On June 21, 2018, a 5-4 decision from the U.S. Supreme Court eliminated the “physical presence” safe harbor from state sales taxation that had stood since 1967. Until now, businesses – including non-U.S. businesses – with no physical presence in a given state (“customer state”) did not have to bother with the various sales tax rules of that state, much less register and then collect and remit the various sales taxes within that state. “Out-of-state” and “out-of-country” businesses have relied upon this rule for over 50 years, just as their customers have benefited from correspondingly lower pricing.

No more. The literal and figurative question for today is whether this abrupt change is “for good.” In one sense, we do not know yet: Congress may further change the situation, but as explained below, so far it has failed to act for decades. In another sense, we know immediately that the Wayfair decision is bad for U.S. and non-U.S. businesses (who are not protected from state and local taxation by treaties) with U.S. customers and their cost-conscious U.S. customers.

Historical Summary

In 1967, the U.S. Supreme Court announced in National Bellas Hess v. Illinois that the U.S. Constitution prohibited a customer state from asserting sales tax “nexus” over businesses without a “physical presence” in that state.

In 1992, 25 years after Bellas Hess, the Court reassured the U.S. economy in Quill Corp. v. North Dakota that the physical presence safe harbor remained a constitutional requirement under the Commerce Clause. The taxing authority’ had contended that the growth of a remote mail order seller economy was a legal “game-changer” that justified scrapping the physical presence safe harbor. The Court rejected this argument, noting that businesses had relied upon the safe harbor. The Court also stated that it would be inappropriate for anyone other than Congress, to change these “settled expectations.” At that point, the U.S. had several thousand different sales tax jurisdictions, so Quill was welcome news to both the business community and U.S customers alike.

Just now, however –26 years after Quill and 51 years after National Bellas Hess – a majority of the Wayfaircourt:

• Overruled both Quill and National Bellas Hess – explicitly stated that the Court had been wrong for the last 50 years and that the physical presence rule was not constitutionally required, and
• Confirmed that the Court had been wrong for the last 25 years – arguing that it is now somehow appropriate for the Court to change the rule, and upset those “settled expectations.”

The Wayfair majority justified this change in “settled expectations” by hammering the physical presence rule as “unfair and unjust” in a new “virtual economy” in which businesses could sell to customers without ever crossing the state line.

Before the Court had even agreed to consider the Wayfair case, many states already had laws and/or regulations on their books that broke the Bellas Hess/Quill rule: for example, by providing that interstate (or even international) advertising alone could trigger sales tax nexus (see chart in the last section of this article). In recent years, states enacted laws and rules that more overtly attacked the physical presence rule, asserting that mere “economic nexus” (“virtual presence,” via merely having customers in the customer state) was sufficient.

South Dakota’s law represents one of these overt constitutional attacks. Although the Wayfair court did notexplicitly decide whether the South Dakota law was constitutional (the Supreme Court remanded for a lower court decision on that issue), the majority emphasized that South Dakota:

1. Enacted a law that provides a de minimis exemption – a remote seller only has South Dakota sales tax nexus in a year in which it (a) has 200 or more sales transactions with in-state customers, or (b) generated more than $100,000 in sales of goods or services to in-state customers;

2. Could only enforce that law prospectively, by the law’s own terms;

3. Is one (of 23) states that are “full members” of the Streamlined Sales and Use Tax (SSUT) initiative, which aims to enhance “uniformity” among the (now) more than 10,000 U.S. sales tax jurisdictions;

4. Taxes virtually all goods and all services alike, with very few exemptions available; and

5. Has no corporate or individual income tax, such that it was peculiarly disadvantaged by an inability to collect sales taxes from remote sellers under the physical presence rule.

The Wayfair majority likely intended these five points to send a signal that (a) the South Dakota law should beupheld as constitutional, at least on these particular facts, and (b) different facts might well invalidate a given customer state’s “borderless taxation” nexus law.

Putting factors (4) and (5) aside, it seems clear that many states will be in a rush to clone the South Dakota standard in order to cash in on the new “borderless taxation” rule.

