South Dakota V. Wayfair: From International Shoe to Interstate Sales Tax
By Marc Brandeis and Daniel W. Layton
Even attorneys who only vaguely remember law school will still remember the holding of International Shoe, that the Constitution’s Due Process Clause requires a party have sufficient minimum contacts with a forum state to be personally subject to its courts’ jurisdiction, so long as it does not offend “traditional notions of fair play and substantial justice.” What some may not recall is that the subject matter of International Shoe was collection of employment-related tax imposed by the state of Washington. In the 1992 case of Quill Corp. v. North Dakota, which involved use tax, the Supreme Court instead adhered to a bright-line physical presence test, requiring physical presence in-state to meet the dormant Commerce Clause’s requirement of “substantial nexus” and justify the burden sales tax would place on interstate commerce. Last month, the U.S. Supreme Court issued its decision in South Dakota v. Wayfair, which overturned Quill and allows states to impose a use tax collection requirement on sellers with no physical in-state presence.
Sales Taxes v. Use Taxes
There is a common misconception that tax is not due from a purchase made from an out-of-state seller who does not collect tax. However, all of the forty-five states, including California,that impose sales tax also impose a “use tax.” Sales taxes are generally imposed upon the in-state sellers who collect and remit the tax from in-state customers. The use tax (frequently referred to as a sales tax), on the other hand, is generally imposed upon the purchaser when making a purchase that would otherwise be subject to the sales tax, from a seller that is not engaged in business in-state or that ships from a point outside the geographic boundaries of a state. The use tax is generally the liability of the purchaser, but an out-of-state seller who meets nexus requirements must register with that state and collect the use tax from their customer.
Stare Decisis v. The Changed Times
Although use tax has been around for as long as sales tax, compliance by purchasers who are required to self-assess and report their use tax has been a challenge. Previous attempts by states to impose a use tax collection requirement on remote sellers were limited to companies with an in-state presence by the U.S. Supreme Court in two well-known opinions: the 1967 National Bellas Hess v. llinois  opinion, where the Supreme Court held that sales to in-state customers where delivery is made via common carrier was insufficient to create nexus and the Supreme Court’s 1992 Quill opinion reaffirming that holding. In the intervening twenty-five years between those two cases, the Supreme Court saw little reason to stray from stare decisis or to disrupt the expectations of retailers set by the 1967 decision.
In 2018, just over twenty-five years later, the retail landscape is radically different. In the decades since those two decisions, e-commerce transactions have risen to a level that could not be foreseen. As the volume of e-commerce transactions continued to rise year after year, states’ resentment of the physical presence test grew in tandem. With each passing year, the so-called “kill Quill” momentum grew as more tax revenue went uncollected and perceived imbalance between in-state“brick and mortar” sellers and remote sellers widened.
By the 2010s, the rapid growth and public acceptance of e-commerce made it much easier for a remote seller to tap into a market in another state without creating physical presence. At the same time, new software was available to help remote sellers comply with the complexity of sales and use taxes across state lines. In response, states increasingly passed legislation that challenged Quill (i.e.click-through nexus, reporting requirements, cookie nexus, etc.). One of those laws, a 2010 Colorado law which required certain out-of-state vendors to provide information to Colorado customers about their Colorado sales tax responsibilities, was brought to the fore in Direct Marketing Association v. Brohl,  in which the Tenth Circuit initially ruled that the Tax Anti-Injunction Act barred the case from federal court. The Supreme Court disagreed with the lower court and found that the Tax Anti-Injunction Act did not prevent the Tenth Circuit from hearing the case. More than just ruling on the jurisdictional question, though, the opinion contained a strong message regarding the possible death of Quill, with Justice Kennedy stating, among similar lamentations about Quill in his concurrence, that the physical-presence rule “now harms States to a degree far greater than could have been anticipated earlier.” After the Tenth Circuit ruled in favor of Colorado in an opinion that was fairly critical of Supreme Court precedent, the Supreme Court’s denial of certiorari was widely read as an invitation for a more direct challenge to Quillby the states.
In March 2017, South Dakota passed Senate Bill 106, one of the first “kill Quill” bills enacted as a challenge to the 1992 decision. The law applies only to online retailers that, on an annual basis, deliver more than $100,000 worth of goods or services into the state or engage in 200 or more separate transactions for the delivery of goods or services there. Further, the law applied prospectively (not retroactively).
After the Supreme Court granted certiorari, forty states (including California), two territories, and the District of Columbia joined in filing an amicus brief agreeing with South Dakota’s position. The brief focused intensely on the harm being caused to the states by out-of-state internet sellers. Justice Kennedy’s concurrence in Direct Marketing Association was cited several times, including his specific reference to California’s difficulties in closing the use-tax gap: “California, for example, has estimated that it is able to collect only about 4% of the use taxes due on sales from out-of-state vendors.”10
On June 21, 2018, the Supreme Court issued its 5-4 split decision in favor of overturning Quill. In the majority opinion for Wayfair, Justice Kennedy wrote that “[t]he internet’s prevalence and power have changed the dynamics of the national economy,” noting that at the time Quill was decided, revenues for mail order products were around $180 billion, while e-commerce retail sales in 2017 were $453.5 billion. Furthermore, without the physical presence bright-line rule, a state tax on out-of-state sellers must still pass the substantial nexus test, as it clearly did in South Dakota where the law only applied to large companies engaging in significant business in the state, as well as the other Commerce Clause factors laid out in the Supreme Court’s 1997 Complete Auto Transit, Inc. v. Brady opinion. Justice Kennedy also pointed out that the Court did not rule on whether states could retroactively collect sales taxes, but anticipated this would be an issue of consideration in the future.
