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November 16, 2017 Practice Point

Let’s (Not) Get Physical: States Challenge Physical Presence Sales Tax Nexus Law

By Cody J. Edwards, Dickinson, Mackaman, Tyler & Hagen, P.C., Des Moines, Iowa

I. Introduction

The economy has changed over the past 25 years, in large part due to the internet and the digital economy, and there are no signs that the internet is going away any time soon. The internet allows consumers to purchase goods and services without leaving their homes and retailers to reach consumers without leaving their headquarters. This has been beneficial to both consumers and retailers, but state sales tax revenues have suffered.

Sales and use taxes are a primary source of revenue for many states. Due to the Supreme Court’s sales tax collection requirements in Quill Corp. v. North Dakota,1 the movement to online sales has reduced the number of retailers who are required to charge and remit sales tax on their sales.2 Of course, consumers are required to remit a use tax on their taxable purchases for which sales tax was not charged, but this rarely happens in practice. In response to a concurring opinion by Justice Kennedy in the Direct Marketing Association case,3 some states have proposed legislation that flies directly in the face of long-standing sales tax collection law, hoping the Supreme Court will revisit and overturn Quill.

To help understand the current and future sales tax nexus landscape, this article will briefly revisit the history of sales tax nexus under Quill and Direct Marketing Association. It will then examine the statutes or rules (referred to as economic nexus laws) that states have enacted in response to Direct Marketing Association in an attempt to overturn the nexus law under Quill. Finally, this article will explore competing congressional proposals that attempt to resolve sales tax nexus issues at the federal level.4

II. History

A. Quill Corp. v. North Dakota, 504 US 298 (1992)

In Quill, the Supreme Court held that a state cannot require a company to charge sales tax in its state unless the company has a physical presence, such as a “sales force, plant, or office,” within the state. Thus, for online retailers who do not have physical presence in all 50 states, many sales go untaxed.

At issue was whether Quill, a mail-order office supply company that (at the time) did not have offices, employees, or inventory in North Dakota, was required to collect use tax from its North Dakota customers. To reach its decision, the Supreme Court analyzed the Due Process and Commerce Clauses. With respect to the Due Process Clause, the Court stated that “there is no question that Quill has purposefully directed its activities at North Dakota residents [and] that the magnitude of those contacts is more than sufficient for due process purposes.”5 The Court noted that the inquiry did not end there and analyzed the Commerce Clause.

The Court’s analysis of the Commerce Clause as applied to sales and use tax relied primarily on the Court’s bright-line test applied in National Bella Hess v Dep’t. of Revenue6 , 386 U.S. 753 (1967): “a vendor whose only contacts with the taxing State are by mail or common carrier lacks the ‘substantial nexus’ required by the Commerce Clause.”7 The Supreme Court then noted that “it is not unlikely that the mail order industry’s dramatic growth over the last quarter century is due in part to the bright line [physical presence] exemption from state taxation.”8 Thus, although North Dakota’s imposition of use tax on Quill did not violate the Due Process Clause, the Commerce Cause prevented North Dakota from imposing use tax on an out-of-state seller that did not have physical presence in the state. As discussed in Section IV, below, it is important that the Court decided Quill in this way, as Congress has the power to regulate under the Commerce Clause.

Subsequent to Quill, the mail-order industry continued to grow until catalogues were replaced by more accessible, click-of-the-button internet sales. As a result, sales from out-of-state sellers lacking the physical presence to require sales tax collection have increased dramatically.9 Whether this growth is due to the bright-line physical presence law set forth in National Bella Hess and Quill is debatable, but such sales have certainly reduced state tax revenues.10 Although estimates of the extent of that reduction varies, many states’ poor financial condition has caused them to become creative in searching for ways to tax online sales.11

B. Direct Marketing Ass’n v. Brohl, 135 S.Ct. 1124 (2015)

In Direct Marketing Association, a trade association of retailers challenged as unconstitutional a Colorado law that required non-sales tax collecting retailers (i.e., those without nexus) to notify Colorado customers of their sales and use tax payment responsibility and provide customer-purchase information to the customer and the Colorado Department of Revenue.12 The Supreme Court did not decide the case on the merits, but considered a technical issue regarding the Tax Injunction Act.13 While the Court’s decision is underwhelming for purposes of nexus analysis, Justice Kennedy’s concurring opinion provided unexpected fuel to the nexus debate by suggesting that it is time to “reconsider[]. . . the Court’s holding in Quill.”14 Justice Kennedy noted the “far reaching systemic and structural changes in the economy” since Quill:

[T]here is a powerful case to be made that a remote seller doing extensive business within a State has a sufficiently ‘substantial nexus’ to justify some minor tax collection duty, even if that business is done through mail or the internet.15

Finally, Justice Kennedy called on the Supreme Court to “find an appropriate case . . . to reexamine” sales tax nexus laws.16

Not coincidentally, subsequent to Justice Kennedy’s concurring opinion, states have enacted or proposed legislation or administrative rules setting forth new economic nexus laws that fly directly in the face of Quill. The intent of such laws is either to collect additional sales tax or, more likely, to challenge Quill and lead to its overturning at the Supreme Court.

