In June, the U.S. Supreme Court ruled that states may require a business to collect sales tax even if the business does not have a physical presence in the state. The Court’s decision in South Dakota v. Wayfair, Inc. overturned its prior rulings from 1967, in National Bellas Hess, Inc. v. Department of Revenue of Illinois, and from 1992, in Quill Corp. v. North Dakota. In Bellas Hess, the Court ruled that a state could not require a mail order retailer to collect sales tax if the retailer did not have a physical presence in the state, and it upheld that decision in Quill, which involved another mail order company.
Prior to announcing his retirement, Supreme Court Justice Anthony Kennedy wrote the majority opinion of the Court in Wayfair, in which he was joined by the somewhat unexpected combination of Justices Ginsberg, Alito, Thomas and Gorsuch. The underlying sentiment in Kennedy’s analysis was fairness: exempting retailers who do not have a physical presence in a state from responsibility for collecting the state’s sales tax from consumers located in that state is not fair to businesses with a physical presence in the state, to the states that rely on sales tax to fund their government, and to consumers.
If a physical presence is no longer the test for when a state may require a business to collect sales tax from consumers, when is a business required to collect tax? The Court’s opinion in Wayfair does not precisely answer that question. Justice Kennedy wrote that the test for when a tax applies is when “a substantial nexus” exists between the economic activity and the state. Further, this “substantial nexus” is established by conducting business (i.e., selling stuff) in that state’s jurisdiction.
Just how much business must be conducted in a jurisdiction in order to constitute a “substantial nexus” is not clear. What is a small business with an online presence to do? It is possible that Congress could legislate a solution to streamline small business compliance. In the absence of Congress taking up the issue, however, businesses transacting sales online should be aware of this ruling and prepare to implement a strategy for compliance. Justice Kennedy’s opinion makes a somewhat offhand reference to “software that is available at a reasonable cost may make it easier for small businesses to cope with these problems” – but software may well be the practical solution here.
Overturning precedent is not something the Supreme Court undertakes lightly. Indeed, Chief Justice Roberts’s dissenting opinion in the case begins with the statement that he agrees that Bellas Hess was “wrongly decided” but he nevertheless would have had the Court stand by its prior (wrong) rulings. By contrast, Justice Thomas, who joined the Court’s 1992 ruling in Quill that upheld Bellas Hess, wrote a concurring opinion in which he conceded that he was wrong to have joined the majority in Quill and that it was time for the Court to recognize its mistake and overturn the prior decision. It is not often that I find myself nodding in agreement with Justice Thomas, but his concurrence warrants respect. It takes guts for anyone to admit they are wrong, much less a Supreme Court justice. A Supreme Court willing to recognize and rectify its own mistakes is a sign of our government working as intended.
Photo credit: Mark Fischer on Flickr