Earlier today, the United States Supreme Court, in a 5-to-4 decision, issued its much anticipated opinion in South Dakota v. Wayfair, overturning the physical presence requirement that has been the basis of sales and use tax nexus for the past 51 years. The Court in its ruling declared the standard “unsound and incorrect.”
Due to the large number of state and local taxing jurisdictions in the United States with various rates, rules and regulations, the Court first established the physical presence test in National Bellas Hess v. Illinois, 1967 and upheld this standard 25 years later in Quill Corp. v. North Dakota, 1992.
Due to a rapidly growing retail market on the internet and declining sales tax revenue, many states, in defiance of the physical presence standard established in Quill, passed economic nexus standards based upon a specific dollar amount of sales or number of transactions in a year to state residents.
In 2016, South Dakota passed an economic nexus standard based upon $100,000 in sales or 200 transactions. Soon, a handful of other states passed similar economic nexus standards in defiance of Quill. While the South Dakota Supreme Court declared the law unconstitutional on the basis of the Quill decision, the U.S. Supreme Court granted certiorari on appeal and agreed to hear the case.
In the opinion drafted by Justice Kennedy, it appeared that the South Dakota law’s safeguards against discrimination and undue burdens on interstate commerce were persuasive. The respective safeguards include:
A safe harbor for small sellers who do not meet that annual economic threshold of $100,000 in sales or 200 transactions;
No application of the law retroactively; and
Sales tax simplification features that come with membership in the streamlined sales tax agreement, such as a single state-level tax administration, uniform definition of products and services, simplified tax rate structures and other uniform rules. The state also provides sellers access to sales tax administration software paid by the state. Sellers using this software are immune from audit liability.
The Court’s opinion will have a significant impact on remote sellers throughout the United States. States looking to take advantage of today’s ruling and establish economic nexus standards should consider using the South Dakota law as a model.
While the Court did address the issue of the physical presence standard, it will take time to see the impact of today’s decision on remote sellers and service providers. There will most likely be more litigation on economic nexus standards that are different from the South Dakota model. Then again, there will always be the question on whether Congress will act, especially when a new Congress on comes in next January.
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