Will the U.S. Supreme Court Change the Sales Tax Nexus Rules?
We Predict “No”
By: Karen T. Syrylo, CPA
The U.S. Supreme Court heard oral arguments on April 17, 2018 in the long-awaited state challenge to current sales tax collection nexus rules, South Dakota v. Wayfair, Inc., et al., (U.S., No. 17-494). The case is the state’s request that the Court overturn the South Dakota supreme court’s ruling that the state’s “economic nexus” rule is unconstitutional in accordance with the Supreme Court’s 1992 decision in Quill. The rule requires sellers with no physical presence in the state, e.g. Internet sellers, who have at least 200 transactions or $100,000 of receipts from South Dakota customers, to collect and remit sales tax. The question presented to the Court by the state of South Dakota is: “Should this Court abrogate Quill’s sales-tax-only physical-presence requirement?”
Whatever the Court decides, the results will have huge implications for sales tax administration for businesses and for the states. See our prior coverage at the links below.
The oral arguments involved a lively peppering of questions by the Justices to the attorneys for both sides, which included the South Dakota attorney general, the U.S. deputy solicitor general also advocating for South Dakota, and counsel for Wayfair. Some of the questions and comments from the Court appeared to favor the state’s position, and some appeared to favor the company.
We note that it is an unwritten rule of Supreme Court watchers that we can’t predict the Court’s outcomes based on what occurs in oral arguments, as such predictions are as often as not proved flat out wrong when the Court’s decision is issued. Be that as it may, we still do it, i.e. analyze the questions of the Justices and the arguments and responses of the attorneys, for the exercise of looking into the crystal ball. So, here goes with our summary of what we heard and what we guess the Court will do with the arguments.
Summary of major issues addressed in the oral argument
- Retroactivity – If the Court overturns Quill wouldn’t that decision apply retroactively and wouldn’t that cause major problems?
- What are the costs to a small business of complying with multiple state and local sales taxes, and are those costs a barrier to small businesses doing business?
- If the Court agrees that physical presence is no longer the test, what should be the minimum contact that a business must have with the state to be subject to sales tax collection requirements, what should be the nexus test?
- Will sales tax collection responsibility be a barrier for small businesses’ ability to engage in interstate commerce?
- “Stare decisis” – Should the Quill decision be left in place because businesses have relied on it, so-called settled expectations, in arranging their operations? (discussed mostly by counsel and less by the Justices).
- Or have business circumstances changed sufficiently, i.e. e-commerce, to warrant a different rule today?
- If the Court overturns Quill, what will the states do? What parameters will they use for nexus? Will there be additional litigation over these details? Is there no remaining incentive for states to request Congressional action to deal with the many details?
- If Quill is left standing, what will the states do? More Colorado-type information reporting laws? More aggressive attempts to redefine physical presence? What would be the results of these?
- How much revenue are the states losing? There have been multiple analyses with different numbers. It is admitted that many large remote sellers are now charging and remitting tax.
- Is the physical presence nexus issue one of discriminating against interstate commerce? Or would removing that issue actually be equalizing the responsibilities of all sellers?
- Why should the court favor a business model of selling via the Internet via selling through a physical location?
- Should the Court act at all? What else can be done to get Congress to act?
What seemed to support maintaining the Quill rule?
We heard state tax administrators mention that they had been more confident that the Supreme Court would issue a state-favorable ruling prior to the oral argument than afterward. Here are some of the reasons why.
Justice Sotomayor quickly lowers the boom.
No sooner had South Dakota’s attorney general finished his two sentences of opening remarks (that the two significant consequences of Quill are that the states are losing revenue and that small in-state businesses are harmed by the price differential where remote sellers don’t have to charge sales tax), then boom! Justice Sotomayor asked him “Isn’t the problem not Quill but the fact that you don’t have a mechanism to collect from consumers? It’s not the merchants who are paying the sales tax; its’ the consumer. They’re collecting it for you. So, find a way to collect from them.”
