Supreme Court Poised to Reevaluate the Constitutional Framework Governing Collection and Remittance of State Sales and Use Taxes by Out-of-State Sellers
January 10, 2018
The Supreme Court may soon consider in a case entitled South Dakota v. Wayfair, Inc., No. 17-494, whether to discard the longstanding rule that states can require companies to collect sales and use tax only if they have a physical presence in the state. The rule dates back 50 years to National Bellas Hess v. Illinois Dep’t of Revenue, 386 U.S. 753 (1967), where the Court held that constitutional limitations on states’ jurisdiction found in both the Due Process and Commerce Clauses prevented states from imposing such a collection requirement on companies that lacked a physical presence in the state.
As time passed, however, mail-order businesses became much more prevalent, and this rule began to be seen as creating a serious problem for local businesses that had to collect sales taxes while competing against much larger national mail-order businesses that did not collect such taxes. In 1992, the Court revisited the physical presence rule in Quill Corp. v. North Dakota, 504 U.S. 298. To the surprise of many observers, the Court upheld the physical-presence requirement, relying heavily on the principle of stare decisis – that is, adhering to established precedent because of the reliance interests and expectations that were in place. Importantly, however, the Court departed from National Bellas Hess regarding the exact nature of the constitutional limitation. The Quill Court held that the Due Process Clause did not require the physical presence rule. Rather, the “substantial nexus” requirement, which the Court held required physical presence, was imposed only by the Commerce Clause, which is concerned with “the effects of state regulation on the national economy.” 504 U.S. at 312.
The significance of the Court’s determination to source the requirement in the Commerce Clause is that Commerce Clause restrictions are less absolute than Due Process Clause restrictions. The Commerce Clause is an affirmative grant of power to Congress, and the restrictions on state taxation that the Court has found in the Commerce Clause are justified as protecting that power by striking down state actions that intrude on interstate commerce. (Hence, this body of law is referred to as based on the “negative” or “dormant” Commerce Clause.) In practice, this means that Congress has the power to permit state actions that the Court has found violative of the Commerce Clause (even though Congress cannot permit actions that violate due process). In effect, the Quill decision punted to Congress the question of how states can fairly tax interstate commerce in the modern world—a question that has only grown in significance with the proliferation of the Internet e-commerce. See Quill, 504 U.S. at 318 (“the underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve”); id. at 320 (Scalia, Kennedy, and Thomas, JJ., concurring in part and concurring in the judgment) (“Congress has the final say over regulation of interstate commerce, and it can change the rule of Bellas Hess by simply saying so.”). Congress, however, has not been up to the task and has not passed comprehensive legislation to address the issue.
In the meantime, the states have nibbled around the edges of Quill and largely succeeded in limiting its scope. Beginning with Geoffrey, Inc. v. S.C. Tax Comm’n, 437 S.E. 2d 13 (S.C. 1993), more and more states have used the concept of “economic nexus” to impose state income taxes on companies that lack a physical presence in the state. State courts have increasingly upheld these taxes by distinguishing Quill on its facts, even though the logical justifications proffered for having different rules and constitutional nexus standards for income taxes and sales taxes are not necessarily compelling. Nevertheless, the Supreme Court has repeatedly declined invitations to review these state court decisions and determine whether they are consistent with Quill.
In addition, states have imposed notice and reporting requirements on out-of-state businesses that stop short of imposing an actual collection requirement, but that are designed to assist the state in collecting the sales and use taxes directly from purchasers. These requirements may be more intrusive and burdensome on the sellers than an actual collection requirement, and therefore they can create a disincentive to out-of-state sellers to continue to resist a direct collection requirement. In Direct Marketing Ass’n v. Brohl, 135 S. Ct. 1124 (2015), the Court confronted one such statute from Colorado, but in a context that did not present the Court with the question of the statute’s constitutionality. The issue for the Court was whether the Tax Injunction Act barred the plaintiffs’ challenge to the statute. The Court found that the case could go forward and remanded to the court of appeals to consider the statute’s constitutionality.
Notably, however, Justice Kennedy wrote a concurring opinion in which he criticized Quill (even though he had concurred in the judgment in that case), stating that Quill has resulted in “a startling revenue shortfall in many States, with concomitant unfairness to local retailers and their customers who do pay taxes at the register.” Justice Kennedy concluded that it was time to reconsider the physical-presence rule in a case that properly presented the question, observing that Quill had failed to take into account “the dramatic technological and social changes that had taken place in our increasingly interconnected economy,” which have only increased over time, and that “it is unwise to delay any longer a reconsideration of the Court’s holding in Quill.” Id. at 1135.
South Dakota promptly responded to Justice Kennedy’s invitation by enacting a statute that requires companies to collect and remit use taxes even if they lack physical presence in the state. The statute was challenged and declared unconstitutional by the South Dakota Supreme Court on the authority of Quill, with the court recognizing the criticisms of Quill but noting that only the Supreme Court has the “prerogative of overruling its own decisions.”
A petition for certiorari from that decision is now pending before the Supreme Court, and the Court is expected to rule on the petition this month. Numerous amicus briefs have been filed in support of the petition, urging the Court to abandon Quill, although several others have been filed urging the Court to deny certiorari. The latter include a brief filed by some Senators and Congressmen who have sponsored legislation to address the issues and who urge the Court not “to give up on Congress.” A decision to grant certiorari could be announced as soon as this Friday, January 12, which would mean that the case would be argued in the spring and decided by the end of June.
One interesting brief is the one filed by the Tax Foundation. The Tax Foundation candidly acknowledges that it is “not a partisan for aggressive or expansive state tax power” and that it has consistently urged rulings against the state when addressing this issue in the past. Nevertheless, the brief asks the Court to grant certiorari, overrule Quill, and uphold the South Dakota statute. The brief explores the variety of ways in which states have sought to avoid Quill and asserts that the result is a patchwork of laws ultimately harming interstate commerce. By contrast, the Tax Foundation asserts that the South Dakota statute presents a fairer and more workable way of allowing states to impose sales taxes in the current business environment.
Finally, Justice Kennedy is not the only Justice to have gone on record with the view that Quill should be reconsidered. The Colorado notice-and-reporting statute at issue in Direct Marketing Association was upheld on remand from the Supreme Court by a panel of the Tenth Circuit that included then-Judge, now-Justice, Gorsuch. 814 F.3d 1129 (10th Cir. 2016). Justice Gorsuch wrote his own concurring opinion in that case, suggesting that Quill was intended to have an “expiration date” and remarking that it would be appropriate to allow Quill to “wash away with the tides of time.” Id. at 1151. There is a good chance that Quill will soon be swept away more directly and abruptly than first contemplated by Justice Gorsuch.
Wayfair – Petition for certiorari
Wayfair – Reply Brief in Support of Certiorari Petition
Wayfair – Amicus Brief of Tax Foundation
Wayfair – Amicus Brief of legislators
