On Thursday, June 21, 2018, the United States Supreme Court announced its highly anticipated decision in South Dakota v. Wayfair, __ U.S. __ (No. 17-494, 2018) in which it revisited the Court’s long-standing precedent that a state may only tax businesses that establish “nexus” with a state by having a sufficient physical presence in that state. (See Quill Corp v. North Dakota, 504 U.S. 298 (1992)). Now the Court, in a 5-4 split decision, has concluded that physical presence is not required to establish sufficient constitutional nexus with a state because that view is too narrow given the evolving economic realities of our national marketplace. But many issues still remain in the ongoing discussion of state taxation of on-line sales.
Quill and its physical presence test have governed state taxation of interstate commerce since 1992. In the meantime, interstate commerce has changed and technology has fueled the accelerating growth of remote sales that require neither storefronts nor distribution networks of the past. Thus, the Court in Wayfair observed that, “Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the states.”
The Court has long held that state regulations may not discriminate against, or impose undue burdens on, interstate commerce. But the Court has also said that interstate commerce may be required to pay its fair share of state taxes. Historically, taxation of interstate commerce has required states to meet a four pronged test:
- The taxed activity must have substantial nexus to the taxing state;
- The tax must be fairly apportioned;
- The tax must not discriminate against interested commerce; and
- The tax must be fairly related to the services the state provides.
Wayfair addresses the first and fourth of these tests. The Court expressly recognized that goods provided by on-line sellers such as Wayfair are purchased by customers who enjoy the benefits provided by state governments. Thus, the sales of such companies have a direct relationship to the services provided by the state in which a purchaser resides. Moreover, in light of changed market conditions and the rise of online sales, the “physical presence test” no longer represents our national economic reality, and that test, “must give way to the far-reaching systemic and structural changes in the economy and many other societal dimensions caused by the Cyber Age…The Internet’s prevalence and power have changed the dynamics of the national economy.” The Court found sufficient nexus with the state of South Dakota because the state limited its taxation to on-line retailers with a defined minimum dollar volume of sales or a minimum number of annual transactions. Thus, “nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the state.” The seller could not have met the statutory minimums, “unless the seller availed itself of the substantial privilege of carrying on business in South Dakota.”