The U.S. Supreme Court's review of Quill's physical presence standard sets up a complex dilemma for the justices who may want to avoid creating a regulatory taxing scheme but want to clarify where the line is to be drawn on states' tax authority in the borderless age of online commerce.
The Court's 1992 landmark decision in Quill Corp. v. North Dakota effectively barred states from imposing sales tax collection obligations on remote retailers by requiring businesses to have a non-trivial, physical in-state presence for states to require them to collect and remit buyers’ sales taxes on purchases. The Court decided January 12 to review South Dakota S.B. 106 — a law that deliberately flouts the Quill standard — granting cert to the state’s petition for review of its suit against Wayfair and several other online retailers. South Dakota has said from the beginning that the law is a deliberate attempt to challenge Quill.
The Court's opinion in South Dakota v. Wayfair Inc. could result in a sea change in the taxation of online commerce, and numerous amicus briefs have been filed by parties on all sides of the issue. Online sellers face the risk of new tax liabilities in thousands of jurisdictions, while states see the possibility of substantial tax revenue gains. But the impact of the decision rests on both whether it reverses Quill and whether any guidance it might provide clarifies the kinds of sales tax rules that pass constitutional muster.
The Odds Favor Reversal
The Court’s decision to grant cert in the case suggests the justices are considering overturning Quill’s 26-year-old physical presence requirement. “My guess is four justices would not have agreed to hear this case just to tell the states to leave it alone,” said Arthur Rosen, a partner with McDermott Will and Emery.
“You would have a decent track record of predicting Supreme Court outcomes if you just bet on the petitioner every time,” Daniel Hemel, a tax expert at the University of Chicago, told Tax Analysts. Hemel is one of 37 professors and economists who filed an amicus brief urging review of Wayfair and reversal of Quill.
Wayfair was specifically designed to serve as a vehicle to challenge Quill, in answer to Justice Anthony M. Kennedy’s famous concurrence in Direct Marketing Association v. Brohl (DMA), in which he called for such a vehicle. Kennedy isn’t alone in his criticism of the physical presence requirement. Before becoming a Supreme Court justice, Neil Gorsuch opined in a 2016 Tenth Circuit Court of Appeals decision — also in the DMA case — that Quill’s days are numbered. And Justice Clarence Thomas has expressed criticism of the dormant commerce clause, which the Court declared to be the source of the physical presence requirement in the Quill decision.
One reason the Court may reverse Quill is that Congress has failed to act on legislation that would authorize states to mandate sales tax collection by remote sellers under a standardized set of rules, such as the Marketplace Fairness Act. In Quill, the Court determined that physical presence for the purpose of requiring remote sales tax collection is necessary under the commerce clause, and not under the due process clause as it previously held in 1967 in National Bellas Hess Inc. v. Department of Revenue of Illinois.
Kirk Stark, a tax expert at UCLA, said that shift allowed Congress to delegate to the states its commerce clause authority to require remote sellers to collect tax, but federal lawmakers haven't yet done so. Instead, Stark said, “Quill has been the ultimate excuse" for congressional inaction. “I think it’s going to require . . . gutting Quill in order to provoke congressional action,” he added.
The Supreme Court also appears to be responding to states’ ratcheting up of efforts to circumvent Quill in the absence of either a reversal or a legislative solution. These efforts include state laws such as the Colorado legislation upheld in DMA, which requires remote vendors to either remit tax or report customers’ sales and use tax liability to states. Another state trend is "cookie nexus" laws, which attempt to treat a company’s software as a form of physical presence.
Meanwhile, the e-commerce industry has exploded since 1992, significantly increasing the tax revenue states lose to remote sales. “I expect the Court to grapple with changing technology and the rise of e-commerce since it handed down the Quill decision in 1992,” said David Kall, a tax expert with McDonald Hopkins LLC, in an emailed statement. “The context for this decision is much different than in Quill,” he told Tax Analysts.
The Court decided in Quill that a compliance burden on remote sellers raised commerce clause issues, but the technological sophistication of the industry could negate that. “I don’t think the technological arguments about compliance are very convincing anymore,” said Alan Auerbach, a tax expert at the University of California, Berkeley. “You have so much information about the transaction when you’re a vendor — you know exactly where the person is.”
If the justices are looking for an opportunity to reverse Quill’s physical presence standard, they may be disposed to use Wayfair because of the specifics of South Dakota’s law. The legislation’s $100,000 in-state sales value and 200 in-state sales volume thresholds are relatively high, offering some protection for smaller businesses. The legislation also imposes a purely prospective tax remittance obligation, which prevents thorny issues of retroactive tax liabilities.
However, a reversal of Quill could trigger national uncertainty over remote sellers’ obligations to states.
