Must a taxpayer have physical presence to be subjected to sales tax collection obligations in a state, or is such a requirement antiquated and unrepresentative of the virtual world in which we live? That is the issue the U.S. Supreme Court grappled with in South Dakota v. Wayfair.1 State and local tax practitioners debated the issues in the case for months leading up to the U.S. Supreme Court’s June 21, 2018, monumental decision overturning 50 years of precedent. With a 5-4 decision and a lively oral argument, there is no doubt that the Justices were engaging in some heated debate of their own. At oral argument, Justice Breyer summed up the complex polarity well.
When I read your briefs, I thought absolutely right. And then I read through the other briefs and I thought absolutely right. And you cannot both be absolutely right.2
Justice Breyer would end up joining the dissent; what he and three other Justices ultimately viewed as the “absolutely right” outcome, the majority found to be absolutely wrong.
The majority’s opinion came down to the idea of fairness and of righting the wrongs created by the Court’s prior “physical presence” decisions—but did it achieve that goal? The majority asserts that “Quill created an inefficient ‘online sales tax loophole’ that gives out-of-state businesses an advantage.”3 It goes on to classify the physical presence requirement as “unfair and unjust.”
It is unfair and unjust to those competitors, both local and out of State, who must remit the tax; to the consumers who pay the tax; and to the States that seek fair enforcement of the sales tax, a tax many States for many years have considered an indispensable source for raising revenue.4
Nevertheless, as the majority opinion later concedes, the issue really lies in the use tax system. That system is problematic because it relies upon individuals to document and remit tax on purchases for which they did not pay sales tax. It is based upon an honor system that does not work either because individuals purposefully underreport their unverifiable use tax obligations for the year, or because they are genuinely ignorant to whether they owe the tax and, if so, on what.
Yet, even before the internet, this “loophole” was (and is) being utilized by businesses—and not just for online sellers. For instance, in Delaware—a state without a sales tax—businesses advertise the state as the “home of tax-free shopping.” When individuals make purchases in Delaware from Pennsylvania, New Jersey, or other states, they are supposed to report that use tax to their respective state. The fact that they do not do so is not necessarily a “loophole,” but rather a flaw in the use tax system. Moreover, the majority’s assertion that Quill essentially resulted in a “judicially created tax shelter”5 is a bit extreme: no one would suggest that a brick-and-mortar business’s decision to locate in Delaware instead of Pennsylvania to avoid collecting the sales tax is a “tax shelter.” How can it be a tax shelter when the onus remains on the consumer to report the use tax?
Another consideration is whether the decision has created a new and unintended “loophole” for foreign companies—i.e., those outside of the United States. The same argument can now be made that foreign companies may have the advantage of not collecting sales tax and thereby have the ability to sell their goods at a lower price. While the requirement to collect and remit sales taxes to states with economic nexus laws should apply to both domestic and foreign companies, the ability of states to actually enforce and collect that obligation from foreign companies with no U.S. presence is, in practice, quite doubtful. The Wayfair Court explains that the physical presence rule creates an incentive to avoid physical presence in multiple states. Does its elimination of the physical presence standard now create an incentive to avoid physical presence in the United States altogether?
Finally, the state involved in the Wayfair litigation was South Dakota. South Dakota is one of the twenty-three member states of the Streamlined Sales and Use Tax Agreement, which—as the Court points out—standardizes taxes to reduce administrative and compliance costs. Some of the largest states, however, are non-members, including Pennsylvania, California, and New York. Might the Court’s decision result in remote sellers purposefully avoiding states that are not member states because the cost of compliance is too high in a non-streamlined state? Possibly. However, those non-member states are states with some of the largest populations and, conceivably, part of the remote seller’s largest market. Thus, this will result in compliance costs and potential audits in each jurisdiction—and failure to comply or errors in application of the law can result in hefty penalties. Further, those compliance costs may put small businesses out of business altogether—arguably to the benefit of large businesses. Appropriately, this is the dissent’s chief concern and criticism of the majority’s decision. Chief Justice Roberts, writing the dissent, notes that the Court “breezily disregards the costs that its decision will impose on retailers” and that “[t]he burden will fall disproportionately on small businesses.”6 Small businesses in particular will need to consider how to address the issues that Wayfair has created for them, specifically.
While the Court may have eliminated some perceived unfairness with its decision, it may have inadvertently created new levels of inequity. But the fact remains that whether right or wrong, fair or unfair, we must all now live in the post-Wayfair era and bid adieu to 50 years of physical presence. ■