The US Supreme Court’s decision in South Dakota v. Wayfair.
Earlier today, the United States Supreme Court issued its opinion in South Dakota v. Wayfair, et al. In 2016, South Dakota passed a law that requires out of state vendors to collect its sales tax if those vendors had: (1) $100,000 of sales into the state or (2) more than 200 separate transactions for the delivery of goods or services into the state. Wayfair (an online furniture retailer) sold goods from its website to customers in South Dakota and did not collect sales tax on those transactions. South Dakota sued to compel Wayfair (among others) to collect its sales tax. Justice Kennedy’s majority opinion, finding in favor of South Dakota overruled 26 years of judicial precedent in this area. Prior to Wayfair, states could only make companies with a physical presence in the state collect and remit sales tax on transactions with in-state customers.
States have been trying to get around the physical presence requirement for years. There was a whole stream of affiliate nexus, agency nexus, and flash nexus cases in the early 2000s. These cases have only gotten weirder as business has evolved and our societal relationship with the internet has changed. Most recently, we’ve seen Massachusetts assert that a company has physical presence in a state when that company’s website places a “cookie” on a customer’s web browser. This is based, in part, on the theory that electronic information has a physical component, which is beyond the scope of this discussion.
One of the problems states have had in eliminating the physical presence rule is the legal concept of stare decisis – to stand by things decided. This means that a court must give deference to the applicable prior legal opinions. The majority in Wayfair glossed over the deference that it must give the prior opinion with the broad pronouncement, “If it becomes apparent that the Court’s Commerce Clause decisions prohibit the States from exercising their lawful sovereign powers in our federal system, the Court should be vigilant in correcting the error.” (no citation given). The court also stated: “Though Quill [the earlier cases] was wrong on its own terms when it was decided in 1992, since then the Internet revolution has made its earlier error all the more egregious and harmful.” So contrite was the court that Justice Thomas used his separate concurrence to express remorse that he hadn’t joined in Justice White’s dissent in the original Quill decision. Chief Justice Roberts, joined by Justices Breyer, Sotomayor, and Kagan, state that State had not overcome the burden of proof necessary to overturn the earlier cases.
In Wayfair, the Supreme Court opinion focused on the evolution of online sales and the “significant revenue loss” to the states that has resulted from the requirement that vendors have a physical presence. Justice Kennedy’s opinion specifically called out a statement on Wayfair’s webpage that stated, correctly, “[o]ne of the best things about buying through Wayfair is that we do not have to charge sales tax.” The irony of this position is that each state that has a sales tax also has a use tax. Use taxes are complementary taxes whereby an individual resident of that state is required to remit use tax, if they don’t pay sales taxes on the transaction, at the same rate that they would pay sales tax if the sale “occurred” in Oregon. Use taxes are unpopular and many states are incompetent at compelling their residents to remit use tax. If the states were better at collecting use tax, there wouldn’t be any revenue loss at all. Prior to this decision, while Wayfair didn’t have to collect sales tax, its customers in South Dakota still did have to self-assess and remit use tax.
The court said that the South Dakota thresholds, noted above, created the presumption of a company having “minimum contacts” with a state sufficient to survive constitutional scrutiny.
The Court’s decision in Wayfair is going to open the floodgates for state sales tax audits on out of state companies that sell goods or perform enumerated services for customers in their states. Many of these states have statutes that allow them to impose their tax systems “to the fullest extent allowed by law” (i.e., under the Constitution).
There has been a question for some years about whether Congress would act to address the question about when physical presence is required for states to tax transactions. In part, the question has been gaining traction because many states have started to impose their non-sales taxes (income, franchise, etc.) on out of state vendors that have so-called “economic nexus” with the state. Justice Gorsuch’s separate concurrence invited a discussion of whether there is a discussion that needs to take place about the role of Article III courts to invalidate state laws. Specifically, Justice Gorsuch does not appear to agree entirely with the Court’s prior dormant commerce clause holdings, preferring to defer to Congressional action to regulate interstate commerce. Chief Justice Roberts’ dissent correctly noted that “A good reason to leave these matters to Congress is that legislatures may more directly consider the competing interests at stake. Unlike this Court, Congress has the flexibility to address these questions in a wide variety of ways.”
From a practical perspective, one of the biggest issues with this case is that the majority opinion basically ignores the issue of how horrifically complicated it will be for companies to report sales and use tax to all taxing jurisdictions where they are over the minimum thresholds. It states “Eventually, software that is available at a reasonable cost may make it easier for small businesses to cope with these problems.”
In 2018, there are over 10,000 state and local jurisdictions that impose a sales tax on their customers. Most of these overlap in one way or another, so (for example) a taxpayer could buy a widget for $10 and pay $1 of tax. This may be broken up as: (1) a state level tax at 6%; (2) a municipal tax at 2.5%; (3) a school district tax at 1%; and, (3) a cultural district tax at 1%. This taxpayer’s neighbor, across the street is located outside of the cultural district, but may be located in a football stadium district that imposes a rate of 2%. If the widget vendor rises to the minimum economic level, its invoicing systems will have to distinguish between the different taxing districts and assess the correct rate of tax on both sales (10% and 11%, respectively). Therefore, the widget vendor is going to have to buy complex and expensive software and then integrate it with its existing systems to know whether transactions are subject to tax. Chief Justice Roberts’ dissent correctly called out the majority: “The Court, for example, breezily disregards the costs that its decision will impose on retailers. Correctly calculating and remitting sales taxes on all e-commerce sales will likely prove baffling for many retailers.”
Why Should Oregon Business Care?
Oregon, emphatically, does not have a sales tax. Except on heavy equipment, bikes and cars…. So, ya know…. But we don’t have a sales tax!
Oregon business owners, however, sell things to customers outside of the state to jurisdictions that do assess a sales tax on their residents. Therefore, if the Oregon business crosses the state’s economic nexus thresholds it will now be required to collect and remit sales tax to that state. Each state has different thresholds and we expect that we’ll see states asserting economic nexus that have previously abstained from doing so as a way to export their tax collection obligation to out of state folks.
One thing to keep in mind as well in this new world order is the fact that sales tax is imposed on the sale of tangible personal property at retail AND certain specific enumerated services. Most service business owners in Oregon don’t think of what they are providing as taxable, so they should confirm that they are still not subject to tax in the states where they provide services to customers. Areas that are often taxed by states may include: Services related to tangible personal property (decorating, repair, etc.); Services to real property (landscaping, maintenance, decorating, etc.); personal services; Business services; Professional services (lawyers, accountants, physicians, etc.); and amusement/recreation services. We’ve seen a tremendous rise in the last few years of services provided remotely or over the internet and of “software as a service.” These may also be subject to tax.
A large number of our clients are now going to be subject to sales tax collection and remittance requirements. Therefore, we’re going to do a few blog posts in the next few weeks — sales tax 101 — for our Oregon business owners.