The U.S. Supreme Court is set to hear its first state sales tax case in more than 25 years this week and the verdict could have sweeping implications for e-commerce companies, like Amazon, and customers across the country.
The case, South Dakota v. Wayfair could finally clarify how online retailers are expected to collect sales tax in states where they have customers but may or may not have a “physical presence.”
In the past, the Supreme Court limited states’ power to collect sales tax to companies with a “physical presence” in that state but those decisions were issued before the online retail revolution. Limiting state taxing authority in that way made sense when the majority of sales were done by brick-and-mortar retailers.
Today, a company can make thousands of sales across the country while maintaining a physical presence in just one city. Local governments could have collected up to $13 billion in additional sales tax in 2017 if they had the authority to tax remote retailers, according to Bloomberg.
On April 17, the Supreme Court will review these standards given our new retail reality. The court’s decision is expected this summer.
What is this case about?
South Dakota passed a law in 2016 requiring online retailers to collect sales tax when they sell goods to the state’s residents. The state’s lawsuit under the legislation targets three online retailers: Wayfair, Overstock.com, and Newegg. Amazon hasn’t joined the lawsuit or filed a friend of the court brief, as other internet sellers have. But Amazon is no doubt watching the case closely, as one of the biggest e-commerce companies in the world. Amazon initially did not collect taxes on many out-of-state sales but now collects it in all states with a sales tax. It still doesn’t collect taxes on items sold by third-party sellers on its platform.
South Dakota v. Wayfair questions a decades-old standard that states can only force a business to collect sales tax if they have some kind of presence there, whether that be a store, office, distribution center or other significant connection to the state. This case could upend the long-standing ruling, instead installing a minimum sales threshold in a state as the defacto benchmark for collecting sales tax there.
How did we get here?
Quill Corp. v. North Dakota was the last major Supreme Court decision on this topic, and it came down in 1992, several years before Amazon, the world’s leading online retailer, was founded. It affirmed a ruling made in 1967. Since then, times have changed.
“The law South Dakota passed said that the standard developed by the Supreme Court in 1967 and then affirmed in 1992 is no longer valid because the way that you and I shop and the way that our merchants market to us is completely different than it was in 1967, when this issue was first resolved,” said Scott Peterson, vice president of U.S. Tax Policy and Government Relations at Avalara, a Seattle-based company that helps businesses collect sales taxes and comply with regulations.
Federal legislation to decide sales tax issues has repeatedly stalled, so it’s been up to the courts to sort everything out.
As highlighted by SCOTUS Blog, Justice Anthony Kennedy wrote as part of a 2015 decision in a different case related to sales tax collection: “There is a powerful case to be made that a retailer doing extensive business within a state has a sufficiently ‘substantial nexus’ to justify imposing some minor tax-collection duty, even if that business is done through mail or the internet. This argument has grown stronger, and the cause more urgent, with time.” This case — Direct Marketing Association v. Brohl — marked the first time a state organization had won a case like this and opened up the floodgates for legislatures to pass new sales tax collection laws, Peterson said.
A year later, South Dakota passed the law at the center of this case, requiring retailers to collect sales tax once they’ve cleared a bar of $100,000 in sales or more than 200 transactions.
What are the key arguments?
Overturning a previous Supreme Court decision requires “special justifications.” South Dakota believes its arguments meet that requirement because technology has transformed retail and made it easy to do substantial business in a state without having any kind of physical presence.
“In large part, that is because the internet now makes it possible for out-of-state sellers to reach consumers with engaging, interactive virtual storefronts in our homes or on our smartphones at any hour of the day,” South Dakota wrote in its brief. “Economists have demonstrated that this pervasive access has turned the physical stores of other retailers into virtual showrooms for remote sellers, whose tax advantage now leads to far more diversion of buyers than was ever true for catalog mailers.”
The online retailers take issue with South Dakota’s law and claim the state deliberately tried to get on a “fast track” to the Supreme Court. In its brief, the retailers argue that this is a legislative issue, not a legal one. A ruling in favor of South Dakota would blow up any chance of simplified federal legislation for sales tax collection, the retailers argue.
“If Quill is overruled, the states will have no incentive to seek compromise federal legislation,” according to the retailers’ brief. “Freed of Commerce Clause restraint on their taxing authority, states will oppose any congressionally-mandated restrictions on their cross-border taxing power.”
What are the possible outcomes?
If the court rules in favor of South Dakota, it sets a new precedent for sales tax collection. A ruling for the retailers maintains the status quo, upholding the court’s previous decisions.
Don’t I already pay sales tax on online purchases?
In some cases yes, in others no. It depends on what state you’re in and whether the company you’re buying from has a presence there. Large retailers with big physical footprints already collect sales tax in most states.
What does this mean for consumers, small businesses and big online retailers like Amazon?
For shoppers, the potential outcomes are simple. If South Dakota wins, it basically marks the end of sales tax-free shopping online, according to Avalara’s Peterson.
“Within just a very short time — three or four years — every state will have all these laws and every merchant will effectively be collecting everywhere,” Peterson said. “Consumers won’t be able to shop tax free anymore.”
Even if the Supreme Court rules in favor of the retailers, tax-free shopping is likely on the way out in the near future, Peterson argues, thanks to a variety of laws passed by legislatures to compel businesses to collect sales taxes and allow states to do it themselves if retailers don’t.
Small businesses could be hit the hardest by this ruling. Should a change happen, they will be burdened by having to put systems in place to collect sales tax, Peterson said. Lack of a federal standard means they’d have to look at sales state-by-state and likely purchase software to help with that, adding additional cost. Amazon already collects sales tax in every state, and Peterson said most big online retailers have set up systems that could easily expand to cover all states.
“The potential for severe economic disruption is great,” the retailers wrote in their brief. “Small businesses seeking access to a national market, not the massive multi-channel retailers that already report sales tax across the country, will be harmed most by the new compliance burdens, new barriers to entry, and new obstacles to growth.”
What does the makeup of the Supreme Court say about the likely outcome?
Justices Kennedy and Clarence Thomas are the only two remaining from the court that decided in 1992 to uphold the “physical presence” standard for state sales tax, though Kennedy later called for a re-examination of that ruling.
Before joining the Supreme Court, Justice Neil Gorsuch questioned the 1992 decision and cautioned justices about blindly following precedent, according to the Tax Foundation. Justice Ruth Bader Ginsburg tends to side with states in tax-related matters while Justice Samuel Alito is more likely to side with business.
Taken altogether, the Tax Foundation expects at least five justices to uphold South Dakota’s law. Read the full cheat sheet here.