The Justice continued with stating her concern over “the many unanswered questions that overturning precedents will create a massive amount of lawsuits about.” She listed issues about retroactive application if Quill were to be overturned, as many states are implementing their nexus rules retroactively even though South Dakota’s law is not; whether the Complete Auto test applies (i.e. the four-prong test for finding a state tax permissible); and how much contact is enough to create nexus for an out-of-town seller. And she stated “So you’re introducing now a whole new set of difficulties to put behind something that’s been in place for 30 years.”
And to the state’s point about small in-state sellers’ price disadvantage, the Justice stated “Actually, they’re put at disadvantage not by Quill but by the fact that there are massive discount sellers, not just on the Internet, but even in stores now.”
Justice Sotomayor’s questioning also involved the issues of costs for small businesses to comply with sales tax collection, noting that such costs included not only purchasing software but also installing, integrating and maintaining the software, and also audits.
To the idea that Congress can step in if the Court overturns Quill, Justice Sotomayor voiced the issue that that doesn’t “do any help for what would happen in the interim before Congress acts.”
Noted with almost shock by many tax professionals who were listening, was South Dakota’s answer to Justice Sotomayor’s question regarding “how many sales does it take” to create sales tax collection obligation? The attorney general answered “The minimum would be one sale…” One wonders how this will sit with the entire Court, whether it goes too far in defining the “substantial nexus” that the Court has historically required in a number of state tax settings!
Justices Roberts, Alito, Kagan and Breyer engage in Quill-favorable exchanges
Chief Justice Roberts then asked “Did I understand you to acknowledge that there would be a constitutional minimum with respect to the burden?” In other words, that the states “could not impose the obligation on some small businesses?” He added that the Court has never “recognized a lowest level for things like a physical presence” and that “that would be another special rule” needing to be put in place. We took this to mean that Justice Roberts was indicating the belief that even for economic presence there needs to be a minimum standard in order to be constitutional.
The Chief Justice was the one to comment that “this is a problem that has peaked” in that the major e-commerce companies are now collecting sales tax. “And if it is, in fact, a problem that is diminishing rather than expanding, why doesn’t that suggest that there are greater significance to the arguments that we should leave Quill in place?” When the state responded that e-commerce is “rapidly growing,” Justice Roberts replied that Amazon is “already collecting in all 50 states” and that although e-commerce is expanding, “the coverage in terms of collecting the taxes is expanding as well.” The state’s response was “but what remains is the $100 billion loss over the next 10 years.”
Justice Alito offered the state a choice of two options: A) “eliminate Quill and states can do whatever they want with respect to retroactive liability and with respect to the minimum number of sales required in the state in order for the sales to be taxed;” and B) “a congressional scheme that deals with all of these problems.” “If those are the only two options, which is preferable?” The state attorney general answered with Option A), because “Congress has had 26 years to address this issue. And it’s not Congress, but it’s Quill, it’s this Court’s decision that is striking down our state statutes.”
But Justice Kagan then followed up with her reaction — that the mention of Congress not acting “gives us reason to pause, because Congress could have addressed the issue and Congress chose not to. This is not the kind of issue where you say it didn’t get on Congress’s radar screen…This is a very prominent issue which Congress has been aware of for a very long time and has chosen not to do something about that. And that seems to make your bar higher to surmount.”
Several of the Justices had questions or comments about the concept of Congress’s inaction and what it meant, if anything, and what the Court should do about it, if anything. For example, Justice Breyer pointed to the amicus briefs from three Senators and Congressman Goodlatte, which outlined the proposals that Congress had been considering for the sales tax nexus issue and suggested the Court should leave the issue in Congress’s hands. Justice Breyer stated “They’re members of Congress and they point to many statutes. And you are 50 states. If you do not have the power to get Congress to do something, I don’t know who would.” Justice Alito said things like: currently, both sides have incentive to ask for Congressional solution – the Internet retailers in order to not have to deal with “aggressive moves by the states” and the states in order to collect the tax; “But if Quill is overruled, what incentives do the states have to ask for any kind of Congressional legislation?” And Chief Justice Roberts stated that maybe Congress had already “made a decision, or at least majorities have made a decision that this is something they’re going to leave the way it has been for, whatever it is, 25 years. I think it would be very strange for us to tell Congress it ought to do something in any particular area.”
