On April 17th, the United States Supreme Court heard oral arguments in the case of South Dakota v. Wayfair, Inc. In this case, the Court will decide whether it should overturn the physical-presence limitation established in the 1992 case, Quill Corp. v. North Dakota. In that case, a previous court held that the Constitution’s Commerce Clause prohibits states from requiring out-of-state retailers that do not have a physical presence in a given state to collect sales tax for sales to in-state residents. Their decision could have far-reaching implications for large and small businesses that could be required to compute and collect sales taxes in more than 11,000 jurisdictions nationwide.
By way of background, in 2016, South Dakota enacted a law that requires any vendor who, in the current or prior year, that had more than $100,000 of sales in South Dakota, or who engaged in 200 or more transactions with in-state consumers, to collect state sales tax. The law did not require that the vendor have a physical presence in the state at the time of the sales. Many online retailers were strongly opposed to this new law. Three large online retailers, Wayfair, Overstock and Newegg, filed suit claiming that the law violated the Supreme Court’s decision in Quill. On the heels of this legal action, several other states quickly enacted similar laws, hoping to regain some of the tax revenue lost to online sales. There are currently four cases open in state courts (Alabama, Indiana, Tennessee, Wyoming), all waiting for the Wayfair decision.
By hearing the oral arguments for this case, the Supreme Court has taken on the responsibility of providing clarity on the constitutionality of broadly applying sales tax to internet sales. Times have changed since the Quill decision, which actually involved mail-order purchases. At the time, online retailing was virtually unheard of.
Fun Fact: It is reported that the first secure online sale wasn’t documented until 1994 –a sale of Sting’s Ten Summoner’s Tales CD album.
What’s at stake?
During the past twenty years, states that rely heavily on sales tax for revenue have lost a significant amount of money due to online sales. It is estimated that these forty-five states are losing between $8 and $13 billion in sales tax revenue per year.[i] The losses increase each year as online sales grow and brick and mortar store sales dwindle and stores have no choice but to close. Many brick and mortar stores, specifically mom-and-pop stores, are unable to match online prices due to the overheard costs of maintaining a physical storefront.
Opponents argue that collecting sales tax on online sales will hurt online small businesses who will not be able to handle the burden and cost of compliance. This increased burden would hurt their bottom line and force them out of business.
Which way is the Court leaning?
One of the concerns discussed in the Quill decision was that mail-order retailers faced difficulties in complying with tax obligations from the various jurisdictions. At that time, there were approximately 6,000 separate state and local taxing jurisdictions nationwide. According to the Tax Foundation, in 2017, there were roughly 11,000 state and local taxing jurisdictions nationwide and this number continues to grow each year. This also makes compliance a major concern for the Justices in the Wayfair case and they noted that they lacked the information about both the difficulty and cost of collecting these taxes.
During oral arguments, Justice Ruth Bader Ginsburg noted there could be a market solution, stating “if we did overrule Quill, entrepreneurs would produce software that would meet the market need.” In fact, there are automated tax software solutions in the marketplace that provide tax calculations as well as electronic filing capabilities, including QuickBooks Online.
Alternatively, however, Justices Sonia Sotomayor, Stephen Breyer, Elena Kagan, Samuel Alito and seemingly Chief Justice Roberts indicated that it may be best to leave the Court’s precedents in place and let Congress address the subject of online taxation separately. It is uncertain, however, whether Congress will act. States have been pressing Congress to address this issue for the last decade, requesting a level playing field between brick and mortar stores and online retailers. Despite the interest, Congress has, so far, shied away from addressing the issue of tax on online sales.
What to expect:
The Court is expected to issue a decision in Wayfair in mid-June. The Justices appear to be closely divided, cautious about changing the long-established rules of interstate commerce, while aware of arguments to level the playing field.
There are several potential outcomes. First, the Court could simply uphold South Dakota’s legislation and overturn Quill. Second, the Court could establish its own standards in this area and then evaluate the South Dakota legislation based on these new standards. Lastly, the Court could let Quill stand and push the decision to Congress.
What we do know is that, no matter the decision, it is unlikely to please everyone. For now, states, online retailers, and small businesses wait for a decision that is likely to impact online sales for years to come.