States can collect sales tax from online sellers even if those companies don’t have a physical presence in the state, the U.S. Supreme Court ruled Thursday morning in a case with far-reaching implications for the future of online commerce.
The decision marks new territory dispute over the taxing authority of states in the internet age. Big online retailers have, in many cases, managed to avoid paying sales tax when selling goods to consumers because previously, courts said that a company must have a physical presence in the state to be taxed.
“The physical presence rule has long been criticized as giving out-of-state sellers an advantage,” the ruling says. “Each year, it becomes further removed from economic reality and results in significant revenue losses to the States.”
The case before the Supreme Court, South Dakota v. Wayfair, stemmed from a law South Dakota passed requiring online retailers to collect and remit sales tax even if they don’t have a physical presence in the state. The Supreme Court sided with South Dakota 5-4, overturning a previous ruling, Quill Corporation v. North Dakota.
“Quill creates rather than resolves market distortions,” the ruling says. “In effect, it is a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers, something that has become easier and more prevalent as technology has advanced.”
Justices Anthony Kennedy, Clarence Thomas, Ruth Bader Ginsburg, Samuel Alito, and Neil Gorsuch delivered the opinion while John Roberts, Stephen Breyer, Sonja Sotomayor, and Elena Kagan dissented.
South Dakota brought the lawsuit against major online retailers for failing to comply with its new sales tax law, in an effort to get the Supreme Court to revisit the Quill decision. The law makes an exception for companies with less than $100,000 in annual sales or 200 transactions in the state, seeking to help smaller retailers compete with big e-commerce incumbents.
“Startups and small businesses may benefit from the physical presence rule, but here South Dakota affords small merchants a reasonable degree of protection,” the ruling says.
In the original lawsuit, South Dakota sued three major online retailers: Wayfair, Overstock, and Newegg.
Although it is the poster child for big e-commerce, Amazon wasn’t involved in the lawsuit and the immediate decision doesn’t affect the company dramatically. But the resulting legislative fallout could have an impact. Today, the retail giant collects taxes in every state that has a sales tax.
For the many third-party sellers on Amazon’s platform, it’s more of a gray area. Prior to the ruling, sellers were responsible for collecting sales taxes if they had a presence in the state. But some states, including Washington, have recently passed marketplace bills which force the company that provides the platform for sellers — such as Amazon, Etsy and, eBay — to collect sales tax rather than the asking the seller to do so.
In the wake of the ruling, companies like Amazon will have to keep an eye on how each state handles sales tax legislation and whether they will have to collect the funds on behalf of third-party sellers. Scott Peterson, vice president of U.S. tax policy and government relations at Seattle sales tax automation company Avalara, doesn’t expect much variation between state laws. He predicted that South Dakota’s law will be a model for future legislation.
“Any state that does something radically different from this should expect to immediately find themselves in court,” Peterson said.
The market certainly thinks Avalara will benefit from the decision, as the newly-public company saw its shares spike 30 percent immediately following the ruling.
Despite the historic ruling, the issue isn’t totally settled yet, Peterson said. The decision mainly focused on the physical presence argument. But the court remanded the South Dakota law back to the state Supreme Court to make sure it complies with another Supreme Court ruling: Complete Auto Transit v. Brady. That 1977 decision established a four-part constitutionality check for state taxing power.
- Nexus: There has to be some kind of connection between the taxpayer and the state. In South Dakota, retailers are subject to sales tax once they’ve made $100,000 in sales in the state.
- Fair apportionment: The state may only collect tax on purchases within its borders.
- No discrimination: The state can’t treat out of state retailers differently than in-state retailers.
- Related to services: Retailers must in some way benefit from taxes collected. For example tax money goes towards roads, which benefit retailers shipping goods.
“We’ve got a ways to go before the case is fully resolved,” Peterson said. “Every other state in the country now has to wait until the South Dakota Supreme Court issues a decision to see whether or not South Dakota’s law meets the standards of the Complete Auto Case.”
Rep. Suzan DelBene (D-WA) cheered the ruling in a statement.
“As in so many other areas, technology has evolved faster than the law and left us with at times bizarre, unfair results,” she said. “This is a big win for local brick-and-mortar retailers, who will now get a chance to compete on a level playing field with out-of-state internet companies that have maintained an unfair edge by not collecting sales taxes.”
Here is the full ruling: