The third time’s a charm

Written on Oct 10, 2018

By Rich Molina, CPA

Reversing decades of precedent, the U.S. Supreme Court finally upheld a requirement that retailers withhold and remit sales taxes for purchases made by customers in states in which the retailers have no physical presence.

South Dakota v. Wayfair, Inc., U.S. (2018)

The retailers in this litigation were all large online sellers (Wayfair,, and Newegg, Inc.) who had no physical presence in South Dakota. The retailers challenged a law enacted by South Dakota’s legislature that would require them to collect sales taxes from South Dakota residents and to remit the taxes to the state. The new statute was enacted as a calculated attempt by the state to challenge decades of settled precedent in the hope that the Supreme Court would revisit its prior precedents. This calculation obviously paid off.

The statute

South Dakota, like other states, experienced a substantial decline in tax revenues as more and more of its residents purchased goods and services online from out-of-state retailers. An out-of-state retailer lacking physical presence in a state, under existing Supreme Court precedent, is not required to charge a sales tax. South Dakota estimated its loss of revenue to be $48-53 million annually. Although customers are legally obligated to pay a use tax on their purchases, compliance with the use tax was low to nonexistent. The legislature adopted a statute that required out-of-state sellers to collect and remit sales tax as though the seller had a physical presence. The law would not be retroactive and would not go into effect until the constitutionality of it was settled. Clearly, the legislature anticipated sellers to challenge the law. Moreover, the law applied only to sellers making more than $100,000 of sales annually in the state or engaging in 200 or more separate transactions annually in the state. As expected, the law was immediately challenged by out-of-state sellers and the South Dakota state courts ruled in favor of the sellers based on existing U.S. Supreme Court precedent.

U.S. Supreme Court precedent

More than 50 years ago in National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967) the court held that under the Due Process and Commerce Clauses of the U.S. Constitution, the State of Illinois could not require an out-of-state mail order company having no employees or property in the state, to collect and remit sales taxes on behalf of Illinois customers. The Due Process and Commerce Clause required there be some minimum connection or nexus between the state and the company before the state could impose the burden of tax collection and remittance.

A quarter of a century later, the court re-examined its holding based on changes in the economy and how business works. In Quill Corp v. North Dakota, 504 U.S. 298 (1992), once again, a state, this time North Dakota, required an out-of-state mail order company to collect and remit taxes on behalf of North Dakota residents when the company itself had no physical presence in the state. North Dakota thought it appropriate to challenge the National Bellas Hess decision, as more and more business was done through the mail by sellers not having a physical presence in the state and because of changes in the court’s interpretation of the Due Process Clause. Based on its evolving precedents dealing with Due Process since National Bellas Hess, Due Process would not be a bar to imposing the collection and remittance obligations because there was a minimum connection between the seller and the state as the seller relied and depended upon all of the orderliness provided by the state in enabling an adequate environment in which to do business. The Commerce Clause, however, still demanded a physical presence in the state before nexus could be established. Of significant importance to the court was its desire not to disturb the physical presence requirement as sellers engaged in interstate commerce structured their affairs upon reliance of the physical presence test.1

The court’s reasoning in Wayfair

Very rarely does the U.S. Supreme Court reverse itself, particularly when a precedent has been in existence for so long. But here the court acknowledged the facts were compelling such a reconsideration. On a national level, the states were losing $8-33 billion of tax revenue per year in uncollected sales taxes by out-of-state sellers. In addition, at the time the Supreme Court rendered the Quill decision in 1992, less than 2% of Americans had internet access while that number is 89% today. Moreover, since 1992, online retailer Amazon had overtaken bricks and mortar company Wal-Mart as the largest retailer.

The court justified its reversal with respect to its physical presence requirement for three reasons. First, the substantial nexus requirement under Commerce Clause analysis is satisfied without a physical presence because under Due Process, all that is required is some definite link or a minimum connection between the state and the seller and Due Process and Commerce Clause nexus are closely related, thus requiring a similar result on the nexus question.2 There is no longer an unfair administrative burden imposed on a business to comply with the collection and remittance obligations given the economy’s strong reliance on the internet.

Second, the physical presence requirement creates market distortions in that competitive benefits occur to retailers who choose to limit the location of their physical operations. The court found that its physical presence requirement, in essence, created a “tax shelter” for those firms to pass tax avoidance savings onto customers by not having a physical presence in that particular state.3

Third, the physical presence requirement creates an arbitrary, formalistic distinction between businesses that modern-day Commerce Clause analysis seeks to avoid. For example, if two businesses conduct a substantial online business in Ohio, the business with a small warehouse or distribution facility in Ohio will be at a competitive disadvantage because it would be required to collect sales taxes on all its sales to Ohio residents and not just those attributable to products sold from the Ohio warehouse. The other business, perhaps with a huge warehouse in Covington, Kentucky, shipping lots of goods into Ohio would not have to burden its Ohio customers with any sales tax.

Finally, it is important to note that the court was particularly satisfied that South Dakota’s new tax law included provisions that were designed to prevent discrimination against or undue burdens upon interstate commerce, particularly with respect to smaller businesses or businesses not conducting much activity in the state. The statute exempted sellers conducting limited business in the state (the $100,000 annual sales test and the 200 transactions per year test discussed earlier). Further, the statute, if upheld, would not be applied retroactively. South Dakota had adopted the Streamlined Sales and Use Tax Agreement, a uniform system designed by state tax administrators nationally to reduce compliance costs among its member states by adopting common rules and procedures and common software tools. Perhaps the court was telling other state tax commissioners that if you follow these provisions, you might protect yourselves from further challenges.


Clearly, the court issued a landmark decision in the area of state taxation. The court’s holding has evolved along with modern day commerce just as the court is finding itself having to adapt to new areas in other parts of the law, including privacy in the digital age. No one on the Supreme Court or in business for that matter, could have envisioned in 1967, or even in 1992, how retail sales would evolve to where they are today.

Rich Molina, CPA, is an adjunct professor at Cleveland State University.

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