III. Economic Nexus Laws

Generally, the new economic nexus laws require an out-of-state seller lacking physical presence in the state to collect and remit sales tax if the seller makes a certain number of sales or sales of a certain dollar amount to parties within the state.17 The following is a brief description of each state’s economic nexus laws.

A. Alabama

Effective January 1, 2016, an entity that lacks physical presence in Alabama is deemed to have sales tax nexus if it has (1) over $250,000 in sales into the state per year based on the previous calendar year’s sales and (2) conducts one or more listed activities, some of which do not require physical presence.18 On June 8, 2016, Newegg, Inc., an online retailer, appealed its final sales and use tax assessment, which was based on Alabama’s economic nexus laws.

B. Indiana

Effective July 1, 2017, an entity that lacks physical presence in Indiana is deemed to be an agent for the state of Indiana and to have sales tax nexus if the entity has, for the calendar year preceding the calendar year in which the sale is made, either (1) gross revenue in excess of $100,000 from the sale of tangible personal property, products transferred electronically, or services in Indiana or (2) more than 200 separate transactions in which it sells tangible personal property, products transferred electronically, or services into Indiana.19

C. Iowa

Although Iowa has not enacted economic nexus legislation, it enacted a law, effective July 1, 2017, that appears to run afoul of the aforementioned long-standing nexus laws set forth in Quill. Iowa’s new law requires out-of-state sellers of “alternative nicotine products or vapor products” to, among other things, register for an Iowa sales tax permit and collect sales tax on sales of such products in the state of Iowa.20 The new law applies to telephone, mail, or internet sales of alternative nicotine products or vapor products in Iowa “regardless of whether the seller is located in” Iowa. Although the law applies to sellers located outside of Iowa that have sales people soliciting sales in Iowa, it would also require a seller without a physical presence in Iowa to collect and remit sales tax. As of the date of publication, this law has not been challenged.

D. Maine

Effective October 1, 2017, an entity that lacks physical presence in Maine is deemed have sales tax nexus if, during the prior calendar year or current calendar year, the entity has either (1) gross revenue from the sale of tangible personal property, products transferred electronically, or services into Maine in excess of $100,000 or (2) more than 200 separate transactions in which it sells tangible personal property, products transferred electronically, or services into Maine.21 Interestingly, the Maine Legislature overrode the Maine Governor’s veto of the bill containing the economic nexus provisions.22

E. Massachusetts

Massachusetts is still deciding how, or if, it wants to tax out-of-state sales. On April, 3, 2017, the Massachusetts Department of Revenue issued Directive 17-1 establishing economic nexus; but the Department withdrew that guidance on June 28, 2017, in Directive 17-2.

On September 22, 2017, the Department promulgated rules that set forth economic nexus provisions. Massachusetts’ economic nexus rules are different than those of other states. Specifically, the rule applies to “internet vendors” that have sales in excess of $500,000 and have 100 or more transactions. The rules define an internet vendor broadly as a vendor that derives sales from transactions consummated over the internet, whether such transactions are: (a) completed on a website maintained or operated by the vendor itself, or a website maintained or operated by a related person or a person with which the vendor contracts, including a marketplace facilitator and/or (b) fulfilled by a related person or a person with which the vendor contracts. An internet vendor, in addition to its internet sales, may also derive sales from orders completed other than over the internet.23

This regulation applies to the same out-of-state sellers targeted by many of the other states imposing economic nexus laws, but it also applies to marketplace facilitators such as Amazon that provide a marketplace for third parties to sell goods. On September 25, 2017, the Department sued Amazon subsidiaries to obtain documents on sales and inventory stored in the state, in order to determine whether third-party vendors making sales through the Amazon Marketplace have sales and use tax liability.

F. North Dakota

North Dakota’s economic nexus provisions become effective “on the date the United States Supreme Court issues an opinion overturning” Quill or otherwise confirms that a state may impose economic nexus standards on out-of-state retailers.24 North Dakota’s law would impose collection requirements on entities that lack physical presence if, during the prior calendar year or current calendar year, the entity either has (1) gross sales from the sale of tangible personal property or other taxable items delivered into the state in excess of $100,000 or (2) more than 200 separate transactions in which it sold tangible personal property or other taxable items into the state.

