United States: Justice Kennedy Bids Adieu With A Victory For The States

Last Updated: July 13 2018
Article by Robert Peters, Mary Alice Cashin and Dustin Jensen

It never really seemed to make much sense, did it? From its infancy as a start-up bookseller called Amazon.com to its current stature as a multi-conglomerate retail revolution, online shopping never had to adhere to the same tax burden as its traditional brick-and-mortar counterparts. Along the way, consumers never bothered to question it. Chalk it up to the maverick spirit of the information superhighway, they said. And, hey, it sure makes holiday shopping a lot more affordable.

Until now.

In South Dakota v. Wayfair Inc1. , the U.S. Supreme Court handed down a landmark decision on June 21, 2018, ruling that states can now collect and remit sales taxes from internet retailers, even if they have no physical presence in the state. More than 50 years of blocking states' ability to do so via Quill and National Bella Hess2 was overturned. Depending on who you ask, the Court might be the grinch that stole tax-free internet shopping, or a savior to states in desperate need of tax revenue. Many view the decision as a victory for Main Street businesses that have long complained about being at a disadvantage relative to online sellers (not to mention the time and expense of having to actually leave your home), and a boon for state and local tax revenues.

It's easy to say consumers and some online retailers are going to take a hit given this new landscape, but it might not be as bad as you think. Most states already require consumers to pay a "use tax" equivalent to the state sales tax. And while there were some tremors in a few big-game online sellers' stock prices (Amazon shares dropped 1.1 percent and Overstock.com was down more than 7 percent the day the decision was announced), many market analysts feel the fluctuations will probably level out in the short-term due to several companies' track records of anticipating and preparing for this sea of change. Wayfair, for example, said in a post-decision statement that it already collected sales tax on approximately 80 percent of its orders in the U.S. and, as a result, did not expect the decision to have any noticeable impact on their business. The effect on Amazon could be even smaller since, as of last year, the company started collecting sales tax in the 45 states that have one. But close to half of Amazon's total online sales is generated from independent merchants who post their inventory there. In most states, those merchants are responsible for calculating and paying the state taxes, which has been difficult to track.

A Little Too Ironic?

The irony here is that, with the Wayfair decision, the Court essentially dismantled a system it created. The 1992 Quill decision (piggy-backing off the National Bella Hess case from 1967) helped pave the way—however unwittingly—for the immense growth of online retail by allowing companies to sell goods nationwide while circumventing the uber-complicated patchwork of state and local tax codes. To say that online retail has changed a lot since then would be the understatement of the millennium. Amazon is no longer the quirky tech fledgling that Jeff Bezos hatched in his garage 25 years ago.

As we cited in a previous post about the fate of Quill, online sales have almost doubled just since 2013, skyrocketing from $263 billion to a projected $414 billion in 2018. This isn't just an economic change, it's a cultural change, which is when things really get interesting (witness Supreme Courts correcting themselves after 50 years). Amazon has gone from $7 billion in sales in 2004 to $178 billion in 2017, raising the ire of President Trump in the process for what he deemed to be unfair tax practices. (It probably didn't help that Bezos bought The Washington Post in the process). With numbers like that, one can quickly calculate the huge amount of uncollected sales tax on revenues of that magnitude. Writing for the majority in the 5-to-4 ruling, Justice Anthony M. Kennedy said the Quill decision probably caused states to lose annual tax revenues of up to $33 billion, and in South Dakota alone, estimates put the loss at $48 to $58 million annually.3 The entire time, state budgets were increasingly hurting for ways to repair crumbling infrastructure and support educational and social services.

With regards to stare decisis, Kennedy wrote:

"Because the physical presence rule as defined by Quill is no longer a clear or easily applicable standard, arguments for reliance based on its clarity are misplaced." He added, "If it becomes apparent that the Court's Commerce Clause decisions prohibit the States from exercising their lawful sovereign powers, the Court should be vigilant in correcting the error. It is inconsistent with this Court's proper role to ask Congress to address a false constitutional premise of this Court's own creation." Kennedy acknowledged the changing times: "The Internet revolution has made Quill's original error all the more egregious and harmful. The Quill Court did not have before it the present realities of the interstate marketplace, where the Internet's prevalence and power have changed the dynamics of the national economy."4

Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel A. Alito Jr. and Neil M. Gorsuch joined the majority opinion.

It will not be lost on historians that the Wayfair decision will go down as the last decision, and one of the few rare tax decisions, authored by Justice Kennedy just a week before he announced his retirement from the Supreme Court

In dissent, Chief Justice John G. Roberts Jr. agreed that the Court's rulings in this area had been "wrongly decided," but said there were insufficient reasons to overrule the precedents. "Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress," he wrote.5 Justices Stephen G. Breyer, Sonia Sotomayor and Elena Kagan joined the dissent.

