Balancing Point: Justice Anthony McLeod Kennedy

On June 21, just before his 82nd birthday, Justice Anthony M. Kennedy announced his retirement from the U.S. Supreme Court in a letter to President Trump. His final opinion, South Dakota v. Wayfair Inc.,¹ will have lasting impact. Kennedy was arguably the critical swing vote on the bench, and his departure stirs many questions and opinions.

Remembering My ‘Conversation’ With Justice Kennedy

Walter Hellerstein

Walter Hellerstein is the Distinguished Research Professor Emeritus and the Francis Shackelford Professor of Taxation Emeritus at the University of Georgia Law School and chair of the State Tax Notes Advisory Board.

Justice Anthony M. Kennedy will always be remembered for his landmark opinion in the 5-4 decision in Wayfair,² overruling Quill’s physical presence test of nexus and embracing nexus rules that “‘are appropriate to the twenty-first century, not the nineteenth.’”³ But there is another landmark opinion in a 5-4 decision for which Kennedy will always be remembered — at least by me, because I argued the case — Allied-Signal Inc. v. Director, Division of Taxation.⁴

In Allied-Signal, the Court confronted the fundamental question of whether the unitary business principle should continue to serve as the “linchpin of apportionability in the field of state income taxation.”⁵ During the initial argument of the case⁶ – which appeared to involve the familiar fact-sensitive inquiry under the unitary business principle of whether New Jersey could tax the share of the gain that a Michigan-based manufacturing corporation, Bendix, realized from the sale of its 20 percent ownership interest in an unrelated metal mining corporation, ASARCO — the case took a “dramatic turn.”⁷ Rather than hewing to the line that Bendix’s gain from the sale of its ASARCO stock was apportionable under a straightforward reading of the Court’s unitary business decisions, counsel for New Jersey suggested that the unitary business principle was unworkable and that a state should have the power to tax all the income of a non-domiciliary corporation, as long as the corporation was doing business in the state.⁸ The Court, which was apparently intrigued by — if not sympathetic to — New Jersey’s argument, restored the case to the calendar for reargument and raised questions, the subtext of which was whether the Court should sustain or overrule the unitary business principle as we know it.

It was in that context that I had the following dialogue with Kennedy:

Kennedy’s thoughtful, probing, and precise questions demonstrated his thorough command of the issues in the case. He focused on the critical question whether any “flow of value”¹⁰ between entities or assets can justify apportionability, or whether there has to be what he ultimately characterized in Allied-Signal, as “an operational function rather than an investment function.”¹¹ I would like to think that my “conversation” with him, particularly over my favorite unitary business hypothetical of a beauty parlor and a parking lot, informed his thinking about the nature of the unitary business principle and led to his landmark opinion preserving the principle as the “linchpin of apportionability in the field of state income taxation.” In any event, that is how I will remember Kennedy.

A Thoughtful Justice

Eric J. Coffill

Eric J. Coffill is a senior counsel with Pillsbury Winthrop Shaw Pittman LLP, Sacramento, California.

I feel special kindred with Justice Anthony M. Kennedy. He is from Sacramento (as am I) and taught constitutional law at University of the Pacific, McGeorge School of Law, in Sacramento, which is where I received my JD and LLM (tax), and where I taught for many years as an adjunct professor. Kennedy will be best remembered, and rightly so, for many important decisions and jurisprudence that have nothing whatsoever to do with state tax. For example, in 1992, he cast a crucial vote in Planned Parenthood of Southeastern Pennsylvania v. Casey,¹² which struck down a state law requirement for women seeking abortions to notify their husbands, and which affirmed the essential holding in Roe v. Wade.¹³ In 2015, he wrote the 5-4 decision in Obergefell v. Hodges,¹⁴ which held that states cannot refuse to recognize lawful same-sex marriages performed in another state on the ground of its same-sex character.

In the narrow confines of the state tax world, his impact was also widespread on a variety of complex issues. He wrote the majority opinion in Trinova Corp. v. Michigan Department of Treasury,¹⁵ which found the state’s single business tax, a form of a value added tax, did not violate the Constitution. He wrote the majority opinion in (twice-argued) Allied-Signal,¹⁶ which laid out the rules for taxation of income of a non-domiciliary corporation when the payor and payee are not in a unitary relationship, and which set forth the now famous operational-versus-investment dichotomy. However, he likely will be best remembered in state tax as the justice who wrote the decision in Wayfair, which is one of the most significant dormant commerce clause (and stare decisis) cases of all time, and which was also his final opinion on the Court. In 2015 Kennedy urged the Court in Direct Marketing Association v. Brohl¹⁷ to reconsider Quill.¹⁸ When given the opportunity three years later, writing in Wayfair for a 5-4 majority, Kennedy stated the Quill rule was always wrong and it was not the Court’s place to state an incorrect rule and then wait for Congress to fix it.¹⁹ Perhaps not in all areas of jurisprudence, but certainly in the state tax area, he was a federalist, but also was aware of the tension inherent in state and local tax between the importance of state power and preserving national values. He was a true and strong believer in the dormant commerce clause doctrine far beyond just Wayfair, such as when he sided with the majority in the 5-4 decision in Comptroller of Treasury of Maryland v. Wynne,²⁰ holding that the state’s credit scheme violated the dormant commerce clause because it discriminated against interstate commerce. He was interested in how things worked in practice, aware of changing times, and willing to change his mind, all themes evidenced in Wayfair. Kennedy wrote in Packingham v. North Carolina that “the forces and directions of the Internet are so new, so protean, and so far reaching that courts must be conscious that what they say today might be obsolete tomorrow.”²¹ He wrote in Direct Marketing Association, “given these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill.”²² He wrote in Wayfair, “though Quill was wrong on its own terms when it was decided in 1992, since then the Internet revolution has made its earlier error all the more egregious and harmful. The Quill Court did not have before it the present realities of the interstate marketplace.”²³ We are losing a thoughtful justice.