Summary of Immediate Impacts

• Foreign (non-U.S. companies) beware. The typical international tax treaty does nothing to shield you from U.S. state and local taxation. Moreover, U.S. state and local sales taxes are not based upon treaty-limited federal taxable income, nor are they absorbable like the typical “value-added tax.” (Could we be headed toward a sales tax model similar to the European Union’s MOSS digital content seller valued added tax regime?)
• Sales tax nexus = income tax nexus? In most states, it has long been the rule that in­state customers could create income tax nexus. South Dakota’s “virtual” sales tax nexus rule.
• Goodbye bright-line rule; hello audits, litigation. The physical presence test offered businesses a “clear” compliance rule. That rule is now gone, and all bets are off. Wayfair does not change the constitutional requirement that a nexus rule cannot pose an “undue burden” (“undue” = litigation and uncertain outcomes).
• Expect states to “clone” South Dakota’s statute to the extent they can. States will likely enact laws as identical to South Dakota’s statute as possible and join the SSUT program. To the extent that they fail to do both (including factors (4) and (5) above), their nexus approaches may be more easily challenged.
• States will likely be more aggressive. Wayfair is a pro-state and an anti-business decision. Many states had already pushed well beyond a physical presence rule, out of impatience with the Quillstandard; Wayfair seems to partially condone their behavior.
• Consumers and business purchasers will pay higher prices. If vendor businesses are asked to bear the impact of new or higher taxes, they pass them on to their customers (individuals and businesses).
• Lobby Congress. Congress can still change the rules again – the Court said as much in both Quill and Wayfair. However, it is unclear after decades of inaction whether Congress will be prompted to act now, and most commentary to date has been relatively pessimistic on this chance.
• Businesses should engage a state tax professional with truly multistate experience.
  • It is no longer a defensible business practice to “wait and see” whether your “customer states” assert sales tax nexus over you; it is virtually inevitable, and you wait at your economic peril.
  • Assess the geography of your current customer base, and your current nexus ties to all customer states (the list of nexus factors is very long). In some states, the nature of those connections may remain relevant.
  • Unless you were already operating under a “virtual nexus” sales tax model for several years, it is time to reevaluate both prospective and retroactive liability risks.
    • In virtually every customer state, a business with sales tax nexus that failed to file can be held responsible for taxes for all prior in-state sales years.
    • Do not count on having a grace period for future compliance, particularly since most states have had non­physical presence nexus rules on the books for years.
• If you already complied voluntarily with the “virtual nexus” rules of one or more customer states, it is worth considering (and monitoring) whether the facts of Wayfair and/or the “undue burdens” test might leave you a way out, at least prospectively.

A Legal/Technical Critique of Wayfair

Ordinarily, it might be beside the point to critique a Supreme Court decision, but Wayfair seems to present a different situation. First, the Wayfair court announced that it had changed its historical mind after 50 years, so we now know that even the most long­standing rule is not entirely reliable. Second, Congress may well look at the result in Wayfair and find injustices and/or unintended consequences that need to be legislatively corrected (beyond the pure policy issue of increased costs and prices). Some possible examples of such viewpoints:

