U.S. Supreme Court Broadens the State Sales Tax Base

06.25.2018

On June 21, 2018, the U.S. Supreme Court issued one of its most significant state tax rulings in last five decades. Most states impose a sales tax on the retail sales of goods and services to consumers in the state, obligating sellers to charge, collect and remit the sales tax to the state. In South Dakota v. Wayfair, et al. No. 17-494, the Court broadened the tax base for states’ sales tax to potentially include out-of-state sellers making sales into a state via e-commerce transactions.

However, under the Commerce Clause of the U.S. Constitution out-of-state sellers transacting with consumers in the state must have a “substantial nexus” with the state before the state can require the remote seller to collect and remit sales tax to the state. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977). In National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967) and reaffirmed in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the Court held that, for a substantial nexus to exist and for the state to be able to impose the sales tax, a seller must have a “physical presence” in the state.

As e-commerce has proliferated over the decades since Quill, the physical presence rule has repeatedly been questioned. After numerous legal challenges to the physical presence test, the Court has just overturned Quill in its Wayfair decision, thereby eliminating the physical presence test. Thus, the new standard for the constitutionality of a sales tax on an out-of-state seller is whether the activities of the seller constitute “substantial nexus” with the state as the Court set forth in Complete Auto.

In Wayfair, the Court held that South Dakota’s economic presence test satisfies the substantial nexus standard for obligating remote sellers to collect and remit South Dakota sales tax. The South Dakota test requires out-of-state sellers to collect and remit sales tax if the seller’s sales in South Dakota exceed either an aggregate of $100,000 gross revenue annually or 200 separate transactions.

Though the Court found that South Dakota’s economic presence test satisfied the substantial nexus standard, note that the Court remanded the case for the lower court to consider if “some other principle” of the Commerce Clause “might invalidate” South Dakota’s sales tax on out-of-state sellers. Specifically, a state's tax must satisfy Complete Auto's additional three prongs in addition to the substantial nexus standard. The state tax must be: “fairly apportioned,” “fairly related” to the services provided by the state, and not discriminatory against interstate commerce. Therefore, the lower courts may provide further clarification or details for an acceptable economic presence test in light of the Complete Auto substantial nexus standard as well as further guidance on the remaining three prongs. 

Based on the South Dakota economic presence standard discussed in Wayfair, not every out-of-state seller will be subject to every state’s sales tax. Instead, determinations must be made on a case by case basis to determine whether the seller’s activity, by its assets, employees, contractors, economic activity or other contacts with a state, is sufficient for the seller to have a substantial nexus with the state to obligate the seller to collect and remit sales tax to the state in conformity with Commerce Clause principles.

Going forward, to the extent they have not already done so, most, if not all, states and localities will likely adjust their sales tax rules to obligate out-of-state sellers having substantial nexus with the state to collect and remit the state’s sales tax. Many jurisdictions may implement an economic presence standard for substantial nexus similar to South Dakota, and it remains to be seen what other economic and/or affiliate connections of a seller may be upheld by courts as also creating substantial nexus. For a determination and guidance in a specific case, please reach out to a member of the Hirschler Fleischer Tax Team.