In the dissenting opinion, written by Chief Justice John Roberts, he agreed that past Court decisions in this area were “wrongly decided” due to the growth of e-commerce, but believed that stare decisis weighed heavily against overruling Quill and that it should be left to Congress to enact legislation that would override these previous decisions.
Wayfair’s Impact on Businesses
As of the time this article was written, the California Department of Tax and Fee Administration (CDTFA) has not issued specific guidance on how the state agency will take advantage of the Wayfair decision. However, the CDTFA has placed an alert at the top of the home page of its website  that California supported the rejection of the physical presence test and that “[t]he department is currently reviewing the court’s opinion to determine next steps to support taxpayers.”
Although the $100,000 and 200-transaction floors set by the South Dakota law passed muster in Wayfair, it remains to be seen where the line between substantial and insubstantial falls when other states craft their laws, and which businesses will be most affected. Speculatively, the effect of the Wayfair decision will likely be felt more by smaller businesses (closer to the floor) than larger ones. The cost of compliance, generally speaking, tends to affect smaller and newer businesses more adversely due to higher proportionate overhead despite a smaller tax bill. That is, larger businesses benefit from economies of scale. Only time will tell whether brick-and-mortar stores meaningfully benefit from a more level playing field with out-of-state retailers.
Regardless of the size, businesses engaged in interstate commerce should be prepared to deal with new use tax laws in most states. They should put into place procedures to evaluate if they have crossed, or are likely to cross, the nexus thresholds in each state that has such laws. Businesses must register with the Department of Revenue for permits in those states where their business meets their respective economic nexus thresholds. Depending on what goods or services they sell, they should research how sales and use taxes apply to their sales in each prospective state where they may have to register. In states where they cannot determine the tax ability of their sales with a reasonable certainty, a request for a written opinion should be sent to the state’s Department of Revenue. If necessary, a software provider should be considered if the business determines that the compliance challenges are too great. Record keeping and invoicing should also be reevaluated in order to ensure proper computation and collection of taxes as well as for the eventuality of an audit.
Keep in mind that, since the Wayfair ruling, new laws and guidelines are being issued almost daily. Those in charge of tax compliance will have to constantly monitor any changes in laws or regulations that may impact their tax obligations.
(1) Int’ l Shoe Co. v. Washington, 326 U.S. 310 (1945).
(2) Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
(3) South Dakota v. Wayfair, Inc., 585 U.S.__, 138 S. Ct. 2080 (2018).
(4) See What states impose sales/use tax?, Sales Tax Inst., www.salestaxinstitute.com/sales_tax_faqs/what_states_impose_sales_use_tax.
(5) Nat’ l Bellas Hess, Inc. v. Dep’t of Revenue of Ill., 386 U.S. 753 (1967).
(6) Direct Marketing Ass’n v. Brohl, 575 U.S. __, 135 S. Ct. 1124 (2015).
(7) 26 U.S.C. § 7421.
(8) Direct Marketing Ass’n, 135 S. Ct. at 1135 (Kennedy, J., concurring).
(9) Direct Marketing Ass’n v. Brohl, 814 F. 3d 1129 (10th Cir. 2016).
(10) Brief for Colorado and 40 Other States, Two United States Territories, and the District of Columbia as Amici Curiae Supporting Petitioner, p. 11, Wayfair, Inc., 585 U.S. __, citing Direct Marketing Ass’n, 135 S. Ct. at 1135.
(11) Complete Auto Transit, Inc. v. Brady, 430 U. S.274, 279 (1977) (Supreme Court decisions “have sustained a tax against Commerce Clause challenge when the tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state.”).
(12) The transition of sales tax responsibilities from the Board of Equalization to the CDTFA is part of the restructuring which took effect 7/1/2017, under the Taxpayer Transparency and Fairness Act of 2017.
(13) Cal. Dep’t of Tax and Fee Admin., cdtfa.ca.gov (last visited July 18, 2018).
Marc Brandeis, CPA is a former Senior Sales and Use Tax Auditor with the California Department of Tax and Fee Administration (formerly the Board of Equalization). He can be reached at firstname.lastname@example.org.
Daniel W. Layton, Esq., former IRS attorney and former federal prosecutor, is partner at Layton & Lopez Tax Attorneys, LLP in Newport Beach. He can be found at https://taxattorneyoc.com.
This article first appeared in Orange County Lawyer,September 2018 (Vol. 60 No. 9), p. 33. The views expressed herein are those of the author. They do not necessarily represent the views of Orange County Lawyer magazine, the Orange County Bar Association, the Orange County Bar Association Charitable Fund, or their staffs, contributors, or advertisers. All legal and other issues must be independently researched.