Only Time Will Tell

Craig B. Fields

Craig B. Fields is a partner with Morrison & Foerster LLP, New York.

While Justice Anthony M. Kennedy will be remembered by state tax professionals for having written the 5-4 majority opinion in Wayfair, he wrote many other state-tax related opinions and was the swing vote in opinions written by other justices. These cases covered the gamut of state tax and his impact will be felt for years.

For example, he delivered the 5-4 majority opinion in Allied-Signal, which confirmed there must be a nexus over both the person that the state wishes to tax as well as the transaction it is trying to tax. Without both, the tax cannot survive. Since New Jersey did not have sufficient nexus over the transaction (that is, the company whose stock was sold was not part of the seller’s unitary business), its assertion of tax was rejected. Kennedy’s opinion repudiated what many states had asserted for years, holding that how the funds from a sale are going to be used is not an indicator of whether the asset sold was part of the selling entity’s unitary business.

In Davis v. Michigan Department of the Treasury,²⁴ Kennedy’s opinion rejected Michigan’s attempt to subject federal retirement benefits to income tax when the state exempted from tax the retirement benefits paid by it and its political subdivisions. The Court ruled that this discrimination was impermissible because it violated principles of intergovernmental tax immunity.

Kennedy was the swing vote in Camps Newfound/Owatonna Inc. v. Town of Harrison,²⁵ in which the Court, relying on the dormant commerce clause, first ruled that real estate taxes cannot discriminate against interstate commerce any more than any other type of tax. It then invalidated a Maine statute because the statute expressly distinguished between entities that served a principally interstate clientele and those that primarily served an intrastate market, singling out those that served mostly in-staters for beneficial tax treatment.

In Wynne, Kennedy joined in a 5-4 majority and found that Maryland’s statutes, which imposed tax on the income that Maryland residents earned outside the state, violated the dormant commerce clause because the statute did not offer Maryland residents a full credit against the income taxes paid to other states. In so holding, the Court relied on the internal consistency test.

As in Wayfair, however, many of the state tax-related opinions Kennedy delivered were decided for the state. For example, in Trinova, his opinion found that the three-factor apportionment formula of Michigan’s former single business tax did not violate either the due process clause or the commerce clause. Similarly, Itel Containers International Corp. v. Huddleston²⁶ held that the imposition of Tennessee’s sales tax on leases of containers owned by domestic companies and used in international shipping was valid.

While Kennedy had other noteworthy decisions, the foregoing gives a short overview of his impact on state taxes during his tenure. His decisions have helped to shape state tax as we know it today. Only time will tell whether the current (and future) justices will agree with him regarding the dormant commerce clause (not all the members on the Court currently believe in its viability).

A Faint-Hearted Federalist’s Road to Wayfair

Billy Hamilton

Billy Hamilton is the executive vice chancellor and CFO of the Texas A&M University System.

For me, the biggest question coming out of the Court’s decision in Wayfair isn’t what the states will do or how Congress will react. It’s why Justice Anthony M. Kennedy was so determined to overturn Quill, the ruling that has blocked the states from requiring remote sellers to collect tax from their customers for a quarter-century. After all, Kennedy supported Quill as a junior member of the Court in 1992.

Kennedy’s decision to take the states’ side wasn’t new. He made it clear in his 2015 opinion in Direct Marketing Association, which dealt with Colorado’s notification and reporting law, that he was concerned about the “serious, continuing injustice faced by Colorado and many other States” because of Quill.²⁷ He wrote that the “legal system should find an appropriate case for this Court to reexamine” the decision. A bright line leads from that comment to South Dakota’s adoption of an economic nexus law in 2016 and from there to Wayfair.

But why? Maybe I’ve read too much Malcolm Gladwell, but I always look for a tipping point and wondered when Kennedy had experienced his own conversion on the road to Damascus. Maybe he has a sister who’s a brick-and-mortar retailer suffering because of internet retailing, or maybe he discovered Amazon Prime when Amazon wasn’t collecting tax in D.C. and recognized the inherent unfairness of its customers avoiding tax — although I’m sure he filed a use tax return.

My curiosity stems from the fact that I have worked around this issue since before Quill, and I can count on one hand the inhabitants of official Washington who have shown a willingness to work on a solution to Quill that doesn’t hurt the states as much as it helps them.

In any case, I searched for but couldn’t find a telling anecdote about Kennedy’s conversion to the state point of view. I also polled some of my more learned friends, but they didn’t have much to offer. Max Behlke, who worked on Wayfair while at the National Conference of State Legislatures, reflected the consensus: “I think he just understood that online commerce has changed so many norms that the status quo was simply untenable.”

Probably true, but, how shall I put it . . . unsatisfying. And I’m not the only one looking for a better explanation. Writing in the SCOTUSblog, Daniel Hemel of University of Chicago Law School observed that Wayfair represented “a sharp break from Kennedy’s dormant commerce clause jurisprudence over the preceding three decades.”²⁸

Kennedy, he writes, was “a faint-hearted federalist.” While his rhetoric regarding federalism was “lofty,” his votes in concrete cases didn’t always match his words. He ruled against state and local governments in a range of dormant commerce clause cases and in other cases involving issues as varied as solid waste ordinances and abortion laws. Hemel also points out that Kennedy was a dormant commerce clause “true believer,” unlike other conservative jurists like Justices Clarence Thomas and Neil M. Gorsuch, who are prone to the view that the dormant commerce clause should be discarded because of their originalist philosophy.

So why? Well, Hemel says Kennedy has always been pro-business, and while the case pitted South Dakota against three internet retailers, many brick-and-mortar retailers — maybe including his hypothetical sister — wholeheartedly supported the state. Kennedy framed the case as being about the Cyber Age rather than the 19th century dormant commerce clause, and when it comes to technology, Kennedy has been “something of a wild card.” Still, compare his forward-looking opinion to Chief Justice John G. Roberts Jr.’s backward-looking dissent.