• “Leveling the playing field” (fairness) is arguably irrelevant. The Wayfair majority’s “leveling the playing field” rhetoric presumes that both teams are playing the same game; they are not.
  • Remote (including Internet) vendors on the one hand, and local vendors on the other, are not similarly situated, factually or constitutionally:
    • The former typically charge much lower prices than do the local vendors;
    • Local businesses benefit from a long list of local services, in return for which (under the fourth prong of Complete Auto Transit) their customer (local host) states can tax them; the remote vendors do not utilize these local services.
  • With care, local “brick-and-mortar” businesses could (and often did) form remote/Internet seller affiliates to take advantage of the physical presence safe harbor (which enabled them to offer lower prices on those remote sales).
  • A “level playing field” analysis is more appropriate in an Equal Protection Clause case, not a Commerce Clause case anyway; Wayfair was not an Equal Protection case.
• The “new” economy: really nothing “new” about It. The present-day “virtual” economy addressed in the (anti-business) Wayfair decision is little different from the remote, interstate/international mail-order economy that confronted the Quill court.
  • The mail-order economy was a booming economic innovation when Quill was handed down in 1992, but the Court refused to rescind the physical presence safe harbor despite claims that the economy had undergone a paradigm shift.
  • As the four dissenting justices in Wayfair noted, there is actually evidence suggesting that Internet retailers’ competitive advantage has been on the decline, in contrast to the policy position underlying the majority’s reasoning.
  • The Wayfair majority opinion suggests that the growth of Internet commerce was unforeseeable when that rule was first formulated in Bellas Hess (and then later reiterated in Quill). Under this reasoning, why shouldn’t modern-day sellers of services be eligible for immunity from net income taxation under P.L. 86-272, a law which predated by decades the explosion of the U.S. services industry market? (Yes, Congress could change that income tax rule – interestingly, for decades, Congress has also refused to change the physical presence sales tax rule, despite Quill‘s invitation that Congress do so….)
• The Wayfair majority appears to have misunderstood the requirements of “physical presence” nexus, or else deliberately massaged them to advance their own conclusion.
  • Early in their opinion, the majority implied that the physical presence test required in-state employees or real estate – conspicuously omitting any reference to the in-state physical presence of personal property as a sales tax nexus trigger.
  • Later, the majority noted the “unfairness” of the physical presence test, when a company with “a few items of inventory” in the customer state would have physical presence nexus under Quill, whereas an out-of-state business with a “sophisticated website with a virtual showroom [that was remotely] accessible” would not have nexus.
  • Curiously, two paragraphs later, the majority cites footnote 8 of theQuill decision, which actually established that holding a de minimis amount of personal property in-state was not sufficient to trigger sales tax nexus: the Quill court noted that the in-state presence of “a few floppy diskettes” owned by an otherwise remote vendor “seem[ed] a slender thread upon which to base nexus.”
• The Wayfair result rewards bad state behavior. Many states openly challenged the Supreme Court’s decision in Quill by adopting increasingly aggressive interpretations of “physical presence.” Over time, several states openly abandoned any pretense about limiting their assertion of sales tax nexus to physically present taxpayers. Consequently, by the time Wayfair was decided, South Dakota was hardly the only “virtual presence” sales tax state in the country. Wayfair seems to condone that type of legal misbehavior, inviting states to be “conscientious objectors.”

Current state economic nexus sales tax approaches

Predictably, after Wayfair, most states (the ones that had not already done so) rushed headlong to enact laws codifying their version of economic sales tax nexus. Other state’s tax authorities have re-interpreted extant law as permitting virtual presence nexus, or simply adopted such policies with conclusory legal justification. The nexus landscape has, quite literally, been changing daily, and it has been difficult to keep up with developments.

A majority of these states have somewhat faithfully “cloned” the South Dakota law – though (as previously mentioned) virtually none of them can truly invoke the effectively “taxless” legal climate South Dakota noted by the sympathetic Wayfair majority. Other states have notably different rules. Effective dates vary in many cases (which is surprising given the Supreme Court’s approving focus upon the forward-looking nature of South Dakota’s law). The number of sales transactions and/or the amount of sales revenue may vary. The calculation of these metrics varies as well, as to the chronological measurement period, and which types of sales are included or excluded from the measure. And of course some states are simply less like South Dakota than others with respect to the factors cited in the Wayfair analysis: some are Streamlined Sales Tax members and some are not; a few lack an entity-level income tax (or functional equivalent); but most do not; a few lack a personal income tax, but again, most do not.

The chart found  here attempts to summarize the major features of the various states’ “remote seller” policies as of July 19, 2018.  Note, however, that the situation has been dynamic and a bit confusing so far.

Simple, right?  Though it seems virtually impossible to imagine that we have reached this point, we will soon live in a truly borderless sales tax environment. Congress could change this, though – for good…

Failing that perhaps unlikely event, it is best to be prepared.