Today the United States Supreme Court fundamentally changed the rules governing when states may impose a sales tax. For more than 50 years, decisions from the Supreme Court protected retailers without a “physical presence” in the state from sales tax liability. In South Dakota v. Wayfair, the court eliminated that protection in a 5-4 decision. It held the physical presence rule, first announced in National Bellas Hess and confirmed in Quill, was and remains an incorrect interpretation of the Commerce Clause, and it overruled those cases.
The majority opinion was authored by Justice Anthony Kennedy – who wrote the concurring opinion in Direct Marketing asking for an appropriate case to challenge Quill – and was joined by Justices Clarence Thomas, Ruth Bader Ginsberg, Samuel Alito, and Neil Gorsuch. The dissent, written by Chief Justice John Roberts and joined by Justices Stephen Breyer, Sonia Sotomayor, and Elena Kagan, acknowledged that Bellas Hess was wrongly decided but would have left the matter to Congress. The majority opinion takes a different view, stating: “It is inconsistent with the Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation.” According to the court, “Quill was wrong on its own terms when it was decided” and the passage of time “has made its earlier error all the more egregious and harmful.”
To satisfy the Commerce Clause for sales tax purposes, businesses will now only need to have a “substantial nexus” in a state, rather than a physical presence. A critical issue to watch is how states – and courts – will define substantial nexus. This has been a nebulous concept since the Complete Auto decision in the 1970s, and the U.S. Supreme Court did nothing to clarify that today. Although the court plainly held physical presence is not required to create a substantial nexus, it provided little guidance beyond that on how much contact is sufficient to allow a state to impose a tax. This question will continue to depend on individual facts and circumstances, which means there will continue to be uncertainty and litigation in this area. Further compounding the complexity is that states are free to adopt their own interpretations and thresholds for substantial nexus.
Another concern is retroactivity. The majority opinion signaled that a retroactive application could run afoul of the Commerce Clause’s prohibition on placing undue burdens on interstate commerce. The dissent characterized the possibility of a retroactive application as a “troubling question.” But the court did not ban states from applying this retroactively, so whether states will choose to do so is an open question.
This case marks a fundamental shift in state tax jurisprudence and it will be critically important to watch how the states respond.
For more background on the Wayfair case, you can read our previous analysis here. For additional information regarding the case or for other state and local tax questions, please contact Parker Poe’s SALT Team.