The Supreme Court issued a 5-4 decision overruling its long-standing physical presence rule in South Dakota v. Wayfair this morning. That decision provides welcomed relief to states (and to those of us who already pay use tax) and will have significant short- and long-term consequences. My reactions to Wayfair will surely extend for a long period of time, but here are some brief first thoughts.
The Basics
The Court’s holding was very limited: the physical presence rule no longer governs the determination of what constitutes a “substantial nexus” under the dormant Commerce Clause. The Court also found that nexus existed in the case based on the challengers’ connections with South Dakota. Finally, the Court did not bless the South Dakota statute completely, but remanded the decision back to the South Dakota courts to hear non-nexus based challenges to the law, if any exist.
What this means is that states will be able to continue (or expand) their efforts to require the collection of sales/use tax by online vendors. States will also need to monitor whether and how Congress responds, but they should be able to craft their laws to avoid state-court scrutiny until that time.
Some Questions
The limited scope of the decision left open a question that I’ve addressed previously on this blog and elsewhere. Namely, when would state actions to require vendors to collect state taxes violate the dormant Commerce Clause without a physical presence nexus requirement? Justice Kennedy’s opinion punted on that question– a familiar approach. The opinion wasn’t completely unhelpful on these questions however. It did offer guidance on why South Dakota’s statute might survive further scrutiny: (1) the law has a de minimis safe harbor; (2) the act imposed no retroactive tax liabilities; and (3) South Dakota is a member of the SSUTA. While some commentators seem to be taking these as near requirements (see here), the Court did not go so far. It merely opined that those features “appear designed to prevent discrimination against or undue burdens upon interstate commerce.”
Another question raised by the Court’s opinion is the status of its historical distinction between sales and use taxes. In two cases in 1944, the Court conditioned state authority to impose tax-collection requirements, in part, on whether the tax was labelled a sales tax or a use tax. The Court decided that states lacked the authority to impose sales taxes on transactions that occurred out of the state, but that they could impose an identical use tax on the use of the purchased good.
South Dakota’s statute bucked this historical distinction (whether on purpose or by accident is not known to me) and imposed a sales tax collection obligation on out of state retailers making out of state sales. This issue was never pressed in the case, and Justice Kennedy’s majority opinion massaged over the point. In the beginning of his opinion, he referred to sales tax. At other points, he just referred to the “tax” without any qualifier. It isn’t clear what this means for the distinction between the taxes, or what the real world implications are, but it is something for us state-tax nerds to think about.
Another remaining question is what nexus standard applies after Wayfair. The Court did not eliminate the substantial nexus requirement completely, so that prong remains in its existing framework. The Court did not, however, provide much guidance on what nexus requires post-Quill. The Court merely said that “nexus is established when the taxpayer…avails itself of the substantial privilege of carrying on business” in a state.
Incidentally, the Court then “applied” that standard in much the same way that state courts have “applied” their economic-nexus standards for purposes of corporate income taxes. That is, the Court merely concluded that the respondents had a substantial nexus with the state based on their “economic and virtual contacts” with South Dakota. It did not actually evaluate what those contacts were or when they became sufficient. (For a discussion of this same approach by state courts, see here.)
As an aside, it is not clear where we go from here on the nexus front, but the Wayfair decision seems to put the final nail in the coffin for those arguing that the physical presence rule applies outside of the consumption tax realm. The remaining states that have not imposed economic-nexus standards for purposes of their income taxes have little reason to not do so now.
Going Forward
In the short term, states need to look at their tax systems to see how they can best modify their laws to take advantage of Wayfair, vendors need to prepare for additional tax-collection obligations, and state-tax academics need to digest and write. Congress will also need to hash out whether and how it will act.
In the longer term, Wayfair offers an opportunity for a more sensible approach to the difficult issues presented when trying to balance state taxing autonomy with the pursuit of a common national market. My biggest hope at this point is that Congress does not act reflexively and adopt a statute that balances poorly and that becomes entrenched. (See i.e., P.L. 86-272.)
Ultimately, Wayfair marks the end of Quill, but the beginning of much more work to be done.
The Surly Subgroup 
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