Supreme Court Drops Physical Presence Test: Open Season on Out-Of-State Sellers

June 21, 2018

In South Dakota v. Wayfair, Inc. et al., No. 17-494 (June 21, 2018), the U.S. Supreme Court explicitly overruled Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967). These decisions required, as a matter of constitutional due process, that a vendor have a “physical presence” within a state before the state could require the vendor to collect and remit that state’s sales tax. With Quill and National Bellas Hess overruled, a state can now require both in-state and out-of-state vendors to collect and remit its sales tax for sales made within the state. In short, a vendor’s lack of “physical presence” within a state no longer determines its sales tax obligations.

Although the court affirmed the constitutionality of applying South Dakota’s statute to the taxpayers in Wayfair, it did not determine what level of sales activity amounted to a “substantial nexus” sufficient to subject an out-of-state seller to sales tax obligations under Complete Auto Transit, Inc. v. Brady, 430 U. S. 274 (1977). Citing “both the economic and virtual contacts” the taxpayers had with South Dakota, the court observed that South Dakota’s statute applied only to sellers that conducted 200 or more transactions, or delivered $100,000 or more in goods and/or services, annually. It noted that this volume of business “could not have occurred” by accident, and said the taxpayers were “large, national companies that undoubtedly maintain an extensive virtual presence.”

Even as it relegated long-established jurisprudence to the dustbin, the court’s sweeping decision was at pains to note that it left for another day legal challenges that may emerge relating to the effect, as well as the administration and enforcement of, out-of-state sales tax obligations. The Wayfair majority cited the possibility of further challenges to out-of-state tax regimes as engaging in unfair discrimination, or placing undue burdens, on out-of-state sellers. The court also noted that statutes that impose retroactive liability for sellers may violate the court’s apportionment jurisprudence, as both buyers and sellers would be liable for the same tax. And overly complex or cumbersome state tax systems could effectively discriminate against smaller businesses with few sales in many jurisdictions.

A number of narrow questions emerge from the Wayfair decision and can be expected to receive an array of answers from the nation’s taxing jurisdictions. Most obviously, how does the substantial nexus test work for taxpayers with less sales revenue, fewer transactions or a smaller virtual presence than those in Wayfair? How will states police these limits to determine whether an out-of-state seller must comply? What about state statutes that are retroactive in their terms or in their enforcement, as states seek to collect from out-of-state sellers, as sales tax, the use tax that has long been due from in-state buyers? Practically, how will sellers comply with the maze of collection and remitting obligations, and avoid expensive enforcement actions and ruinous penalties? Expect these issues to generate legislation and litigation for years to come.

McGuireWoods represents retail e-commerce businesses in all aspects of their operations. McGuireWoods state and local tax attorneys offer extensive experience in all aspects of state and local taxation and actively monitor tax legislation. Over the past several years, many states and localities across the country have attempted to require out-of-state vendors to collect and remit sales tax. McGuireWoods attorneys are familiar with these laws and follow their development in Virginia and other states.

In addition, McGuireWoods offers a full range of state and local tax planning and litigation services to public and privately held taxpayers of all types and sizes. They are well-versed in all aspects of state and local tax planning, as well as tax compliance, including civil audit and general and procedural matters before local and state tax authorities. McGuireWoods lawyers regularly represent clients in the preparation of private letter ruling requests, administrative tax protests, and offers in compromise for outstanding tax assessments. They offer the complete range of trial and appellate state and local tax litigation services frequently demanded by cutting-edge taxpayers.

For further information about the Wayfair opinion or any other state or local tax issue, please reach out to the lawyers listed or your regular McGuireWoods contact.