Justice Breyer was also concerned about the barriers of entry to interstate commerce for small businesses, created by the costs and processes of sales tax collection compliance. He agreed that software made compliance easier, but with 10,000 taxing jurisdictions the likelihood and costs of mistakes were significant. He pressed the attorneys for specific numbers on costs for an Internet seller to sell his products in 50 states. “No one asked Amazon. What does it cost Amazon?”
Additionally, Justice Breyer was concerned about increased litigation. He referenced the Complete Auto decision being about “nexus such that the benefits of state revenue do not outweigh the compliance costs associated with the tax collection obligations that the state has imposed.” “I suddenly think of 10,000 cases being brought by 20,000 lawyers on one side and another 20,000 on the other side to decide jurisdiction by jurisdiction, case by case… that was my problem with Complete Auto.”
What seemed to support overturning Quill?
Some of the questions and commentary from the Court did seem to favor the state.
Justices Ginsburg, Gorsuch, Kennedy and Thomas appear poised to kill Quill
Justice Ginsburg was the most vocal Justice who had questions and comments that challenged the ongoing validity of Quill. Her opening salvo was “… Quill, right or wrong, was this Court’s decision. And if time has, and changing conditions have, rendered it obsolete, why should the Court which created the doctrine say we’ll let Congress fix up what turns out to be our obsolete precedent?” She offered that if the Court were to overturn Quill, then Congress could take care of the retroactivity issue that concerned other Justices.
For the point regarding costs for businesses to comply, she asked “Don’t you think there’s enough incentive in the system that if we did overrule Quill, that entrepreneurs would produce software that would meet the market need?”
Regarding the Colorado approach for required information reporting versus the seller’s collection of tax, she said “Then the state has the burden of going after consumers. In the real world, it’s much more efficient, much more likely, to yield funds if you go after the seller than if you go after the individual consumer.” (Note the direct conflict with Justice Sotomayor’s view that the problem was not Quill but the state’s not having a system for collecting from the consumer.)
Perhaps most pointed, Justice Ginsburg said “How about going back to the very basic issue: The assertion is that asking an out-of-state seller to collect tax on goods shipped in-state discriminates against interstate commerce. But, as I see it, why isn’t it, far from discrimination, equalizing sellers? That is, anyone who wants to sell in-state, whether an in-state shop, an out-of-state shop, everybody is treated to the same tax collection obligation. All who exploit an in-state market are subject to the in-state tax. Why isn’t that equalizing rather than discriminating?”
Justice Gorsuch said and asked less than his fellow Justices in terms of volume of time, but he still showed what we had come to believe his position is on Quill – skepticism that it is good law. Such comments had come when he was an appeals court judge in the Federal Tenth Circuit, including his involvement in the Direct Marketing Association v. Brohl case regarding the Colorado information reporting law prior to that case’s arrival at the U.S. Supreme Court.
In the current South Dakota v. Wayfair oral argument, Justice Gorsuch’s points included the issue of remote sellers versus physical operations: “There are a lot of retailers that have to comply with lots of different jurisdictions’ rules. Why should we favor, this Court favor, a particular business mode that relies not on brick and mortar but on mail order? I understand in Bellas Hess [the sales tax nexus case preceding Quill] the Court was concerned about a nascent, small mail order industry. Those concerns seem a little antiquated today … More Internet retailers are moving toward brick and mortar; but, again, why should this Court favor those who don’t over those who do?”
Justice Gorsuch also was the one to make the point that what businesses face is not collect-tax-or-don’t-collect-tax, under Quill-or-no-Quill, but rather “Now states may force Internet providers to provide information, like Colorado does, that enable them to collect tax from the taxpayer [consumer]. So, the real delta here isn’t no duty at all on the Internet supplier versus collecting sales taxes … I’ve wondered whether the Colorado regime might be more burdensome than just simply collecting the sales tax itself.”
