Fifty years of sales tax policy in the United States is coming to an end. In South Dakota v. Wayfair Inc. (Wayfair), the U.S. Supreme Court on June 21 ruled in a 5-4 decision that the physical presence standard for sales tax collection is no longer the law of the land. Retailers across the nation must prepare for a profound increase in sales tax collection responsibilities as states adapt their laws to this new judicial standard.
The physical presence standard has been the cornerstone of sales tax policy in the United States for the last half century. The standard was first imposed by the Supreme Court in 1967. The physical presence standard in simple terms requires a retailer to have physical presence in a state before that state can impose sales tax collection requirements on the retailer's in-state sales.
The proliferation of online retail business in recent years allows a vast number of merchants without physical presence in a state to sell goods or services that are "free" of sales tax. Consumers are required in these circumstances to remit use tax on their purchases; however, compliance under this self-assessment system is notoriously low. The Court in Wayfair noted that states lose between $8 and $33 billion every year as a consequence of this framework, where ". . . the impracticability of [this] collection from the multitude of individual purchasers is obvious."
The Wayfair ruling
In the majority opinion, the Court notes that ". . . the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.” The Court then provided three reasons to support its decision to overturn Quill:
- The physical presence rule "is not a necessary interpretation" of the requirement that an activity must have a substantial nexus with the taxing State;
- The physical presence rule "creates rather than resolves market distortions;" and
- The physical presence rule is an "arbitrary, formalistic distinction" disavowed by modern precedents to the Commerce Clause.
In bolstering its rationale, the Supreme Court in Wayfair frequently cites injustices associated with sales tax policy that has been applied to online businesses and their "brick and mortar" counterparts. According to the Supreme Court [citations omitted]:
Quill puts both local businesses and many interstate businesses with physical presence at a competitive disadvantage relative to remote sellers. Remote sellers can avoid the regulatory burdens of tax collection and can offer de facto lower prices caused by the widespread failure of consumers to pay the tax on their own. This "guarantees a competitive benefit to certain firms simply because of the organizational form they choose" while the rest of the Court's jurisprudence "is all about preventing discrimination between firms."
The Wayfair decision represents a watershed moment in the United States for sales tax policy. While it affects South Dakota sales tax law immediately, many other states are sure to adapt their laws in short order. The Supreme Court in Wayfair noted that 41 States, two Territories, and the District of Columbia all asked the Court to reject the physical presence test, so there is obvious widespread interest by the States to move in a similar direction.
The Wayfair decision will affect retailers in all industries, ranging from corporate behemoths to the smallest startup companies. The idea behind the Supreme Court's ruling is to put all of these retailers on a level playing field with regard to sales tax collection requirements. But, smaller businesses naturally have fewer resources to adapt with the multitude of varying sales tax laws across all of the tax jurisdictions in the United States. As the dissenting opinion in Wayfair noted, there are over 10,000 of such jurisdictions, each with different rates, varying application to products or services sold, and varying scope of substantial presence standards.
As stated previously, businesses with sales activity in South Dakota will be affected immediately by the Wayfair decision. But as this will be merely the tip of the iceberg, all businesses in the United States must immediately begin to plan for systems that can accommodate a profound increase in sales tax collection and compliance across the country. For more information about the Wayfair decision and how it will impact your business, please contact us.
Published on June 26, 2018