In South Dakota v. Wayfair, Inc., the Supreme Court of the United States addressed whether the State of South Dakota, consistent with the Commerce Clause, could require a retailer that has no physical presence in the State to collect and remit sales tax on goods and services. In Quill Corp v. North Dakota, 504 U. S. 298 (1992), the Supreme Court had previously crafted a “physical presence” rule, holding that the Commerce Clause, and the Dormant Commerce in particular, prohibited states from imposing this requirement on businesses unless the business had a physical presence in the state, whether in the form of employees or physical property.
Concerned about the financial loss from such a restriction, the State of South Dakota enacted a law mandating out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the State.” Notably, however, the law had several key limitations. The law, for example, covered only sellers conducting a substantial amount of business in the State.
In Wayfair, the Court upheld the South Dakota law, rejecting the “physical presence” requirement and overruling Quill in the process. According to the Court, state taxes are consistent with the Dormant Commerce Clause so long as they (1) apply to an activity with a substantial nexus with the taxing state, (2) are fairly apportioned, (3) do not discriminate against interstate commerce, and (4) are fairly related to the services the State provides. In Quill, the Court held that the “substantial nexus” requirement necessitated a physical presence in the state. In this case, however, the Court found the Dormant Commerce Clause does not demand such a requirement for several reasons. First, using parallels from Due Process cases, the Court found that “substantial nexus” means only “closely related,” and not necessarily a physical presence. Second, the “physical presence” requirement created, rather than resolved, market distortions by creating a tax shelter for out-of-state businesses. Third, the formalistic requirement was inconsistent with the Court’s more recent “cause-and-effect” approach to the Dormant Commerce Clause. Finally, the Court concluded that the requirement placed a significant imposition on states’ ability to collect taxes.
Without the “physical presence” requirement under the “substantial nexus” prong, the test merely asks whether the tax applies to an activity with a substantial nexus with the state doing the taxing. In this case, the Court found that the tax imposed by South Dakota satisfied this prong because it applied only to sellers conducting a significant amount of business in the State. However, by emphasizing the limited nature of South Dakota’s tax, the Court’s reasoning suggests that a broader tax on out-of-state businesses might create an undue burden, thus violating the Dormant Commerce Clause.
Online Sales Tax Impact To Your Business
After Wayfair, states may require out-of-state retailers to collect and remit sales tax on goods and services sold in the state, even when the retailers have no physical presence in that state. Accordingly, if a state elects to enact such a requirement, and businesses sell goods and services into that state, the businesses may now be forced to collect and remit taxes for such sales. Due to its significant financial benefit, it is likely that states will begin to enact these requirements, potentially testing the bounds of the Court’s holding by crafting broader taxes on out-of-state retailers than those at issue in Wayfair.
Fraser Stryker PC LLO is experienced in tax matters of all types. If you have questions about how the South Dakota v. Wayfair, Inc. decision may impact your business, contact Mark L. Brasee for assistance.
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