David: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. There is a case before the U.S. Supreme Court that should interest anyone in the United States who buys goods online. And given that this is a podcast, I'm going to go out on a limb and assume that this affects all of our U.S. listeners.
The battle lines in this case pit states with sales taxes that want to protect their tax base with their allies in the brick-and-mortar retail industry hoping for a level playing field against online retailers who until now have avoided collecting and remitting sales taxes in states where they lack a physical presence. Here to explain the situation in greater detail is State Tax Today legal reporter Jad Chamseddine, who has been covering this case. Jad, welcome to the podcast.
Jad: Hi, David. Thanks for having me.
David: We're talking today about South Dakota v. Wayfair. Jad, why is this case so important, and why are states lining up behind South Dakota?
Jad: This case basically boils down to whether an online retailer like Wayfair needs to collect sales taxes and remit them to the state, even though they're not located in South Dakota and ship their products into a state through a third-party delivery service or a common carrier like UPS or the postal service. The last time a similar case made its way to the Supreme Court was in 1992, in a case called Quill Corp. v. North Dakota and dealt with filling out purchase orders on a floppy disk.
David: Floppy disks? Okay, so this really comes down to the growth of online shopping with states feeling like they're losing a lot of money and brick-and-mortar stores being placed at a competitive disadvantage.
Jad: That's correct. No one could have predicted the rise of e-commerce in 1992, and it's still growing. According to the U.S. Department of Commerce, in the fourth quarter of 2017 alone, U.S. retail e-commerce sales were $119 billion, a nearly 17 percent increase from the same quarter in 2016. States like South Dakota are arguing that it's unfair because the law is not changing with the times and it's leading to revenue losses. Many states are also arguing that it hurts mom-and-pop shops in their states unable to compete with the online retailers.
David: Now, the argument here seems to be that the physical presence test is outdated and that the law should be brought up to modern standards.
Jad: Correct. The Supreme Court has looked to other variations in the past. They created this physical presence standard actually in 1967 in a case called National Bellas Hess v. Illinois, and it had to do with catalog retailers. I mentioned earlier the Quill decision that involved a company that sold office supplies and would provide customers with floppy disks to fill out purchase orders, but did not have any sales reps, offices, or workers in North Dakota. The Supreme Court ruled against North Dakota and found that the lack of a physical nexus within the state prevented the state from collecting taxes.
David: So now it’s South Dakota going to the Supreme Court against Wayfair.
Jad: Yes. South Dakota passed a law requiring remote sellers that lack a physical presence but have an economic presence in the state — meaning they have $100,000 worth of sales into the state within a given year or 200 transactions into the state — would need to collect sales taxes. This ended up as a lawsuit, with the state suing online retailers Wayfair, Overstock, and Newegg. The South Dakota Supreme Court ruled in favor of the remote sellers because of the precedent set in Quill.
David: Would it be fair to say that this law was created specifically to challenge Quill?
Jad: That's correct. Several state legislatures had so-called kill-Quill legislation on the books. South Dakota was the furthest along, which is why their case got taken by Supreme Court.
David: So why wait 25 years to challenge Quill? Online retail has been a major factor since at least the year 2000.
Jad: Many practitioners look at the concurring opinion penned by Justice Anthony Kennedy in DMA v. Brohl in 2015, a case dealing with use taxes, as an invitation for states to challenge Quill. Kennedy discussed a growth of internet retailers and the lack of taxes they pay to states, basically saying it was time to revisit Quill.
David: Now, you mentioned use taxes. Having filled out my Virginia income tax form lately, I remember a question about how much I purchased from retailers outside of Virginia. What exactly is the use tax?
Jad: You're not alone in not knowing what a use tax is. Most people actually don't know that when they buy a product from an online retailer, they may have to pay a use tax on it, which is basically a sales tax but collected from the consumer. It is rarely collected and enforced, and state governments don't want to go after individuals for a few pennies, so instead they'd rather force the retailers to collect a sales tax from the customers. It's simply easier.
David: As I understand it, there was some level of shock and surprise in the state tax community when the court agreed to hear this case. Why is that?
Jad: Yes, most lawyers and policy experts were not expecting the court to take this case. The majority of lawyers at SALT conferences were pessimistic about its chances, expecting the court to leave it up to Congress because of its political nature.
David: Well, now that this is before the Supreme Court, how is South Dakota trying to convince justices to abandon the physical presence test?
Jad: In its briefs to the court, the state's main argument is that the advent of the internet has made the physical presence rule arbitrary and unclear since the seller can have a substantial economic presence in the state even though they don't have a physical presence there.
