Posted by: Robert Horwitz | July 3, 2018

Supreme Court Overrules Prior Commerce Clause Cases:  Internet Retailers Will Now Be Liable for Sales Tax by Robert S. Horwitz

For over fifty years the Supreme Court has held that the Commerce Clause of the U.S. Constitution prohibits states from collecting sales tax from out-of-state retailers unless the retailer had a physical presence in the taxing state.  National Bella Hess, Inc., v. Ill. Dept. Rev., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 US 298 (1992).  A physical presence normally required the retailer to have employees or physical facilities in the taxing state. On June 21, 2018, the Supreme Court jettisoned its prior interpretation of the Commerce Clause and held that a state can require an out-of-state seller who ships goods into the state to collect and remit sales tax.  South Dakota v. Wayfair, Inc., here,

Like most states, South Dakota has seen a decline in tax revenues.  To increase the amount of sales tax collected, it enacted a law in 2016 requiring out-of-state retailers to collect sales tax on goods shipped to consumers in South Dakota.  An exception was carved out for retailers that annually shipped $100,000 or less of goods or services into the state or engaged in fewer than 200 separate transactions for the delivery of goods or services in state.  The law could not be applied retroactively.  Wayfair, Inc., and several other online retailers who did not have employees or physical facilities in South Dakota challenged the law.  Although the South Dakota high court found the State’s rationale for the law persuasive, based on the physical presence test it held that the law was unconstitutional.   The Supreme Court granted certiorari.  Over forty-one states, two territories and the District of Columbia filed amicus briefs urging the Court to overturn Quill.

In reversing the state court and overruling its prior decisions, the Supreme Court began by focusing on the two “primary principles that mark the boundaries of a State’s authority to regulate interstate commerce.”  These are: 1) a state may not discriminate against interstate commerce and 2) a state may not impose undue burdens on interstate commerce.   The Supreme Court will uphold a state tax “so long as it (1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce and (4) is fairly related to the services the state provides.  The physical presence rule enunciated in Bella Hess and Quill “is an incorrect interpretation of the Commerce Clause.”

The Court additionally stated that Quill put local and many interstate businesses at a competitive disadvantage to sellers who did not have a physical presence in the state.  This allowed out-of-state sellers to avoid the regulatory burden of tax collection and to offer lower prices, especially since most consumers do not pay use tax on goods purchased from out-of-state sellers.  Overruling the physical presence test ensured that artificial competitive advantages are not created by the Court’s precedents.

The Court further noted that modern ecommerce does not align analytically with a test that relies on Quill’s physical presence test.  Due to targeted advertising and instant access on the internet an out-of-state retailer may be present in a state in a meaningful way without having employees or a physical location in the state.

The Court also rejected the argument that stare decisis required affirmance of the state court’s decision.  First, stare decisis is not an inexorable command.  If a prior decision is incorrect, it should be rejected.  This is especially true where circumstances have radically changed, as occurred with the internet’s prevalence in commerce and the economy.  This has increased the revenue shortfalls faced by states seeking to collect sales and use tax.

Because of South Dakota’s exceptions for out-of-state retailers that do a limited amount of in-state business, the Court did not need to address at what point imposing the duty to collect and remit sales tax on out-of-state retailers imposes an undue burden on commerce.  The Court also did not address whether a complex sales tax system could be unduly burdensome, though it did note that there are various plans to simplify collection and that, since small in-state retailers pay the tax as well the risk of discrimination against out-of-state businesses is avoided.

The exceptions in the South Dakota law also meant that the Court did not have to address whether there was a substantial nexus between the out-of-state retailer and the taxing state.  The Court finally noted that there may be questions of whether other principles in the Commerce Clause could invalidate the law, but these had been neither briefed nor litigated.  Nonetheless several features of the law ensured that it did not discriminate against or place undue burdens on interstate commerce: 1) the safe harbor for those who only did limited business in South Dakota; 2) the law was not retroactive; and 3) South Dakota had adopted the Streamlined Sales and Use Tax Agreement that reduces administrative burdens and provides sellers access to sales tax administrative software paid for by the state.

Justices Thomas and Gorsuch concurred.  Chief Justice Roberts, joined by Justices Breyer, Kagan and Sotomayor dissented.  They argued that while Quill and Bella Hess were wrongly decided, they are stare decisis and any alteration in the rules should be undertaken by Congress.  Additionally, many businesses have acted in reliance on the Court’s prior jurisprudence and changing it may have unintended effects on the growth of ecommerce.  Thus, they would “let Congress decide whether to depart from the physical-presence rule that has governed this area for half a century.”

We can expect to see a number of states, including California, amend its sales tax statutes to reach out-of-state retailers.  It remains to be seen whether all states will 1) have exceptions similar to South Dakota’s for those that do limited in-state business or 2) have simplified procedures or 3) not apply retroactively.  These are issues that will be litigated in the future.

The Wayfair decision could affect a state’s ability to impose tax on non-residents.  Earlier Supreme Court cases barred a state from taxing an out-of-state lender on interest from loans made to a resident of the state because the out-of-state lender did not have a situs in-state (and the site of a loan is where the state where the lender resides or has business offices).  See Beidler v. South Carolina Tax Comm., 282 U.S. 1 (1930).  Whether any state will argue that these decisions must be overturned in light of Wayfair cannot be predicted.  But probably several state taxing agencies are already thinking about it.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at

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