Justice Kennedy’s participation in the discussion involved only one point: “The assumption of many of the questions is that Quill is incorrect.” But, when it comes to leaving the issue for Congress to act, does it make a difference as to whether the Court’s ruling in Quill was correct or incorrect? (Wayfair’s counsel replied that this “introduces the issue of stare decisis, because the standard of stare decisis is that even where the Court has ruled incorrectly, there’s a value in settled expectations and standing by the decision previously. And that is most powerful when Congress has the ability to correct an error if that error existed. And both the state and the United States deal very lightly with the issue of stare decisis [in their briefs and argument].”)
Even in hearing so little of his voice in the oral argument, we expect Justice Kennedy’s vote in favor of abrogating Quill. It was he who wrote in his concurring opinion in the U.S. Supreme Court’s first Direct Marketing Association v. Brohl decision (regarding Colorado’s sales tax information reporting law), that “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” and “The legal system should find an appropriate case for this Court to reexamine Quill.”
Justice Thomas, as is most usual for him in the Court’s oral arguments, said nothing the entire time. But we note two things about Justice Thomas: We know from his prior decisions and writings that he does not believe in a “dormant Commerce Clause” theory, the theory the Court has relied upon when ruling that a state’s actions are a prohibited imposition on interstate commerce; Thomas calls it the invisible commerce clause. Also, colleagues who were in the Court room in a position to view Justice Thomas described him as appearing physically agitated; perhaps because of his position on the dormant commerce clause he was agitated to even have to be hearing the case. We clearly expect his vote will be to overturn Quill and leave the sales tax nexus issues to Congress.
Predictions on what to be ready for
Regardless of what approach the Supreme Court takes in its ultimate decision, the South Dakota v. Wayfair case will undoubtedly have significant impact on the states’ sales tax administration and on what businesses need to do. Perhaps there are multiple possibilities (although we should keep in mind that the Court rarely strays from just answering the question they were presented, which in this case was “should Quill’s physical presence requirement be abrogated?”)
- Will the Court overturn Quill, period, as no longer the correct standard in the modern business environment of electronic commerce, leaving open such questions as is the change retroactive, and what should be the new standards for nexus?
- Will they overturn Quill, but indicate the new rule should be prospective only, even though they generally don’t place such restriction in their decisions?
- Will they not overturn Quill entirely, but rule that the South Dakota law is constitutionally acceptable, e.g. because of its specific parameters of 200 transactions and $100,000 revenues? Will they be concerned that such an answer would generate additional litigation, e.g. regarding state statutes that use different parameters?
- Beyond the specifics of South Dakota’s current law, will the Court give guidance as to what is an acceptable threshold contact that creates a business’s sales tax obligation, in terms of number of transactions or volume of sales?
- Will they leave Quill in place, period, by saying that the South Dakota law in unconstitutional, or that under stare decisis they will not change the settled expectations that have existed for over 25 years?
- Will they leave Quill in place and yet again state the invitation that they extended to Congress in the body of the Quill decision, that it is up to Congress “to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect [sales] use taxes”?
Our crystal ball at April 17 predicts that Quill will not be overturned, likely by the slim vote of 5 to 4. Although the attorneys for both sides were put on the spot multiple times by the Justices, we believe that the Court was not convinced that, when balancing all the issues, the case was made to overturn the Quill decision. Thus, the physical presence rule would stay in place with all that that means for what alternatives the states will look for. But as we said in the opening above, predictions based on the oral argument are often incorrect. It is entirely possible that one or more of the Justices who engaged in discussion that appeared to be favorable to retaining the Quill precedent could instead vote to overturn it. We won’t know until sometime in June when the Court’s decision is released prior to the close of their current session. And then we will watch for the reactions of the states and Congress.
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Ed BenBenbu-state-local-tax transaction-taxvirginia-bpol-tax-serviceshunt-valleySenior Director
Last updated on September 4th, 2019 at 05:06 pm