Retroactive Taxes Remain a Concern

The overturning of Quill is perhaps the most groundbreaking event in sales and use taxation in decades. Still, the Court did not offer guidelines regarding South Dakota's economic nexus standard and whether or not it should be the bellwether by which all states should follow, nor did it indicate if states can seek sales taxes retroactively (South Dakota's law does not). Instead, the decision of the South Dakota Supreme Court was vacated and remanded back to South Dakota for further review. Meaning, technically speaking, there is no set standard for how states should go about taxing online sales, leaving more than 10,000 (no, that's not a typo) different state and local taxing districts to decide for themselves. What could possibly go wrong?

Hence, there is a bit of a wild, wild west feel to what's happening right now. Many experts think that South Dakota's current law could become the standard-bearer, in that it establishes two reasonable criteria for requiring remote sellers to collect sales tax on sales of tangible personal property, any products transferred electronically or services delivered: (1) the remote seller's annual gross revenue exceeds $100,000, or (2) the remote seller has 200 or more separate transactions. Since the Wayfair decision, some states (e.g., Louisiana) have already issued guidance/statements confirming similar nexus standards as South Dakota and affirming remote sellers are required to collect sales tax where as other states (e.g., Minnesota) are taking some time to analyze the decision. New Jersey introduced Senate Bill 2794 and Assembly Bill 4261 to extend sales tax collection responsibility to remote sellers that meet the economic nexus standards consistent with the South Dakota standards as noted above.

Either way, the mind reels with questions about what's next:

  • Will states attempt to collect taxes retroactively? If so, how does that work?
  • Is South Dakota economic nexus standards the model for all states to base their new laws upon?
  • Will there be any leniency? Amnesty Programs?
  • When will states actually start collecting taxes for online sales? Immediately? 30 days? 60 days?
  • Does Congress have anything to say about all this?
  • It can't really be a complete free-for-all...can it?

Over 30 states currently have internet sales tax laws, several of which replicate South Dakota, and many others are expected to follow. In the past year, Washington State and Pennsylvania enforced requiring internet retailers to collect taxes on third-party sales. Some laws are more creative than others, e.g., in 2017, Massachusetts asserted that internet cookies, or data files stored on your computer by a Web browser, constituted tangible personal property—and presence—for purposes of sales tax (the state was forced to rescind that stance after a lawsuit challenged its constitutionality). Other states will have to adapt their current laws if they want to take advantage of the Wayfair decision, which is sure to kick-start a maelstrom of activity in legislatures.

It's interesting that this was a close 5-4 decision, because it underscores the need for Congress to participate in protecting the growth pattern of the e-commerce sector of the economy. While they have made some attempts, Congress remains stymied between proposed solutions, such as the Remote Transactions Parity Act (RTPA) or Marketplace Fairness Act (MFA), which lets states collect if they agree to simplify their sales taxes. There was also a proposal from Rep. Bob Goodlatte (R-VA) calling for the sales tax to be a business obligation rather than a consumer obligation, and have it collected based on the tax rate where the company is located but send the revenue to where the customer is located. Perhaps the Court's decision in Wayfair will be the impetus for Congress' renewed focus and action.

The nexus-creating activity of the proposed bills varied throughout the years. Yet, what has been consistent is Congress' failure to enact legislation regarding this matter. If they did, there would probably be more uniformity (translation: less confusion) around how taxes were collected, possibly easing the pain for everyone involved—states, online sellers, and consumers alike. Congress would also be able to protect taxpayers from a retroactive application of the nexus changes.

Expect the Unexpected

The online sales tax struggle is not over, as Justice Kennedy added in his opinion:

"These issues are not before the Court in the instant case; but their potential to arise in some later case cannot justify retaining this artificial, anachronistic rule that deprives States of vast revenues from major businesses."6

With a multitude of questions still looming over the Court's decision, it will be important to remain vigilant about how this massive change could impact your business. It is vital to re-assess your risk of an expanding nexus footprint and stay on watch for how new tax laws could affect your operations.

Here are some key considerations that businesses should carefully evaluate:

  • Navigating the new nexus footprint;
  • Sales and separate transaction activity by state;
  • Flexibility in monitoring taxability of goods and services for additional jurisdictions based on new physical presence standard;
  • Adaptability with revenue sourcing, invoicing and appropriate line item billing to support all applicable jurisdictions;
  • Preparing for potential surge in registration and sales and use tax reporting responsibilities for a potentially large population of jurisdictions keeping up with ever-changing state and local sales and use tax rates.
  • Record retention requirements associated with online activities to ensure you can appropriately support transaction detail during an audit and for other reporting purposes; and
  • Tracking legislative updates related to economic nexus

You can read the majority opinion, together with the concurring opinions and the dissent, here.


1. South Dakota v. Wayfair, Inc., U.S. S. Ct. Dkt No. 17–494, 6/21/2018

2. National Bella Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992)

3. per p. 2 of the Supreme Court decision, citing Sales Taxes Report, at 11-12; Brief for Petitioner 34-35 citing estimates of $23 and $33.4 billion

4. per p. 4 of the Supreme Court decision, Syllabus

5. per p. 1 of the Supreme Court decision, Roberts, C.J. dissenting

6. per p. 22 of the Supreme Court decision, Opinion of the Court

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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