G. Rhode Island

Rhode Island enacted new chapter 18.2 of Title 44 of the General Laws, effective August 17, 2017, which takes aim at taxation of internet sales.25 Included within the new chapter 18.2 is the requirement that “non-collecting retailers” that had sales of tangible personal property or services to Rhode Island within the preceding calendar year of (1) at least $100,000 or (2) more than 200 separate transactions collect and remit sales tax on taxable sales.26 In lieu of collecting and remitting sales tax, the non-collecting retailer can provide Rhode Island with certain notice and sales reports, a provision that is similar to those challenged in Direct Marketing Association.

The definition of “non-collecting retailers” is broad and includes a person who, among many other activities, sells, leases, or delivers in Rhode Island “or participates in any activity in [Rhode Island] in connection with the selling, leasing, or delivering in [Rhode Island], . . .of tangible personal property, prewritten computer software delivered electronically or by load and leave, and/or taxable services or use, storage, distribution, or consumption within” Rhode Island.27 Rhode Island imposes harsh penalties for non-compliance—$10.00 for each failure but not less than $10,000 per year.28

H. South Dakota

Effective May 1, 2016, all entities with either (1) annual sales into the South Dakota of greater than $100,000 or (2) more than 200 separate transactions in the state are deemed to have sales tax nexus. Three out-of-state sellers—Wayfair,, and Newegg—challenged this law. On September 13, the South Dakota Supreme Court, in South Dakota v. Wayfair, et al. 2017 S.D. 56 (S.D. 2017) ruled on the economic nexus laws and stated that it saw “no distinction between the collection obligations invalidated in Quill and those imposed by” South Dakota’s economic nexus law. Notwithstanding the persuasiveness of South Dakota’s arguments on the merits, the court held that “Quill remains the controlling precedent on the issue of Commerce Clause limitations on interstate collection of sales and use taxes.”

South Dakota is expected to appeal the decision to the United States Supreme Court.

I. Tennessee

The Tennessee Department of Revenue enacted an economic nexus rule that would have required certain out-of-state sellers to collect Tennessee sales tax beginning July 1, 2017. After the rule was challenged by vendors, the Department issued Notice #17-12 indicating that out-of-state sellers are not required to comply with the new rule “while the court challenge is pending.”

If the rule is resolved in favor of Tennessee, out-of-state sellers without physical presence in the state who engage in regular and systematic solicitation, by any means, of consumers in Tennessee and who have made sales exceeding $500,000 to Tennessee consumers during the previous 12-month period are deemed to have sales tax nexus.29

J. Vermont

Effective the later of July 1, 2017, or the beginning of the first day of the quarter after a controlling court or federal legislation overturns Quill, out-of-state sellers without physical presence in Vermont are deemed to have nexus with Vermont if the seller made (1) sales of tangible personal property into Vermont totaling at least $100,000 or (2) at least 200 separate transactions within a 12-month period preceding the period that the seller is required to remit sales tax.30

K. Washington

Effective January 1, 2018, Washington implements a “new program” that requires “remote sellers” to elect one of two options relative to sales tax.31 If a remote seller has at least $10,000 in gross receipts from retail sales sourced to Washington during the current or preceding calendar year, the seller must elect either (1) to collect sales or use tax or (2) to comply with the sales and use tax notice and reporting requirements.32 A remote seller is any seller who does not have a physical presence in Washington and makes retail sales to Washington purchasers.

L. Wyoming

Effective July 1, 2017, all sellers with more than (1) $100,000 in aggregate annual sales to customers located in Wyoming or (2) 200 separate transactions in the state are deemed to have sales tax nexus.33 On June 28, NetChoice and American Catalog Mailers Association filed a lawsuit claiming the statute is unconstitutional under Quill.34 In addition, on July 7, 2017, Wyoming filed a lawsuit in Wyoming District Court seeking a declaratory judgment requiring five vendors with no physical presence in Wyoming to collect tax on sales into the state.35 Under the statute, the filing of a declaratory judgement action operates as an injunction: while the action is pending, the Department of Revenue is prohibited from enforcing the statute.

IV. Legislative Proposals to Resolve Sales Tax Nexus Issue

It is important that the Court decided Quill under the Commerce Clause. The Commerce Clause explicitly grants “Congress...the regulate Commerce...among the several States.”36 The Court has interpreted this Clause to give Congress broad authority to regulate a wide array of matters including food,37 child support,38 and guns,39 among many others. If the Court had decided Quill solely under the Due Process Clause, Congress’ ability to regulate sales tax nexus may have been less clear. Recognizing the need to resolve the state sales tax nexus issue, Congress has proposed legislation that would do so.