Hemel concludes where Behlke began. One of the justice’s greatest virtues, he writes, has been “the ability to change his mind.” Until Kennedy writes a book with an anecdote about his sister or some other moment of epiphany, I suppose we must live with that answer. However it happened, at least he arrived at the right conclusion.

Discerning Justice Kennedy’s Legal Philosophy

George S. Isaacson

George S. Isaacson is a senior partner at Brann & Isaacson. He and colleagues Martin I. Eisenstein and Matthew P. Schaefer represented Wayfair in South Dakota v. Wayfair Inc.

In many respects, Justice Anthony M. Kennedy’s legal philosophy has been difficult to discern. At times he was prone to sweeping — even grandiose — expression. For example:

No one understands exactly what he meant by such phrases as “concept of existence,” and “meaning of the universe.” Nonetheless, many readers found such soaring sentiments sublimely inspiring, even if they had little to do with resolving the specific legal issue before the Court. In this regard, Kennedy could be criticized as an undisciplined jurist, who was prone to take poetic license in drafting his decisions and willing to elevate undefined and limitless terms, such as “dignity,” to the status of core constitutional principles.

Other than his recent engagement with the subject through his concurring opinion in Direct Marketing Association and his authorship of the majority opinion in Wayfair, Kennedy did not leave a significant legacy in the field of state tax law. Nor do his relatively few opinions in this area reflect a distinct vision regarding state tax issues. Two possible strands, however, do run through the cases discussed below. First, Kennedy believed that federal courts should not overstep their authority regarding state tax regimes. Second, perhaps inconsistently, he was willing for the Court to step in where a rule of law was not, in his view, “workable.” It is evident that Kennedy’s reversal of position regarding the Quill physical presence rule indicates that he (rightly or wrongly) viewed what had once been a workable rule of law was no longer functional in the internet age.

As a general matter, Kennedy was of the view that federal courts should not be intrusive in matters of state taxation. In a concurring opinion in Missouri v. Jenkins, in which the Court held that a federal district court could not order the imposition of a tax increase to fund desegregation efforts, Kennedy wrote: “The power of taxation is one that the Federal Judiciary does not possess.”³⁰ In Hibbs v. Winn, he wrote a lengthy dissent critical of Justice Ruth Bader Ginsburg’s majority opinion, in which he viewed the majority as having taken the position“that state courts are second rate constitutional arbiters.”³¹ His concern was that the majority did not accord the proper respect to the jurisdictional reach and constitutional judgment of state courts.

In a taxpayer standing case, Arizona Christian School Tuition Organization v. Winn, Kennedy wrote for the majority in denying standing to Arizona taxpayers, and stated: “Few exercises of the judicial power are more likely to undermine public confidence in the neutrality and integrity of the Judiciary than one which casts the Court in the role of a Council of Revision, conferring on itself the power to invalidate laws at the behest of anyone who disagrees with them.”³²

His position on the application of the doctrine of stare decisis in state tax cases depended on whether, in his view, an established doctrine remained “workable.” In the same year Quill was decided, Kennedy wrote the majority opinion in Allied-Signal, affirming the unitary business principle as an appropriate device for ascertaining whether a state had transgressed constitutional boundaries, whether under the due process or commerce clauses, in taxing a non-domiciliary corporation. Applying the principles of stare decisis, Kennedy wrote that New Jersey had not made the case for abandoning the unitary business principle. In doing so, he was at pains to note that the Court’s “precedents are workable in practice,” and that, “if anything would be unworkable in practice, it would be for us now to abandon our settled jurisprudence defining the limits of state power to tax under the unitary business principle.”³³

Despite his decision in Wayfair abandoning the dormant commerce clause’s physical presence nexus standard, he was not opposed to the clause’s undue burden rule in principle. To the contrary, writing in the dissent in Kentucky Department of Revenue v. Davis, Kennedy strongly affirmed the legitimacy of the undue burden test under the dormant commerce clause: “The undue burden rule, however, remains an essential safeguard against restrictive laws that might otherwise be in force for decades until Congress can act.”³⁴

Justice Kennedy’s SALT Claim to Fame?

Amy F. Nogid

Amy F. Nogid is counsel in Mayer Brown LLP’s New York office.

When asked to name the state and local tax case for which Justice Anthony M. Kennedy would be most remembered, many SALT practitioners will name Wayfair. And for good reason. Wayfair, a case in which Kennedy delivered the Court’s decision, repealed Quill’s and National Bellas Hess’s physical presence requirement for substantial nexus and initiated a sea of change for how we determine whether a state will have jurisdiction over a company (at least in the sales and use tax context).³⁵ However, the impact of Wayfair and its perceived expansion of nexus may be tempered by another decision written by Kennedy: J. McIntyre Machinery Ltd. v. Nicastro,³⁶ one of a pair of cases decided the same day addressing the due process clause, albeit outside the tax context.³⁷ Although it may take some time for the impact of J. McIntyre Machinery to be felt in the SALT world, Kennedy’s opinion may cause states to retreat from some of their more aggressive income tax nexus determinations.

In J. McIntyre Machinery, Kennedy issued the Court’s plurality opinion, reversing the New Jersey Supreme Court’s decision that upheld the exercise of specific jurisdiction over a foreign manufacturer of a product because the manufacturer “knew or reasonably should have known” that its product was being sold through a nationwide distribution system that might lead to its products being sold in any of the 50 states, including New Jersey. The state supreme court upheld jurisdiction over the manufacturer even though the manufacturer never advertised in, sent goods to, or in any relevant sense targeted the state.

