South Dakota v. Wayfair U.S. Supreme Court Sales Tax Decision in June

The Supreme Court of The United States has entered the month when most decisions it heard during this session will be announced.

This process really started a few weeks ago, but as we move further into June, the number of decisions released will increase.

Certainly, the first day in June brought out two decisions dealing with hot-button issues of religious freedoms (Masterpiece Cakeshop v. Colorado Civil Rights Commission) and abortion rights of undocumented immigrants.

But as much as those decisions received headlines on Monday, they were very narrow in scope, mostly dealt with procedural issues that arose in those cases, and actually didn’t change the legal landscape that much.

But larger cases with far more reaching political and societal impact still await a decision and the high court has until the end of June to release decisions on these cases on in rare circumstances, defer decisions.

The court has a bit of history for the dramatic, leaving the most interesting and often controversial decisions to the final days in June.

More than 30 percent of all decisions by the court come in June and more than half of the June decisions come in the last week.

Considering the number of more “mundane” cases that are awaiting a decision, it was probably a bit of a surprise that the Supreme Court rendered a decision on Masterpiece Cakeshop v. Colorado Civil Rights Commission.

But considering it narrowed the focus of that decision to procedural issues and bias during the hearing at the Colorado Civil Rights Commission, and didn’t really get into the heart of the dispute if owners of public accommodation (retail store) are allowed to refuse services on religious grounds, the legal impact was not particularly significant.

Hence the decision in this case probably was moved forward in the June calendar to make room for more legally interesting and relevant cases.

Sales Tax

South Dakota v. Wayfair, Inc. may not be as politically interesting for the mass media as Trump’s Travel ban (Trump v. Hawaii) or Partisan gerrymandering (Gill v. Whitford and Benisek v. Lamone), but it could have the most significant impact on commerce for virtually all shoppers and retailers in the United States.

Depending on the decision by the court, it could even impact out-of-country sellers that overnight may have to deal with a “dysfunctional” U.S. sales tax system that includes over 10,000 tax jurisdictions.

South Dakota v. Wayfair, Inc. effectively reargued Quill Corp. v. North Dakota, which mostly set the precedent that unless a retailer has a physical presence in a state, it cannot be forced to collect sales tax in that state.

At the time, the mail-order business was nothing in size to today’s eCommerce business.

The court effectively decided there was too much burden on remote businesses to try to collect sales tax in locations in which they did not have Nexus.

Nexus was mostly understood to mean a physical presence such as offices, warehouses, or sales organizations. As eCommerce grew, sellers on eBay, Amazon, and their online stores only collected sales tax in the state from which they operated because there was no Nexus.

With consumers shifting buying patterns to online, local retailers faced increased competition from out-of-state retailers who didn’t have to collect sales tax.

The sales tax alone could in some jurisdictions be up to an automatic 10 percent or more price disadvantage for local retailers.

State and local governments complained that the rise in online commerce caused reductions in sales tax income as consumers looked for buying products from out-of-state retailers to actively avoid the sales tax.

Even so, most states have laws on the books that require residents to declare purchases from out-of-state retailers and then submit so-called use-taxes to their home state, the reality is that enforcing use tax laws is expensive and tedious.

Therefore, states effectively didn’t engage in any meaningful enforcement for decades and allowed the situation to become worse.

But How Big is This Problem Really?

If one listened to the states, they are claiming it is ruining their budgets. But that might not be entirely accurate and the actual impact on budgets is about 1/3 of 1 percent.

The GOA (United States Government Accountability Office) released a study on this issue in November 2017 and found that if enforcement was expanded to all sellers, the total revenue gain for states could be anywhere from $8.5 billion to $13.4 billion.

With state and local governments spending in 2018 estimated to be around $3.7 trillion, even if one considers the high mark in additional revenue of $13.4 billion, that revenue gain would be .36 percent of the total expenditures by state and local governments.

The report also stated that nearly 80 percent of sales tax due is collectible under current laws, but compliance is a significant problem. Which brings up the question are states really doing everything to enforce sales tax compliance within their own borders?

California Example

To provide an example of a typical collectible sales tax sale that is often not collected, let’s take a look at common transactions in California.

California requires that wholesale distributors and manufacturers that drop ship to in-state residents collect sales tax on the sale if their customer (or retailer) is located outside the state.

In the majority of such sales, the California company’s customer (ie online retailer) does not have a physical location (NEXUS) in the state and therefore is not required to obtain a California Resale Certificate.

