The old joke is the only things certain in life are death and taxes. This cliche hasn’t necessarily been true online where we’ve spent two decades arguing over whether online retailers should collect and pay sales tax to jurisdictions the retailer has no nexus with. After taking its sweet time, the Supreme Court has finally addressed the issue. While states will be happy with the ruling, all is not lost for smaller retailers.
Ah, the Internet. A platform for the exchange of vast amounts of information. Unfortunately, the web is also a platform for the spread of vast misinformation. If you are reading articles online about the doom and gloom of the sales tax decision, most are simply wrong. Instead of reading such trash and panicking, I would encourage you to read the actual decision so you know what the Supreme Court is stating versus the chicken littles of the web. The decision in this case – South Dakota vs. Wayfair – is only four pages long. Give it a read here. Knowledge is power.
To understand the online tax issue, we need to travel back in time to the days of marketing through catalogs. Much like email marketing today, companies built fortunes by sending out thick catalogs full of products to consumers who could then sit on the bathroom throne while dog-earing pages for products they intended to order. Recognizing the volume of business being conducted, states sued the catalog companies seeking sales tax. Catalog companies responded by arguing they only had a sales tax collection obligation if they had a physical presence in the state. In cases such as National Bellas Hess v. Department of Revenue of Illinois, 386 U.S. 753 (1967), the courts ruled again and again in favor of the catalog companies. No physical presence in a state equaled no requirement to collect and pay sales tax.
The law was clear…and life was good.
Then the world of commerce changed radically.
A computer file exchange platform evolved into something called the Internet and became a massive commercial medium. The age of catalogs faded to be replaced by online retail giants such as Amazon and smaller businesses hocking their goods on a borderless web. If the Internet was borderless, many wondered, did the catalog-sales tax decisions of the 1970s still apply?
And there was much arguing [to the profit of lawyers such as moi].
The “Amazon sales tax” wars generated a decade or more of litigation, appeals, thumbing of noses and rolling of eyes as courts struggled with the question while a Supreme Court comprised of croquet-playin’ mint munchers…err, munched mint and let the issue fester because, hey, this new-fangled Internet thing will never last.
Well, the Internet survived and grew. After asking their great-nephews to get them online, the Supreme Court Justices agreed to hear an appeal in the case of South Dakota vs. Wayfair, Inc. – addressing whether the catalog cases are still good law.
The Supreme Court’s answer? No. Specifically, “Because the physical presence rule of Quill is unsound and incorrect.”
As the Court notes, “When the day-to-day functions of marketing and distribution in the modern economy are considered, it becomes evident that [the] physical presence rule is artificial… Modern e-commerce does not align analytically with a test that relies on the sort of physical presence… And the Court should not maintain a rule that ignores substantial virtual connections to the State.”
Reading to this point in the decision, one might think the Supreme Court has given states the authority to collect sales tax from online retailers without limitation. Many commentators have suggested as much, but this is incorrect.
A New Test
In ruling on the case, the majority opinion as drafted by Justice Kennedy, doesn’t just terminate the physical presence test, it replaces it with a new version – the substantial test.
“In the absence of … Bellas Hess, the first prong of the test…simply asks whether the tax applies to an activity with a substantial nexus with the taxing State. Here, the nexus is clearly sufficient. The Act applies only to sellers who engage in a significant quantity of business in the State, and respondents are large, national companies that undoubtedly maintain an extensive virtual presence. Any remaining claims regarding the Commerce Clause’s application in the absence of Bellas Hess may be addressed in the first instance on remand.”
While the language may be vague, it points to two critical facts in the case:
1. The South Dakota sales tax law only requires out of state online retailers that generate sales of $100,000 plus a year or 200 transactions from the state to collect and pay sales tax.
2. The defendants are all large companies that will not be unduly burdened by building compliance systems.
The decision suggests that where these two factors are not present, the Supreme Court would rule against the states. Indeed, the majority decision concludes with,
“Any remaining claims regarding the Commerce Clause’s application in the absence of … Bellas Hess may be addressed in the first instance on remand.”
In short, this battle has not concluded.
Let’s start with a simple question. Does your online business generate more than $100,000 in sales or 200 transactions from South Dakota? If not, you don’t need to worry about collecting and paying sales tax to the state. Given the nature of the ruling, one can reasonably expect that many other states are going to draft sales tax laws or regulations that contain similar thresholds. Yes, a few states will set no minimums, but those states will face an uphill battle in court based on this Supreme Court decision.
What do you do now? Talk with your CPA and look for sales tax software programs online. States will likely take a few months to react to the new decision so the world isn’t ending tomorrow. Relax. Enjoy the fourth of July weekend, and then deal with it the week after.
Richard A. Chapo, Esq.