Kennedy, in rejecting the New Jersey Supreme Court’s exercise of jurisdiction over the U.K. manufacturer, said: “The principal inquiry in cases of this sort is whether the defendant’s activities manifest an intention to submit to the power of a sovereign. . . . In other words, the defendant must purposefully avail itself of the privilege of conducting activities within the forum State, thus invoking the benefits and protections of its laws.” He found the U.K. manufacturer’s nationwide distribution agreement insufficient to establish that the manufacturer purposefully directed its activities to New Jersey, and he found no need for the manufacturer to contractually opt out of allowing the distributor of its products from making sales to New Jersey to establish that it had not targeted New Jersey. Significantly, Kennedy rejected Justice William Brennan’s “stream of commerce”/foreseeability test set forth in Asahi Metal Industry Co. v. Superior Court,³⁸ finding “it is not enough that the defendant might have predicted that its goods will reach the forum state” because “it is the defendant’s actions, not his expectations, that empower a State’s courts to subject him to judgment.” Furthermore, Kennedy emphasized the “undesirable consequences” from states’ exercise of jurisdiction based on a stream-of-commerce approach:

Kennedy’s view of due process jurisdiction as announced in J. McIntyre Machinery provides authority to reject some states’ income tax nexus positions, including positions that rely on the activities of third parties or on happenstance. Take, for example, Company X, which is in State A (it is incorporated in State A, and all its employees and property are in State A) and sells its product to Company Y, also located in State A. Company Y then sells Company X’s product nationwide. Some states may try to look through to the location of Company Y’s customers to impute nexus onto Company X, but nexus assertions on this basis should fail even if Company X understands that its product may be sold by Company Y to customers nationwide and the income Company X receives from Company Y is computed based on the sales that Company Y makes to its customers in particular states. Likewise, if Company X permits its employees to occasionally telecommute in states other than State A, that fact alone should not support a nexus finding by a state if that is Company X’s only connection to State B. In either of these examples, one would be hard-pressed to find that Company X has manifested its intention to submit to the jurisdiction of any state other than State A.

Kennedy’s opinion in J. McIntyre Machinery also supports the rejection of states’ attempts to assert jurisdiction over a corporate limited partner due to the partnership’s in-state activities or over a member of a limited liability company due to the LLC’s in-state activities. In either case a mere passive investor in another entity should not itself be viewed as having “purposefully avail[ed] itself of the privilege of conducting activities” in the states in which the partnership or LLC has nexus.

So while many SALT practitioners will either rue or praise Kennedy’s opinion in Wayfair, his opinion in J. McIntyre Machinery may end up being significant in tax nexus determinations and will likely engender similar sentiment.

Justice Kennedy’s Tax Legacy: A Lot of Wayfair and a Little Wynne

Timothy P. Noonan

Timothy P. Noonan is a partner in the Buffalo and New York offices of Hodgson Russ LLP.

This topic would have been a little difficult to tackle had Justice Anthony M. Kennedy retired 12 months ago. Sure, he was involved in numerous decisions around the dormant commerce clause. These include C & A Carbone Inc. v. Town of Clarkstown,³⁹ in which he wrote for a five-justice majority to invalidate a local law that required solid waste generated within the town’s boundaries to be deposited at a designated processing facility, and Granholm v. Heald,⁴⁰ in which again he wrote for a 5-4 majority striking down state laws that limited the ability of out-of-state wineries to sell directly to consumers. But today any question about Kennedy’s legacy will start and end with the Wayfair case. And what will that legacy be?

Wayfair could be viewed as a helpful push by the Court to usher in a sales tax collection method that makes more sense in the internet-based economy. The fact that he had to lead the charge to reverse not one but two prior Court decisions to get there (including one where he stood with the majority) will simply be an interesting footnote. Alternatively, Wayfair could be cited as another example of judge-based lawmaking that wreaks havoc in industry and forces businesses into predicaments better solved by lawmakers. But one thing is clear: from a tax perspective, without question or debate, I think Wayfair is Kennedy’s legacy. Indeed, he spurred the debate almost single-handedly through his concurring opinion in Direct Marketing Association, in which he essentially egged on states like South Dakota to pick a new case to re-examine Quill. And having started the fight, he was appropriately the one to end it with his decision this past summer.

The reverberations from the decision will be felt for years. The decision promises to change not only sales tax nexus for all time, but state tax nexus in general. And maybe it will force Congress to finally step in and solve the problem. If that happens, I suspect Kennedy’s tax legacy will be as positive and great as his legacy in other areas of the law. But if that does not happen, and if we continue to find ourselves in the Wild Wild West on sales tax nexus issues, with thousands of localities left free to pick different economic nexus thresholds and impose different kinds of taxes on different kinds of products and services at different tax rates, I expect many practitioners and businesses will not look so kindly on Kennedy, at least when doing their monthly sales tax returns.

Finally, on a personal note, I hope that Kennedy’s swing vote in Wynne, a 2015 decision that invalidated a Maryland personal income tax scheme on dormant commerce clause grounds, spurs similar victories for other taxpayers fighting to strike down state taxing regimes that impose double taxation on the states’ residents. The Court’s decision in Wynne, which (before Wayfair) had been called one of the most important state tax cases in decades,⁴¹ made clear that the dormant commerce clause can apply to personal income taxes, and clarified that the internal consistency test is the test to apply in dormant commerce clause cases to determine whether a taxing scheme unfairly burdens or discriminates against interstate commerce. There are two cases working their way through the New York court system⁴² in which taxpayers are seeking to apply this Wynne analysis to invalidate a New York scheme that they allege violates the internal consistency test and fails commerce clause scrutiny. If these taxpayers win, they’ll have Wynne (and Kennedy) to thank for it!

Inroads, Narrowings, and Restrictions

Richard D. Pomp

Richard D. Pomp is the Alva P. Loiselle professor of law at the University of Connecticut School of Law.

There is probably no one reading State Tax Notes who could not identify Justice Anthony M. Kennedy as the author of Wayfair. And probably everyone could identify the significance of his concurrence in Direct Marketing Association, which led to Wayfair. Unfortunately, this legacy will be undercut should Congress adopt one of the bills now pending to revert to physical presence — back to the good old days of cookie nexus, click-through nexus, and Colorado’s reporting regime, unless Congress outlaws these as well.