David: Is it likely that the Supreme Court will be concerned that some smaller businesses may have trouble collecting and remitting taxes from the various jurisdictions?
Jad: That is certainly an argument that has been raised by past courts in both Bellas Hess and Quill. Since every state and locality has its own taxes, businesses operating in one state have to comply with numerous tax jurisdictions. Just imagine the entire country. There are over 9,000 local taxing authorities in the United States. But South Dakota is arguing that certified service providers have the technology and resources to make collecting and remitting easier. Several states have agreements with these providers, limiting liability in case of mistakes.
David: So what do practitioners see happening in this case? Do they expect the Court to overrule Quill?
Jad: Certainly most petitioners we spoke with expect the Court to do more than just affirm Quill. As most have put it, why take the case in the first place? One of the law professors we spoke with said chances are always good when betting on the petitioners in a Supreme Court case. Several practitioners and law professors expect the physical presence standard to be replaced with another threshold. Some expect that the court will uphold South Dakota's threshold requiring a certain amount of sales into the state to become the new norm. This would allow small online retailers to be exempt from collecting and remitting sales taxes if they don't hit the threshold numbers. But, many have argued that the threshold should be uniform and the Court should provide some sort of guidance if they don't think South Dakota’s standard is good enough. After all, $100,000 in sales in South Dakota is very different from $100,000 in sales in New York or California.
David: This will be a major change. Are states ready for a ruling in their favor?
Jad: Most states I spoke with seem ready to register online vendors and have them collect and remit. Many states already had certain rules on the books allowing for voluntary registration and collection of sales taxes, so the next step wasn't going to be too hard. Quite frankly, most states are eager to collect sales taxes.
David: Now this case goes back a few years, so retroactivity would seem to be a looming issue. Is that something that's expected to be addressed?
Jad: Most tax administrators told me that they're not interested in bankrupting companies with large sales tax bills, but ultimately those decisions are up to the legislatures to decide. There wasn't a tax commissioner willing to commit that retroactivity would be banned by their department. Some states, like Indiana, which passed a kill-Quill bill last year, would have retroactivity dating back to July 1, 2017, according to Indiana [Revenue] Commissioner Adam Krupp.
David: Can the U.S. Congress step in and settle this whole mess and deal with the retroactivity of remote sales and all that?
Jad: Yes, they can. And that was acknowledged by the Quill Court. But like most things in politics, it gets complicated. The idea of requiring internet retailers to collect and remit sales taxes if they don't have a physical presence remains a polarizing subject and has created strange bedfellows.
David: How so?
Jad: Well, you have lawmakers from states like New Hampshire, which doesn't have a sales tax, urging the Court to keep the physical presence standard. And that includes Democratic Senator Jeanne Shaheen. While on the other side you have Democrats like Heidi Heitkamp from North Dakota pushing for a bill that requires online sales to be taxed. Several bills have been introduced over the years, including in this session, but none have gained traction. The Senate in 2013 came closest by passing the Marketplace Fairness Act by a wide margin, which would've required large internet retailers like Amazon to collect and remit sales taxes. But the companion bill in the House, sponsored by a Republican, couldn't get a hearing in the House Judiciary. This has been a major hurdle because of House Judiciary Chairman Bob Goodlatte, a Virginia Republican who has vehemently opposed such measures over the years and is currently blocking the Remote Transactions Parity Act, which is sponsored by a fellow Republican.
David: With the Supreme Court about to act on Quill, is there any chance of a change of heart?
Jad: No, it doesn't appear likely. After the Court took the case, Goodlatte’s office told me that he will continue to protect consumers. And although lawmakers are pushing hard for Congress to act before the Supreme Court does, there just isn't enough political will in the Capitol to deal with such a sensitive subject.
David: Has the Trump administration taken a position on this?
Jad: Not officially, but the solicitor general submitted an amicus brief backing South Dakota in which it argued that a virtual presence in a state is enough for the state to collect taxes. The White House, through Treasury Secretary Steve Mnuchin, has indicated it would support having online retailers collect taxes, while Donald Trump has over the past year directed some of his ire against Amazon.
David: This is definitely something we want to keep an eye on. Jad, where can listeners find you online?
Jad: Well, they can find me on Twitter @J-C-H-A-M-S-E-D-D-I-N-E-10.
David: Thank you for being here. That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. Be sure to subscribe to us on iTunes or Google Play to make sure you get the next episode of Tax Notes Talk.
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