Supreme Court Decision on Sales Tax – But What Does It Mean?
The US Supreme Court issued an opinion on South Dakota v. Wayfair, Inc. a case brought by South Dakota to force the collection of sales tax from remote sellers (online sellers).
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We asked Scott Peterson, Avalara’s VP of US Tax Policy, for his view on the court’s ruling. Avalara has a unique insight into this issue as they provide sales tax automation software for online retailers subject to various tax jurisdictions.
“First of all, you have to define what you mean by “small business.” The majority of very small businesses will not be impacted at all by this ruling because it establishes a threshold of $100,000 in sales or 200 transactions in South Dakota.
Small businesses that are selling independently or through marketplaces – such as Amazon FBA, eBay, Etsy, and more – may have to go from filing sales tax in the states where they’re currently located to potentially having to file taxes in many states – where they have nexus issues based on their threshold of sales.
It’s challenging to suddenly have to understand the tax requirements and threshold logic across the entire country.
While the ruling won’t go into immediate effect – the ruling has been passed back to the South Dakota State Supreme Court – small businesses should understand the possible future implications.
In the era of eCommerce, the Supreme Court stated that physical presence is no longer a suitable test so small businesses may need to consider where they sell, not where they are, for tax compliance requirements.”
His summation brings up a good point on the thresholds the court accepted and maybe one states now regret has happened.
The court was unanimous in stating that previous opinions on interstate collection were flawed as the court, not legislation, created an artificial barrier for when a retailer was required to collect sales tax from an out-of-state customer.
Previously, retailers were only required to collect sales tax from remote buyers when that buyer was located in a state in which the retailer had a physical presence such as a store, office, warehouse, or sales force.
But in this opinion, the court agreed with the state of South Dakota that the physical presence standard is not relevant in today’s connected commerce world and that nexus (the requirement to collect sales tax), should be based on another method.
Since it is the legislature (Congress) that actually has to make laws in the US, South Dakota (and indirectly all other states) asked the high court to overturn previous opinions on this issue (Quill and National Bellas Hess) and give the states the rights to set new standards for nexus.
Beware of What You Ask For
In simple terms, the case was about state rights and the state’s rights and abilities to control when to enforce sales tax laws on entities located outside of their state.
It’s been obvious the states wanted the court to eliminate the physical location standard as they considered it limiting and just give them full power to determine other methods to enforce tax collection.
Knowing the court cannot legislate, but also understanding the court was going to be sympathetic to issues in the constitution’s Commerce Clause, the states supported the argument by South Dakota that setting a minimum standard before sales tax collection from remote sellers is required, would not create an undue burden on small businesses.
They went so far as to argue that it is even burdensome for states to create laws with very low minimum standards. From the “Friends of The Court” brief by the Multistate Tax Commission:
“…states will, themselves, incur costs to register, track, process returns, and provide notices to small sellers, that, like the fixed costs of compliance, make imposing tax collection obligations on small sellers inefficient from the states’ standpoint.”
So, the states said something to the effect, trust us, we won’t do anything to harm ourselves, but we need the power to set our own standards based on an alternative method that will work better to capture lost sales tax revenue.
However, during the oral arguments before the court, South Dakota acknowledged that if the court overturned the physical presence requirement, a new minimum standard could be based on a requirement as low as one sale.
And apparently, that must have scared the court.
9-0 On Flaw of Previous Decision
In both the majority and the minority opinion, all justices agreed that the previously set threshold by the court was arbitrary and had to be fixed.
But they disagreed on the method and timing, mostly around how to “nudge” Congress to act, which to date, Congress had failed to do so.
So it seems to fix the big problem of undoing the previous “wrong” decisions, the court narrowed the focus of this problem by concentrating on the specifics in this case. Meaning does South Dakota’s law represents an undue burden on small businesses.
Under the Commerce Clause, and without legislation from Congress, states cannot enact laws that negate or reduce the ability of merchants to conduct commerce across state lines.
