Court Overturns Physical Presence Standard in Sales Tax Decision

With the surge of online shopping dominating the retail space, a recent U.S. Supreme Court 5-4 ruling leveled the playing field between traditional shops and remote sellers, now allowing states to collect sales tax from online retailers.

The court’s decision in South Dakota v. Wayfair reversed the physical presence rule previously upheld in 1992 with Quill v. North Dakota and in 1967 with National Bellas Hess v. Department of Revenue of Ill. The ruling means that states can impose sales tax on online transactions even if the retailer does not have a physical presence in that state.

The court found that the physical presence standard upheld in 1992 was a flawed interpretation of the Commerce Clause in our modern-day marketplace and creates an unfair advantage for online stores. As it stood, previous law favored online retailers, resulting in billions of lost tax dollars for the states.

As a guiding factor, the court weighed the impact of “substantial nexus” within the taxing state, meaning the state has the right to collect taxes from out-of-state businesses. In South Dakota v. Wayfair, the court concluded substantial economic nexus has been met through extensive virtual presence and did not require a physical presence to have an economic impact.

While many large online retailers, such as Amazon, currently remit sales tax, many businesses argued against collection due to logistical complexity. Based on state law, online retailers are required to collect and remit sales tax to the state, but if they refuse, in-state consumers are responsible for paying a use tax on those purchases. Wayfair, Overstock and Newegg are among those businesses that undeniably bring an extensive virtual presence to the e-commerce space, but do not collect sales tax for the states.

Moving forward, details are still being untangled, as nexus laws are driven at a state level. South Dakota was one of the first states to establish economic nexus, wherein online retailers with more than $100k in annual sales or 200 transactions in the state are required to collect sales tax. In recent years, more and more states are getting on board with similar laws. Before a state can align with this precedent-setting case, however, it must first show “nexus” and test their law for constitutionality.

The State of California currently imposes click-through and affiliate nexus, which is different from economic nexus discussed in South Dakota v. Wayfair. However, tax collection is similar in that it is the sole responsibility of the seller to collect and remit these taxes regardless of physical presence in the state.

More than half of states have passed laws expanding nexus beyond a physical presence. All but five states—Alaska, Delaware, Montana, New Hampshire, and Oregon—impose sales taxes.

This case sets a new standard moving forward in our online-saturated retail environment and may entice Congress to enact national legislation to provide overarching guidelines for sales and use tax collection.

If you have questions regarding this case or general sales and use tax nexus laws, please contact me at ecole@bpw.com or (805) 963-7811.