkt. No. 2004 CA 1702,(La. App. 1st Cir. 2006), both of which are use tax cases in which the Louisiana First Circuit Court of Appeals cites Tyler Pipe in holding that the seller’s connection with in-state warranty service providers may provide the necessary physical presence for the taxpayer because the possibility that the activities of the repairers were significantly associated with the seller’s ability to establish and maintain a market in the state.

27 Geoffrey Inc. v. South Carolina Tax Commission, 313 S.C. 15 (1993), cert. denied, 510 U.S. 992 (1993).

28 Wisconsin v. J.C. Penney Co., 311 U.S. 435 (1940).

29 Wayfair, slip op. at 15.

30 Pike, 397 U.S. 137.

31 The Court seems to blame the remote vendor for a state’s inability to enforce its own laws, and it seems to imply that a nonresident with a virtual or economic connection to a state should bear some responsibility for enforcing the state’s laws against the state’s own residents. This proposition raises a slew of interesting questions that are beyond the scope of this article, such as whether a state can compel a nonresident to take an enforcement action for the state against the state’s own residents.

32 Harper v. Virginia, 509 U.S. 86, 94 (1993).

33 See J. McIntyre Machinery v. Nicastro, 564 U.S. 873 (2011).

34 Id. at 880.

35 See La. R.S. section 47:339 as amended by 2018 La. Sess. Law Serv. 2nd Ex. Sess. Act 5 (H.B. 17); and 2018 La. Sess. Law Serv. 2nd Ex. Sess. Act 5 (H.B. 17). As of June 21 a bill, S.B. 1, had been introduced in the Louisiana Legislature to change the effective date of the Louisiana law to a specific date (August 1, 2018) to remove the reference to a final decision by the Court in Wayfair, but it does not fix the all the references at issue and may be unconstitutional because it originated in the Louisiana Senate.

36 See supra note 35.

37 See generally Normand v. Wal-Mart.com USA LLC, Dkt. No. 769-149 (La. 24th Judicial Dist. Ct. 2018). (In which the Louisiana 24th Judicial District Court issued an unusual opinion holding that a marketplace facilitator was a dealer for purposes of Louisiana sales and use tax laws solely because it engaged in solicitation of a customer market and even though it never owned or sold the good at issue. This case is unusual because it implies that the remote seller and the marketplace facilitator are both dealers for the same transaction and that either (or both) could be pursued for the same tax. It also could be read as standing for the proposition that in Louisiana, any third party that plays any role in facilitating a transaction could be a dealer for that transaction. This case is being appealed to the Louisiana Court of Appeals.)

38 Bridges v. Geoffrey Inc., 984 So.2d 115. 128 (2008).

39 15 U.S.C. section 381.

40 See Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934) (“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”).

41 Wayfair, slip op. at 13 (citing Direct Marketing Association v. Brohl, 814 F.3d, 1129, 1150–1151 (10th Cir. 2016) (internal quotations omitted).

42 Peoples Gas, Light, and Coke Co. v. Harrison Central Appraisal District, 270 S.W.3d 208, 218-219 (Tex. App. 2008).

END FOOTNOTES

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