But since the court can only rule on the laws as they are today, not create legislation that enforces minimum standards not found in the law, it decided on an interesting strategy to agree that it considers South Dakota’s minimum standards a reasonable threshold and does not violate the undue burden provision of the Commerce Clause.
“Here, the nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State. The Act applies only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State. Ibid. The Act also forecloses the retroactive application of this requirement and provides means for the Act to be appropriately stayed until the constitutionality of the law has been clearly established.”
But South Dakota’s law went beyond defining a reasonable standard for the future, it also included language that prohibits retroactive enforcement.
And by including the language in its opinion, it seems the court may have effectively stopped retroactive enforcement actions because states now have guidance from the court on what it considers an acceptable burden on businesses.
The court did not give, nor is it allowed to, provide states guidance on what other minimum thresholds may be acceptable. Therefore, states now have to consider South Dakota’s law a minimum acceptable standard that satisfied the court.
But states have no clue on what other thresholds may be acceptable to the court, therefore, states are now forced to interpret this court’s opinion.
To make matters worse, the court even reminded states that it has the power to effectively null and void unreasonable minimum standards.
“States may not impose undue burdens on interstate commerce. State laws that discriminate against interstate commerce face “a virtually per se rule of invalidity.”
The court was emphatic that only Congress can provide legal changes that would create a single standard for all states.
Absence such legislation, the court only agreed that South Dakota’s specific law is an acceptable minimum standard. But this may have opened up a box of worms.
For example, some states coerced monies from remote retailers on “back taxes,” what happens to those monies? Is retroactive collection an undue burden?
Could a merchant now argue that since in this case, the court accepted that retroactive action was being prohibited by South Dakota’s law, it may consider such action a burden?
The big question here is that while most states supported this case, did states expect the court to tie the South Dakota thresholds and prohibition of retroactive enforcement into a de-facto standard?
It seems the court told states you must look forward and your laws must be reasonable and not create an undue burden or we may just throw them out.
With this narrow ruling, Congress may feel compelled to act to avoid further ambiguity because it has the power to set any standard it sees fit, and that takes this whole situation out of the state’s hands.
Is this really what they wanted because that is what they got!
State legislatures around the country may have to revisit their laws to ensure they meet the “suggested” accepted standard of South Dakota’s law because the court changed the nexus standard from physical location to one of “undue burden.”
So any attempt to deviate to a standard that may be perceived as a lower standard than South Dakota could tie up sales tax legislation for years again before it may land with the high court to determine if another standard is acceptable to them.
Salex Tax Not Really Settled
For those that expected the Supreme Court to settle this issue, this may actually be a blow to clarity. There was so much the court didn’t address and even hinted could be argued in future cases.
Paul Rafelson, Executive Director, Online Merchants Guild, an industry organization that represents the interests of small business online retailers provided us with this analysis.
“This ruling is not a game changer it’s a wake up call that we as a seller community need to take action to protect our constitutional rights as online merchants. The Court removed physical presence from the nexus equation, that’s it.”
“They Court, admittedly, left many questions unanswered, including whether it’s appropriate for small business merchants to have massive multi-state tax collection responsibilities.”
“The Court found the physical presence standard to be unworkable in the context of a large company like Wayfair, but left the door open for further challenge from online merchants whose only connection in the state is via Amazon, eBay, etsy, Walmart, etc.”
One could argue that after a night of celebrating a “victory,” states now find they have more confusion about what this really means for them.
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Richard is co-founder of eSeller365. He has over 17 years of experience on eBay which includes tens of thousands of sales to buyers in over 100 countries and even has experience with eBay’s VeRO program enforcing intellectual property rights for a former employer. And for about two years Richard sold products on Amazon using Amazon FBA in the US.
To “relax” from the daily business grind, for a few weekends a year, he also works for IMSA as a professional race official.
Despite The U.S. Constitution gives to Congress exclusive power to regulate trade among people of different states, it isn’t a very first attempt of South Dakota legislature to regulate such interstate activities.