Kennedy, of course, wrote other significant decisions in state tax. The decisions themselves are well known, but how many readers could identify them as Kennedy’s? The authors of opinions fade with time. Here is proof: Who wrote Complete Auto Transit Inc. v. Brady,⁴³ Moorman Manufacturing Co. v. Bair,⁴⁴ Mobil Oil Corp.,⁴⁵ Container Corp. of America v. Franchise Tax Board,⁴⁶ Barclays Bank PLC v. Franchise Tax Board,⁴⁷ Allied-Signal,⁴⁸ McKesson Corp. v. Division of Alcoholic Beverages and Tobacco,⁴⁹ MeadWestvaco Corp. v. Illinois Department of Revenue,⁵⁰ Kraft General Foods Inc. v. Iowa Department of Revenue,⁵¹ and Hunt-Wesson Inc. v. Franchise Tax Board,⁵² just to pick a few of the more significant tax cases? Ten decisions, how many did you get right? These cases live on, but as important as the authors are, their names retreat into the wings.

I suspect that others writing in this column have traced common tax themes in Kennedy’s writings, and as important as these are to all of us, they will not mark Kennedy's legacy. Those in academia who teach constitutional law will try to define his legacy (they have already started) and do not care as much about our state tax cases as they do about his opinions on gay rights, abortion rights, the death penalty, affirmative action, and his willingness to cite foreign law. They will deconstruct, vet, analyze, search for his core values, debate his judicial philosophy, question his empirical assertions, and mock his baroque writing style. As Justice Antonin Scalia said in dissent in Obergefell⁵³: “if, even as the price to be paid for a fifth vote, I ever joined an opinion for the Court that began: ‘The Constitution promises liberty to all within its reach, a liberty that includes certain specific rights that allow persons, within a lawful realm, to define and express their identity,’ I would hide my head in a bag. The Supreme Court of the United States has descended from the disciplined legal reasoning of John Marshall and Joseph Story to the mystical aphorisms of the fortune cookie.” What seems a safe prediction is that few constitutional scholars will mention prominently Kennedy’s state tax opinions.

Kennedy disappointed many conservatives, who considered him a traitor because he was often the swing vote on the side of the liberals, but he showed his loyalty to the party by retiring before the midterm elections (or as some think, the president made him an offer he could not refuse). Ironically, by doing so, his more “liberal” decisions are likely to be eroded by the new Court, especially if Justice Ruth Bader Ginsburg is forced to retire. We can expect less of a frontal attack and outright reversal of some of Kennedy’s liberal decisions, but more of a series of inroads, narrowings, and restrictions.

Over time, Kennedy’s landmark cases will be undercut, and that part of his legacy will slowly fade away. Perhaps the dissenters in Wayfair, with their emphasis on stare decisis, had their eyes on what they feared would be an abandonment of Kennedy’s liberal decisions often not firmly rooted in the language of the Constitution. To protect these decisions, the Court’s liberals have to emphasize the principle of stare decisis more than Kennedy himself did.

What is likely to prevail as his legacy, at least for decades, will be Kennedy’s authorship of Citizens United v. Federal Election Commission,⁵⁴ which led to the proliferation of the super political action committees. Their corrosive undermining of our democratic values can be seen everywhere, and their impact has been cataclysmic. As Justice John Paul Stevens said in dissent, “While American democracy is imperfect, few outside the majority of this Court would have thought its flaws included a dearth of corporate money in politics.” “A democracy cannot function effectively when its constituent members believe laws are being bought and sold.” And as Chief Justice John G. Roberts Jr.'s recent rebuke of President Trump warns, it cannot function effectively when its judges are seen as nothing more than partisans. We witness daily the collapse of public trust in our institutions. Not exactly the legacy one would want.

The Game-Changer

Mark J. Richards

Mark J. Richards is a partner in the Indianapolis office of Ice Miller LLP.

At 82 years of age and after 43 years on the federal bench — 13 on the U.S. Court of Appeals for the Ninth Circuit and 30 years as an associate justice on the U.S. Supreme Court — Justice Anthony M. Kennedy moved into the twilight of his public service career by retiring and moving to senior status as a federal judge. The nominations to his seat immediately before and after his own were famously contentious. President Reagan appointed him to the Court after the Senate declined to confirm Robert Bork by a vote of 42-58; and his successor and former law clerk, Brett M. Kavanaugh, was confirmed by the razor-thin margin of 50-48 following heated confirmation proceedings. But the Senate unanimously confirmed Kennedy both to the Ninth Circuit and the Supreme Court.

It is perhaps fitting then that his jurisprudence leaves something for everyone to appreciate regardless of where you fall on the ideological spectrum. Much attention has been given to the high-profile issues on which Kennedy sided with more liberal members of the Court, such as abortion,⁵⁵ LGBT rights,⁵⁶ and the death penalty.⁵⁷ Yet, more often than not, he sided with the conservatives, including with respect to voting rights,⁵⁸ campaign finance,⁵⁹ and gun control.⁶⁰ As commentators continue to analyze his impact on the Court and the law, it is natural that their focus will be on many of these hot-button social issues. But his impact on state tax law should not be overlooked.

Kennedy was a member of the Court when it issued its decision in Quill, reaffirming the sales tax nexus physical presence requirement under the commerce clause as enunciated in National Bellas Hess. Notably, Justice Antonin Scalia, joined by Kennedy and Justice Clarence Thomas, concurred based solely on stare decisis.

With the subsequent growth of e-commerce into a multitrillion-dollar sales platform, coupled with the struggles of the traditional brick-and-mortar retailers, concerns grew among the traditional retailers about the perceived unfair competition, and concerns grew among states about the significant losses of revenue. There were many unsuccessful efforts to “kill Quill” through the Court system or through Congress.

But hope was reborn with Kennedy’s concurring opinion in Direct Marketing Association. After describing Quill as a “case questionable even when decided,” Kennedy stated that there is “a powerful case to be made that a retailer doing extensive business within a State has a sufficiently ‘substantial nexus’ to justify imposing some minor tax-collection duty, even if that business is done through mail or the Internet,” and “this argument has grown stronger, and the cause more urgent, with time.” He closed with: “The legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.”