“ABC Co. is not a retailer engaged in business in this state. It contracts to sell tangible personal property to a California consumer. ABC Co. then contracts with XYZ Inc. to purchase the tangible personal property. ABC Co. instructs XYZ Inc. to ship the property directly to the California consumer. XYZ Inc. is a retailer engaged in business in this state. XYZ Inc. is the drop shipper liable for the applicable tax as the retailer.”

Example from California Regulation 1706. DROP SHIPMENTS

By law, the California business should be collecting sales tax on the sale from the remote seller when shipping the product to a California resident. Obviously, the remote seller would need to address with their end-user the sales tax burden this arrangement incurs.

So let’s consider this quote from the Online Merchants Guild Brief of Amicus Curiae (Friend of The Court) that highlights one of California’s tactics to attempt to collect sales tax from out-of-state small businesses:

“California has employed a task force of call center representatives, all with minimal tax training, to bombard the landlines and cell phones of small business online merchants with the sole purpose of bringing the merchants “into compliance” and pitch a deal for cooperation that, surprise surprise, includes the merchants’ having to estimate and pony up six years of back taxes.”

For this specific situation, this begs the question, why isn’t California aggressively enforcing laws already on the books instead of trying to collect sales tax from out-of-state businesses?

Generally, states claim that use tax laws are difficult to enforce as auditing every single resident would cost more money than the collection efforts would bring in. Probably true!

Therefore, why not expand collection on businesses in the state that are not following the law first instead of contacting out-of-state businesses?

Is it politically more advantageous to try to collect taxes from entities that do not have voting power in the state? Basically taxation without representation.

There are large distributors and manufacturers in California that do not follow the dropship law mentioned in this example.

But despite this apparent ineptitude in collection, now the kicker!

California municipalities are using loopholes to attempt to raise sales tax rates but the state has a $6.1 billion budget surplus.

And California cities are fighting each other over tax revenues because even the change from small retail stores to mega distribution centers is causing friction.

Doesn’t it make sense for states to first clean up their own internal problems before trying to go after pennies from small businesses around the country?

Oral Arguments in South Dakota v. Wayfair, Inc.

When the Supreme Court took the case of South Dakota v. Wayfair, Inc., some saw this as a sign of interest by the court to overturn Quill Corp. v. North Dakota.

Several justices had made comments in previous cases that seemed to suggest a review of Quill Corp. v. North Dakota may be necessary.

But what was interesting going through the transcript of the oral arguments in the South Dakota v. Wayfair, Inc. case was how much the justices challenged the State of Dakota’s position.

Specifically, one exchange seemed to show how skewed the issue really is:

Marty Jackley, Attorney General of South Dakota who argued for the state said: “Congress has had 26 years to address this issue. And it’s not Congress, but it’s Quill, it’s this Court’s decision, that is striking down our state statutes.”

In response, Justice Kagan said: “But, General, usually, when somebody says something like that, that Congress has not addressed an issue for 25-plus years, you know, it — it gives us reason to pause, because Congress could have addressed the issue and Congress chose not to.”

Other exchanges seemed to suggest that the court was very uncomfortable to get into an area that really is the domain of Congress.

While the State of South Dakota claimed it was looking forward, not backward when it comes to the collection of sales tax, and the state also claimed other states were doing the same, there was no guarantee that would be the case.

In another discussion about the costs of collecting sales on small businesses, the issue of the burden this may bring, what that the real costs may be, and if the court is even able to set a minimum standard before the burden kicks in became significant talking points.

Fundamentally, the case is about the “dormant” Commerce Clause which refers to the prohibition, implicit in the Commerce Clause, against states passing legislation that discriminates against or excessively burdens interstate commerce.

While justices may try to elicit responses from the litigants that are opposite of their own “initial” opinion in order to better understand the issue, it does appear there was an overall skepticism about the state’s position.

Completely overturning a previous Supreme Court’s position is not unheard of, but it also is not that common.

But since the court in Quill Corp. v. North Dakota acknowledged that under the U.S. Constitution Congress has the full authority to address interstate commerce, it really seems the State of South Dakota didn’t bring any new legal arguments to the table that should result in a radical rethink of the issues already considered in Quill.

The fact that the state of South Dakota even mentioned the inaction by Congress, which really is an action by Congress, should ring alarm bells with the justices.

It really seems this case is more about trying to establish legislative-style policy, because another branch of government normally responsible for such policy, decided not to act.

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