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Supreme Court to hear challenge to sales tax standards

02.01.18

Update: As of June 21, 2018, the US Supreme Court has overturned the overarching standard for applying sales tax to online retailers.


Have things changed so much since 1992 that a physical presence standard should no longer apply in determining whether a state can subject you to sales tax? In January, the Supreme Court agreed to hear a case challenging the over-arching sales and use tax collection standard.

The standard, imposed in 1992 by Quill v North Dakota, requires that a taxpayer have a physical presence in a state for that state to enforce sales and use tax collection on a seller. As online sales have become the norm, states have struggled with sales tax collection. Sales that may have historically occurred in a brick and mortar store now occur online, and the seller, without physical presence in the state, is not required to collect and remit sales tax.

While many states still impose a use tax requirement, making the customer liable to pay the sales taxes that they were not charged at the time of sale, this is largely self-reported and difficult to enforce. As a result of this lost revenue, states have stretched the definition of physical presence or blatantly challenged it, making it increasingly difficult for businesses to navigate the cumbersome rules in each state. Over time, different states have adopted several methods of capturing out-of-state sellers into their tax base. Here are three:

  • New York uses click-through nexus, which provides that if an out-of-state retailer contracts with an in-state affiliate website, the relationship may constitute a physical presence. The court upheld the law and several states have since joined New York in using it.
  • Colorado and several other states use retailer notification to improve use tax compliance. Under this rule (after a threshold is met), out-of-state retailers must provide customers with an accounting of purchases and a statement that no sales tax has been remitted—and is the responsibility of the customer. The Department of Revenue receives this information, providing a measure of lost revenue and opportunity for enforcement.
  • Several states, including South Dakota, use economic nexus, which sets a “bright line test” for determining when a seller is responsible to collect and remit sales tax. This generally correlates to a set level of sales or gross receipts within the state, and requires no physical presence. In South Dakota v. Wayfair, Inc., the South Dakota Sixth Judicial Court ruled the state’s economic nexus standard was unconstitutional, referencing the Quill physical presence standard. While the state agreed the statute was unconstitutional, it argued brick-and-mortar stores are at a competitive disadvantage to online retailers and the physical presence standard is no longer appropriate due to the increase in online commerce compared to 1992. They also cited a comment made by Supreme Justice Kennedy in another case that it may be time to reevaluate the Quill standard.

States have pushed for the Supreme Court to address the issue and overturn Quill, but until now it has declined to hear any cases. On January 12, 2018 the Supreme Court agreed to hear South Dakota v. Wayfair, Inc. This long-awaited and highly anticipated case is critical in providing some much-needed clarity for states and taxpayers alike.

What does this mean?

The result of this case may redefine the sales tax collection standard for online businesses. We can only speculate on the outcome, but nevertheless, the Supreme Court taking the case suggests additional clarity is coming—and it will impact virtually all sellers conducting business in multiple states.

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