South Dakota took Kennedy’s cue and passed its new sales tax nexus law in 2016, which was promptly challenged by Wayfair Inc. and others. A challenge was not only expected, but arguably welcomed to expedite the judicial review process. South Dakota raced through the state judicial system to get to the Court, where Kennedy wrote the majority opinion in Wayfair, striking down the half-century-old physical presence requirement in what can be fairly described as the most significant state tax case of the last quarter-century, if not longer.

Wayfair is a state taxation game-changer. Taxpayers (wholesalers, retailers, and buyers), states, and to some extent Congress, are wrestling with these new sales and use tax ground rules, as are taxpayers and states more broadly with the nexus implications on other taxes. Wayfair changes marketplace dynamics; it will change state revenue forecasts; it will lead to new sales tax legislation and administrative practices; it will likely influence nexus considerations for gross and net income taxes; and it affects financial accounting reserves and company revenue forecasts. With the new world economy flowing through e-commerce, it will create new, or at least elevated, issues with foreign commerce into the states. And those are just the currently identified issues flowing from Wayfair.

Kennedy was the catalyst for this sea change in state taxation. The significance of his decisions in Direct Marketing Association and Wayfair might be the equivalent of the three-point line to the game of basketball. Incidentally, the three-point line was introduced by the old American Basketball Association in 1967, the same year National Bellas Hess was decided.

Stirring the Cauldron

Arthur R. Rosen

Arthur R. Rosen is a partner in McDermott Will & Emery’s Miami and New York City offices.

Justice Anthony M. Kennedy’s impact on the most fundamental state and local tax issue — the extent of a subnational government’s tax jurisdiction over persons not within the government’s borders — is best viewed in light of the respective aftermaths of the Supreme Court’s rulings in Direct Marketing Association and Wayfair. The first of these aftermaths may be seen as a vigorously stirred caldron, while the second as a Category 5 hurricane in that same caldron (not a mere “tempest in a teapot”).

Although the Direct Marketing Association decision was ostensibly solely, about whether the federal Tax Injunction Act was applicable to a challenge to a specific state’s use tax reporting requirement statute, Kennedy — gratuitously, some might say — added commentary that unabashedly invited a relitigation of the Quill/National Bellas Hess physical presence criterion. It is likely that we will never know whether Kennedy wanted the issue to be relitigated or was merely trying to prod Congress into acting on the issue; in any event, his commentary created a major, vigorous stir in the SALT community. Those in state governments seeking sales and use tax jurisdiction over remote sellers had a very difficult time hiding their giddy glee — many announced that the physical presence criterion was all but dead. Those representing retailers seeking the same result were guardedly optimistic; since the Quill decision was primarily based on principles of stare decisis, and since North Dakota’s arguments in that case were as applicable today as they were then, their enthusiasm was restrained. Those businesses that wanted the physical presence criterion to remain — whether because of their happiness with a competitive advantage or because of their fear of attempting multistate compliance — were relatively optimistic because of the stare decisis aspect of Quill. Detached, objective practitioners were primarily concerned with the future of the stare decisis principle in the broader context of American jurisprudence (especially in tandem with Janus v. American Federation of State, County and Municipal Employees,⁶¹ which also overturned solid precedent). Those working in the SALT world, being in this bubbling cauldron, were getting dizzy.

Those who read the transcript of the oral argument in Wayfair were confident that the Court would again defer to Congress and thus rule for Wayfair, possibly with some strong language to encourage Congress to finally act. Those who attended the oral argument thought it more likely than not that South Dakota would prevail; those who focus on individual justices’ inclinations and histories reached the same conclusion. The aftermath of the decision, just like a hurricane on the far horizon, threatened massive pandemonium and destruction. State government officials were gratified by the prospect of increased revenue and fewer nexus fights (and obviating the need to develop and implement Quill workarounds, such as reporting and click-through laws). Retailers that were already collecting nationwide or virtually nationwide were, obviously, pleased. Those retailers that wanted the physical presence criterion to remain became concerned about compliance burdens and possible retroactivity — they thought that the Court’s mention of three aspects of the South Dakota statute that made that law not an “undue burden” on interstate commerce (and thus not unconstitutional for that reason) was too casual of a mention; they had hoped that if the Court overturned the physical presence criterion, it would do so with language such as “we highly doubt that a statute without thresholds equal to greater than those of South Dakota would not impose an undue burden on interstate commerce.” Many in the business community, as well as those representing such interests, were concerned that the states would see the nonchalant tone of this language in the Court’s opinion to be an invitation for them to proceed in any manner they wished — doing so would surely have caused the cauldron to abruptly explode.

As with many a hurricane, however, much of the territory potentially at risk escaped with only minor damage. With few exceptions, the states have responded honorably, admirably, and responsibly, establishing thresholds no lower than those of South Dakota’s and implementing Wayfair’s economic nexus approach on a prospective-only basis. However, there appear to be two or three states (it is yet too early to know how far these states will go) for which retailers are in the direct, devastating path of the storm. Rather than understanding that the replacement of physical presence by economic nexus should be applied prospectively only (based on fairness and the Court’s own comments), a couple of states are asserting that the earlier effective date of their economic nexus statutes should apply; at least one other state is demanding that its relatively unique — and probably illegal — Quill workaround be applied retroactively to the date of that state’s workaround statute; this seems to many as an arrogant “kick ’em while they’re down” attitude.

In sum, Kennedy created a huge boiling world, starting with his comment in Direct Marketing Association and likely ending as soon as the issues in the two or three recalcitrant states are resolved. It has been quite interesting to see the ups and downs of hopes and fears that he created in the various stakeholders. As one of my colleagues has described the situation, “Those in the state and local tax world who spent much of their careers reading the Quill tea leaves have now been told that there is no cauldron and there never was a cauldron even though they can still see the cauldron.” There have been very few — if any — individuals who have had such an impact on our SALT world.