Potential Scope of Ruling
If the Court reverses Quill in its Wayfair ruling, it may consider providing additional guidance. Simply overturning the physical presence standard with no further instruction could leave states and sellers with little clarity regarding which activities establish substantial nexus in a state and which compliance obligations are burdensome enough to potentially violate the commerce clause.
“If physical presence is no longer the limiting factor, is there a limiting factor?” asked David Gamage, a law professor and tax expert with Indiana University. Gamage, who also joined the amicus brief urging the Court to hear Wayfair, told Tax Analysts he “would hope that [the Court] will specify in some way what they think the new limits on states’ abilities to impose limits on out-of-state companies might be.”
It is possible the Court will vote to reverse Quill and uphold South Dakota’s remote sales tax law, highlighting in its opinion elements of the state’s rules such as the sales threshold and lack of retroactivity, and also the state’s membership in the Streamlined Sales and Use Tax Agreement. With the physical presence standard reversed, such a move could help clarify what kinds of laws might pass muster in the new legal landscape.
The Court could also consider articulating general criteria in its opinion that could be used to vet whether a state's remote sales tax legislation overburdens interstate commerce or properly establishes substantial nexus given repeal of the physical presence standard.
The Court should outline “what criteria a state should look to adopt in designing a threshold,” according to Richard Pomp, a tax expert at the University of Connecticut and a signatory of the amicus brief seeking reversal. “Otherwise we might end up with statutes all over the country having different thresholds,” which he said could hurt e-commerce and cripple small sellers. The Court might also provide guidance on local sales taxes, he added.
Another possibility would be for the Court to reverse Quill’s physical presence standard but remand the case to a lower court to determine whether South Dakota’s remote sales tax law can withstand an existing dormant commerce clause test: the balancing test in Pike v. Bruce Church Inc.
“If a state had a rule that said, 'If you sell even $5 of product into our state, you have to collect the use tax, and registration costs $1,000 and you’ll need a lawyer,' clearly that fails Pike balancing” because it would be too burdensome, according to Darien Shanske, a tax expert at the University of California, Davis, and coauthor of an amicus brief in Wayfair on behalf of six congressional lawmakers.
A remand could also shed light on substantial nexus post-Quill by having a lower court apply the substantial nexus criteria established by Complete Auto Transit Inc. v. Brady to South Dakota’s law, which would allow review of the specifics of the law and the nature of substantial nexus without the physical presence rule.
A simple overturning of the physical presence requirement with no guidance or further instruction could create confusion and encourage states to pursue incompatible remote sales tax collection rules, burdening remote retailers. A potential silver lining would be a scenario in which Congress was pressured to finally address the issue by approving legislation to establish guidelines for states. That would be consistent with justices’ original goal in the Quill ruling, which was to have federal lawmakers create a legislative solution to the larger issue of remote state sales tax compliance.
However, depending on the Court’s opinion, a reversal without additional guidance might result in state lawmakers waiting for further clarification, rather than rushing to pass their own remote sales tax legislation.
“This doesn’t give states open season to do anything they want in terms of creating unreasonable burdens on out-of-state merchants,” according to Alan Morrison, a professor at George Washington University and coauthor of the amicus brief on behalf of six members of Congress. “I think the Court will make it clear that the dormant commerce clause is not irrelevant to these transactions.”
The justices have a wide range of options in how they rule; some possible outcomes include radical changes, such as rejecting the premise of substantial nexus in the commerce clause entirely, according to Stark.
“It’s possible they could . . . eliminate the notion of there being any sort of nexus requirement for purposes of the commerce clause,” Stark said, suggesting the Court could effectively reduce the four-part Complete Auto test to a simple review of whether state tax laws are discriminatory and whether state taxes are fairly apportioned. He said establishing nexus could be accomplished through the due process clause instead.
Gamage suggested that rejection of Quill’s physical presence standard might ultimately require review of the due process clause protections against state sales tax collection requirements that might exist for small vendors.
Another potential outcome is that the court could side with Wayfair and uphold the physical presence standard, but sources say they think that's less likely. "It would be a huge setback for the states because the Court has not accepted a case challenging Quill since it was issued,” according to Kall.
If the Court doesn’t overturn the physical presence standard, states will have a renewed incentive to work around the requirement using existing strategies. More states could adopt Colorado-style laws requiring retailers to disclose information about purchasers if they don’t collect and remit sales tax to the state; Washington state has applied such a rule to both retailers and marketplaces.
Also, “if Quill is upheld, we’re going to see more of these 'cookie nexus' laws,” according to Karl Nicolas, a tax expert with EY. A decision by the Court won’t end the fight, he said, but will merely shift it “away from what is the definition of nexus and to what is the definition of physical presence.”