Supreme Court Eliminates “Judicially Created Tax Shelter”

Blog
June 25, 2018

On June 21, the U.S. Supreme Court issued its long-awaited decision in South Dakota vs. Wayfair, Inc.  The ruling overturns it’s 26 year old “physical presence” sales tax nexus standard established in Quill Corp. v. North Dakota. In doing so, the Court upheld the constitutionality of South Dakota’s law establishing a sales tax collection requirement if a seller’s annual in-state sales exceed $100,000 or if a seller engages in 200 or more transactions involving in-state deliveries of goods or services. In anticipation of the Court’s decision, many other states had already enacted similar legislation, and others are sure to follow.

Prior to the landmark decision in Wayfair, a state could not require a retailer to collect the state’s sales tax unless the retailer had a physical presence in the state. Thus, online retailers, such as Wayfair or Overstock.com, have not collected any sales tax on sales to states in which they had no physical presence, including an office or warehouse. As consumers increasingly buy more and more from online retailers, states have seen a significant loss in revenue due to sales tax not being collected on an increasing number of transactions. The Wayfair decision cites estimates of annual revenue losses of between $8 to $33 billion.

Although the Court was clearly swayed by state revenue losses due to the expansion of modern e-commerce, it went out of its way to declare that the “physical presence” rule established in Quill was an “incorrect interpretation of the Commerce Clause” even when is was “first formulated.” The opinion labeled the Quill standard “flawed on its own terms,” “arbitrary, formalistic,” and a “judicially created tax shelter.” It was this flawed, arbitrary tax shelter created by the Court that compelled the majority to disagree with the dissenting opinion’s position that only the legislature is suited to overturning Quill.  The justices joining the majority opinion saw it as “inconsistent with the Court’s proper role to ask Congress to address a false constitutional premise of [the] Courts’ own creation.”

Requiring a retailer to have a physical presence in a state before having a sales tax collection obligation, in the Court’s opinion, has created market distortions. Local businesses and multistate business that already have a physical presence in a state are at a competitive disadvantage to online retailers that chose a different business model. It’s difficult to determine which types of business will benefit more from the Wayfair decision – big-box retailers that already collect sales tax in most, if not all, states, such as Target and Walmart, or small town businesses losing out to online sellers that have not been required to collect tax in the past.

Although the Court upheld South Dakota’s law in part because of the small seller safe harbor created by the annual $100,000 sales and 200 transaction thresholds, some smaller businesses will now be required to collect and remit sales tax in more states. These businesses need to look past the headlines that label the Court’s decision as an “Internet sales tax.” The Wayfair decision applies to all sellers of taxable products and services, not just those engaging in e-commerce retail sales. For example, a company that supplies certain construction materials to contractors that has not collected tax on sales to certain states where it has a number of customers will need to analyze the impact of the decision on its sales tax collection obligation. The same can be said for a software company that sells software-as-a-service to customers in others states. These types of businesses can easily reach $100,000 in annual sales to a particular state, usually much quicker than many small online retailers.

If you have any questions about the impact of the Wayfair decision on your business, please contact Michael Colavito or one of our tax advisors at 301.231.6298.