Justice Kennedy Was a Boss

Mark F. Sommer

Mark F. Sommer is a member of Frost Brown Todd LLC in the Louisville, Kentucky, office, where he chairs the Tax, Benefits, and Estate Planning Practice Group and leads the firm’s tax and incentives practices.

Joining the Court in February 1988, Justice Anthony M. Kennedy served with the purest intentions and most admirably and honorably, leaving the Big Bench this year after 30 years. Perhaps known best in his role as the swing vote on many split decisions, and particularly after Justice Sandra Day O’Connor retired in 2006, Kennedy made a huge impact, including on the state and local tax world.

He is, as some of my children would say, “a boss.” He led the charge to refine and sharpen many areas of law, which directly or indirectly impact our state tax world. Going out guns a-blazing by writing the opinion that eviscerated the so-called Quill doctrine, he raised questions about the continuing applicability of stare decisis in SALT cases, or so some commentators suggest.

What a career, though, outside state tax. Writing the majority opinion in Citizens United, he was not afraid to stray into controversial social topics, including such generational cases like Obergefell and Planned Parenthood. In hindsight, and in evaluating his judicial career over a lifetime of service, regardless of which side of the aisle your politics finds you, a reasonable person must conclude that Kennedy called it the way he saw it, and in doing so did it with flair or understatement — his drop-the-mic moment was retiring just after Wayfair.

In Kennedy’s tenure, he saw well over 1,000 certiorari petitions seeking court review of SALT disputes. While we in the SALT community have a tendency to believe these types of cases are what the Court ought to be looking at, our professional bias surfacing, it is clear that for whatever part he played in deciding which cases SCOTUS would look at or not, he applied the same standard, and a measured one at that, regardless of the particular area of law involved.

Look at the SALT cases that came forward during his tenure, cases in which the Court did, and didn’t, act. In the 1996 term, the Court declined 87 SALT-related cases, granting certiorari in four, including General Motors v. Tracy⁶² and Newfound.⁶³ In the 1997 term, the Court heard only one matter with any kind of state tax implication, denying certiorari in 24 SALT-related cases. The number of SALT cases advancing continued to increase during Kennedy’s time, including the Court taking on a landmark matter in Hunt-Wesson.⁶⁴ The Court also heard the Woolworth v. Franchise Tax Board⁶⁵ case. Similar statistics on declinations, with a major case every few years, present themselves during Kennedy’s tenure.

Was he the swing vote in SALT matters that he undoubtedly was in other transformational cases? Were Kennedy’s actions paramount to which state and local cases made (or better stated, didn’t make) it to the full review stage of the Court? Only time will tell, but with two new justices on the Court in Neil M. Gorsuch and Brett M. Kavanaugh, notably both former law clerks for Kennedy, the next few years in SALT will be telling, and perhaps lead to a continued restatement of how we in the SALT world characterize Kennedy, perhaps as an agent of change.

Balanced Decisions More Reflective of Consistency Than Swing

Philip M. Tatarowicz

Philip M. Tatarowicz is a professor in the graduate tax department at the Georgetown University Law Center and is of counsel to Morrison & Foerster LLP’s Washington office. Tatarowicz thanks Rebecca M. Balinskas, an associate with Morrison & Foerster, for her assistance.

Many commentators characterize Justice Anthony M. Kennedy’s judicial record as more reflective of individually balanced decisions than slaved ideology. If true, it is from this judicial approach, when applied against the totality of his voting record, which touched a diverse array of social issues (e.g., abortion, gay rights, free speech, capital punishment), that Kennedy came to be identified as a swing voter, a moniker he openly disliked: “The cases swing, I don’t.” When Kennedy’s voting record is evaluated more narrowly, only considering his votes in decisions concerning state and local tax matters, one finds a record of individually balanced decisions reflective of consistency within the heartland, rather than ideologically driven overspray of the outliers.

Without serious question, in the field of state and local taxes Kennedy’s influence on the Court was most recently on display in overturning over 50 years of precedence — established in National Bellas Hess in 1967 and upheld by Quill in 1992 — requiring a physical presence in a state before that state may impose a sales or use tax collection obligation on a seller under the commerce clause. The rapid fall of the physical presence requirement began with Kennedy’s concurrence in 2015 in Direct Marketing Association — which no other justices joined – in which he called into question the continuing validity of the physical presence requirement.⁶⁶ Three years later, in Wayfair, Kennedy wrote the 5-4 decision overturning the physical presence requirement.

Unlike the discontent expressed by other justices in applying or expanding dormant commerce clause principles to judicially resolve SALT matters rather than deferring to Congress, Kennedy’s record, if nothing else, expresses no such reservation and supports broad application.

For example, he was part of the 5-4 decision in Newfound that struck down a property tax deduction applicable to charitable organizations on dormant commerce clause grounds.⁶⁷ Also, Kennedy joined the 5-4 decision of Wynne,⁶⁸ striking down a personal income tax regime, where one possible argument was that the dormant commerce clause was not needed, because the voters of Maryland could have ultimately resolved the disparate tax regime through their legislative process.

While one can reasonably differ over the decisions Kennedy reached in SALT controversies, overall his voting record reflects strong support for the application of dormant commerce clause principles, and a need for nuanced (not slaved) decision-making that is sensitive to temporal, material, contextual, and reliance factors.

For instance, contrary to the dissenting opinions in Wayfair that would have upheld Quill and its physical presence rule, the majority opinion written by Kennedy attributed less weight to stare decisis due to the contextual differences and material costs to the states resulting from the Court’s earlier and questionable decision in Quill.