The Supreme Court was not able to identify a potential issue for South Dakota with its decision to revert physical presence requirement. The result might be quiet different than expected. A retail establishment with a single state location is primarily regulated by the authority of it own state. Since Court’s decision is now that sales tax can be collected whenever a product sold to in-state or to out-of-state consumer, the state will have a “right of the first night” on its own licensees to require collect sale tax. South Dakota may end up with zero rights to claim sale tax for sales situated outside of its borders. In all circumstances, hasty and not deliberates decisions may toss the states to interstate tax wars.
If there is a real need in such taxation then possible it needs to be federal sales tax, because of interstate nature of such sales transactions. Then the federal government could remit some portion of collected taxes to the states, as it is already done with excise tax.
We will have more on this in another article, but fundamentally, South Dakota did not receive “authority” to regulate interstate commerce.
The Commerce Clause does that and the only issue at hand was did the Supreme Court make mistakes in Quill and National Bellas Hess by defining physical presence as Nexus. At the time, it seemed like a good solution, but now the Court opined other methods, more appropriate for eCommerce and remote sales, could be used as long as they do not create an undue burden.
But “Undue Burden” is now the defining line and what does that mean?
I think this decision is a major nudge at Congress to set the minimum standard for States to follow. Will they act upon that nudge is the big question now.
As far as creating a national sales tax, that is a slippery slope that could get into VAT style taxation. I doubt there is an appetite in Congress to do that as Democrats will see such a tax as a regressive tax that impacts poorer Americans more than richer Americans, a hard sell to its constituents. And Republicans will see it as tax increase, again not an easy sell for its constituents. I believe a national sales tax proposal would be DOA in Congress.
Thank you for your comment, you brought up very interesting questions and points.
Great read! Thank you for clarifying everything.
Being a foreign company doing business in US via subsidiary it really helps to understand United States tax system better.
I don’t think that the Supreme Court could make a mistake twice. In Quill decision Supreme Court has followed the Congress’s point of view, second paragraph in Wiki page here: https://en.wikipedia.org/wiki/Internet_Tax_Freedom_Act, and the previous similar Supreme Court decision on National Bellas Hess v. Illinois in the 1967 which also ruled that unless the vendor has a physical location, or nexus, within a state, the vendor cannot be required to collect tax for that state. This limitation was defined as part of the Dormant Commerce Clause.
The opposite ruling to two previous Supreme Courts decisions may undermine legitimacy of the Supreme Court itself.
This court was 9-0 on overturning the physical presence rule. The only issue for them was how it would be done and what impact a change in their opinion would have on the industry (Hence the final 5-4 decision).
Overturning previous opinions is not typical, but also not without precedent. Especially when it comes to issues in the Commerce Clause, absent specific law from Congress, the Court tries to consider changes in economic conditions.
Ultimately, I believe this Court wants Congress to take up this issue. The Internet Tax Freedom act does not address prohibit states from charging sales tax on goods. It only restricts the number of “same” taxes that can be charged (to one per same-type jurisdiction).
In other words, Congress wanted to ensure that if one state charges tax and then another cannot charge the same tax on the same transaction. Here is the wording form the Congressional Research Service on ITFA:
“The ban on multiple taxes prohibits more than one state, or more than one local jurisdiction at the same level of government (i.e., more than one county or city), from imposing a tax on the same transaction, unless a credit is offered for taxes paid to the other jurisdiction. However, the state, county, and city in which an electronic commerce transaction takes place could all levy their own sales (or use) taxes on the transaction.”
Since the Court now says that another method besides physical presence can dictate where the electronic commerce transaction takes place, it doesn’t conflict with ITFA.
Basically, Congress needs to take up this issue and set a standard that is applicable to all States for when sales tax are due. With this decision, the Court effectively opened up 47 plus different interpretations of “undue burden.” (Note: 4 states have not sales tax and D.C. is included as a tax district in that count).
It is all very confusing and I am sure reasonable people will disagree what some of this all means.
Thank you for your comments,