The Marketplace Fairness Act of 201740 would authorize states meeting certain requirements to obligate certain out-of-state sellers to collect state sales tax, essentially repealing Quill. The No Regulation Without Representation Act of 201741 would prohibit states from forcing out-of-state sellers that do not have physical presence in the state from collecting sales tax on sales made into the state, essentially codifying Quill. Congress has had the opportunity to consider both these bills in prior years, but neither has become law.42

V. Conclusion

Each of the laws discussed here is in various stages of implementation or litigation. In some states the effective date is unknown pending the outcome of a Supreme Court case resolving the economic nexus issue. In other states, the laws have not been challenged or have been challenged and appealed. Given the South Dakota Supreme Court ruling that Quill is still the law of the land and Justice Kennedy’s suggestion that the United States Supreme Court should consider revisiting Quill, it is not unlikely that the issue of economic nexus will be resolved by the Supreme Court in the future. Congressional action before the Supreme Court rules on constitutionality could make the issue moot. Passage of either of the proposed nexus bills after the Supreme Court rules on the state question could undo the Supreme Court’s decision, which would have made states’ efforts all for naught.

2 Estimates regarding the extent to which states’ tax revenues have decreased as a result of the increase in internet sales vary. A 2014 study by the National Conference of State Legislatures estimated that, for 2012, nationwide sales tax losses due to remote sales was $23.3 billion.

3 Direct Marketing Ass’n v. Brohl, 135 S.Ct. 1124 (2015).

4 Recognizing the lost revenue as a result of online sales, on September 21, 2017, the European Commission adopted the Communication on A Fair and Efficient Tax System in the European Union for the Digital Single Market that proposes to impose a tax on digital companies and digitalized products through numerous adjustments to the European Union’s tax laws.

5 Quill Corp., 504 US at 308.

6 National Bella Hess v Dep’t. of Revenue, 386 U.S. 753  (1967)

9 According to one study, in 2010, total e-commerce has increased almost 200 percent since 1999.

10 See n.2, above.

11 States have enacted Affiliate Nexus, Click-Through Nexus, and “Cookies” Nexus laws, all of which are beyond the scope of this Article.

12 The Direct Marketing Association entered into a settlement with the Colorado Department of Revenue, withdrawing its claims. Under the settlement, the law is considered to be effective as of July 1, 2017.

13 The Tax Injunction Act prevents federal courts from hearing cases involving attempts to “enjoin, suspend, or restrain the assessment, levy or collection of any tax sue under State law where a plain, speedy and efficient remedy may be had in the courts of such State.” 28 U.S.C. § 1341.

17 Many of the economic nexus laws are similar and have requirements in addition to the economic nexus provisions. For example, some laws allow the state to bring a declaratory judgement against an entity that the state believes meets the criteria of the economic nexus requirement, without auditing the entity first. Additionally, some states are prevented from collecting tax from out-of-state sellers while the courts are resolving the constitutionality of the state’s economic nexus provisions. Furthermore, in a rush to resolve this issue, many of the new laws require that the appeals go directly to the state supreme court. Finally, some states’ laws provide that, in the event the economic nexus standards are ultimately upheld, the law will only apply going forward and not retroactively.

18 Alabama Admin. Code Rule 810-6-2-.90.03.

21 36 MRSA § 1951-B.

22 State of Maine Legislature, Summary of LD 1405.

23 Mass. Dep’t of Rev. Regulation 830 C.M.R. 64H. 1.7 (effective Oct. 1, 2017).

24 North Dakota Code § 57-39.2-02.2.

25 Chapter 18.2 also creates Affiliate Nexus, Click-through Nexus, Marketplace Nexus, all of which are beyond the scope of this Article.

27 Id. §44-18.2-2(4).

28 Id. § 44-18.2-5.

29 Tenn. Comp. R & Regs. 1320- 05-01-.129(2).

31 65th Legislature, 2017 3rd Special Session, HB 2163. This new law also requires “marketplace facilitators” and “referrers” to make this election.

32 See the discussion of reporting requirements in Direct Marketing Ass’n in Section II.B, above.

34 Am. Catalog Mailers Assn. v. Noble, Wyo. Dist. Ct., No. 188-137 (June 2017).  

35 Wyoming v. Newegg Inc., Wyo. Dist. Ct., No. 34238, (July 2017). 

37 21 U.S.C. §602 (inspection of meat).

38 18 U.S.C. §228 (failure to pay child support obligations).

39 26 U.S.C. §5861 (2005) (machine guns, destructive devices, and other firearms).

40 S.976, 115th Cong. (2017).

41 H.R. 2887, 115th Cong. (2017).

42 Senator Michael Enzi (R-WY) first introduced the Marketplace Fairness Act (S.1832) in 2011. Congressman Jim Sensenbrenner (R-WI) first introduced the No Regulation Without Representation Act (H.R. 5893) in 2016.