Also reflecting Kennedy’s balancing approach are other dormant commerce clause decisions in which he joined the Court in striking down (or upholding) state tax levies deemed to impermissibly (or permissibly) discriminate and burden (not discriminate or burden) interstate commerce. For instance, Kennedy joined the Court’s opinions in such cases as New Energy Co. of Indiana v. Limbach (Ohio tax credit against its motor vehicle fuel sales tax impermissibly discriminated against protected commerce),⁶⁹ and Fulton Corp. v. Faulkner (North Carolina intangibles tax discriminated against interstate commerce).⁷⁰ In contrast, in American Trucking Associations Inc. v. Michigan Public Service Commission, Kennedy joined the Court’s decision holding that a fee lacking internal consistency was not impermissibly discriminatory.⁷¹

Kennedy’s tenure on the Court included other significant SALT decisions in which his balancing approach carried the day and continues to inform controversies involving similar substantive issues.

For example, on the corporate income tax front, early in his career on the Court Kennedy was the deciding vote and wrote the opinion in Allied-Signal. That 1992 opinion upheld the unitary business principle and the constitutional requirement that, in addition to having a connection with the entity subject to tax, a state must also have a connection with the activity it seeks to tax.⁷² Although Kennedy wrote the opinion of a 5-4 Court, the decision and the principles articulated in the opinion were later reaffirmed by a unanimous Court in MeadWestvaco in 2008.⁷³

Kennedy’s record will have lasting impact in a multitude of matters pertaining to the SALT world. While the Court will continue to issue decisions that shape the SALT field, so too will the thoughtful and reasonably balanced decisions of Kennedy remain the foundation upon which others may build.

Telling Examples

Kathleen K. Wright

Kathleen K. Wright is the director of the SALT program in the School of Taxation at Golden Gate University, San Francisco.

The implications of Justice Anthony M. Kennedy’s retirement on state tax matters are hard to predict. This is because his greatest contribution to the cases decided during his time on the Court — being the notorious swing vote — proved that he had the ability to change his mind. He was willing to consider the social and economic climate and allow the constitutional provisions to be interpreted against the current societal backdrop. His final decision in Wayfair is a telling example.

His last decision (and arguably most significant in state tax) was decidedly different from his prior decisions involving the dormant commerce clause, proving again how unpredictable Kennedy could be. In Wayfair, the Court overruled Quill and its physical presence nexus rule, which had applied since 1992 to states’ ability to require out-of-state retailers to collect sales tax. The issue was the dormant commerce clause, and whether a state could impose sales tax collection and remittance requirements on an out-of-state retailer without imposing an undue burden on interstate commerce. Kennedy wrote the majority opinion that cast off the burdens of physical presence and allowed the states to collect sales tax from out-of-state retailers with no physical presence in the state. The South Dakota statute at issue required only $100,000 in sales or 200 transactions to establish nexus for sales tax collection purposes.

In the past, Kennedy, an ardent supporter of the dormant commerce clause, voted for litigants challenging a state or local law that adversely affected interstate commerce. Although most of these cases were nontax cases, he did cast a decisive vote in Wynne, a Maryland case that struck down a state statute on the basis of the dormant commerce clause. At issue was a feature of Maryland’s personal income tax scheme denying a full credit to residents for income taxes paid to other states. Maryland’s personal income tax is composed of a state tax and a county tax. Maryland granted its residents a credit against their state tax liability, but it offered no such credit against the county portion. Since there was no relief, the Maryland resident who earned income outside Maryland paid the Maryland state income tax, the Maryland county tax, and the other state income tax. The Maryland resident got a credit for the income tax paid to the other state against the Maryland state income tax, but not against the county tax. Therefore, if the rate paid to the other state was higher than the Maryland tax rates, the Maryland resident was double taxed simply because his investment involved interstate commerce. The Maryland statute was struck down as unconstitutional, and Kennedy joined the majority opinion. This decision was more typical of other dormant commerce clause opinions written or joined by Kennedy, who was not a strong federalist.

Kennedy’s retirement became a concern in California because of another case pending before the Court, Franchise Tax Board v. Hyatt (Hyatt III),⁷⁴ which raises the question of whether Nevada v. Hall⁷⁵ should be overruled.

In Nevada v. Hall,⁷⁶ a Nevada state employee had a car accident in California and injured California residents. The California residents sued the state of Nevada in California state court and were awarded over $1 million damages. The Supreme Court ruled that the doctrine of state sovereign immunity did not prevent California residents from bringing their suit against Nevada in California court.

This issue became central to the ongoing litigation involving the California Franchise Tax Board and Gilbert P. Hyatt. Hyatt was audited after he moved to Nevada and started receiving large royalties on patents he was granted based on research done in California. Hyatt did not merely challenge the findings of the residency audit, but also the audit process, which he alleged involved an invasion of privacy. This case was brought in Nevada state court, and the FTB challenged whether it was protected from this kind of lawsuit under California’s law, which granted state sovereign immunity. The jurisdiction question ended up in the Supreme Court, which held that the full faith and credit clause did not require Nevada to substitute another state’s statutes for its own. The case was remanded to Nevada for a jury trial, which resulted in millions of dollars of damages against the FTB.

The FTB appealed the record damage award on the basis that damages should be limited to the amount awarded under Nevada law if the case involved Nevada employees. The case ultimately surfaced again at the Supreme Court and California asked the Court to overrule Nevada v. Hall.⁷⁷

On the issue of Nevada v. Hall, the Court split 4-4 ((Justice Antonin Scalia, the ninth member of the Court, had died in the interim and had not been replaced). Therefore, there was no opinion from the Court on this issue. The actual vote count by justice was never published, so we do not know how Kennedy voted.

Following a third appeal — to ask a full Court to rule on Nevada v. Hall — the Court accepted jurisdiction of the case. So how would Kennedy vote? The lawyer representing the FTB in Hyatt II is quoted as having said that based on questions from the justices, he believed that Kennedy might be interested in overruling Nevada v. Hall.⁷⁸ In light of his decision in Wayfair, that conclusion might have been his next step toward achieving his long-standing mission, which was a result that is right for the parties involved at that time and in that place.