The life of an e-retailer – especially one of small or medium size – became much more complicated and costly on June 21. On that day, the U.S. Supreme court, in South Dakota v. Wayfair, Inc., ruled that sellers online are now legally obligated to collect sales taxes on transactions anywhere and everywhere they occur, whether or not they have a physical presence.
Unlike their brick and mortar brethren, Internet sellers previously had enjoyed a virtual exemption from sales taxes. The legal basis for this exemption was the so-called “physical presence” rule, under which a business could be required to collect and remit sales tax only in a state in which it had a physical presence, such as an office, store or warehouse. The rule gave effect to the constitutional guarantees, under the Due Process Clause and Commerce Clause, that a business or interstate commerce could only be taxed in a state with which they have “minimum contacts” or a “substantial nexus.” As online commerce has grown, however, with consumers easily able to make purchases not only from local merchants but from anyone anywhere, the Court found that the physical presence rule has become “removed from economic reality.” It has created distortions in the modern marketplace, giving out-of-state sellers an arbitrary advantage – a “judicially created tax shelter” – over their local competitors, and depriving states of billions of dollars in revenue. As the Court explained, the rule has created an:
an “arbitrary, formalistic distinction” between “economically identical actors” ….Modern e-commerce does not align analytically with a test that relies on…physical presence….Physical presence is not necessary to create a substantial
nexus…The “dramatic technological and social changes” of our “increasingly interconnected economy” mean that buyers are “closer to most major retailers” than ever before – “regardless of how close or far the nearest storefront.” A virtual showroom can show far more inventory, in far more detail, and with greater opportunities for consumer and seller interaction than might be possible for local stores. This Court should not maintain a rule that ignores these substantial virtual connections to the State.
With the demise of the physical presence rule, Internet merchants now face the complex, daunting challenge of having to collect sales tax in potentially thousands of jurisdictions. For the Amazons of the world, with their vast resources, legal teams, and administrative infrastructure, this will be a hassle but not much of a problem. But what about the millions of small online businesses, with few employees, sparse infrastructure, and limited access to sophisticated legal and accounting advice? How are they to cope, and are they at an even greater competitive disadvantage to the behemoths of e-commerce than they were before?
While not dismissing this concern, the Court downplayed it by emphasizing that the South Dakota sales tax statute has a safe harbor for businesses that do less than $100,000 in sales in the state, or make fewer than 200 sales into the state, on an annual basis. It further noted that South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement, which standardizes taxes to reduce administrative and compliance costs. It also speculated that eventually, software would be available at a reasonable cost to make it easier for small businesses to cope with these problems, and that elimination of the physical presence rule could hasten its arrival, either from private providers or from state taxing agencies themselves. Further, some small businesses with only de minimis contacts could seek relief from collection systems thought to be a burden. Finally, Congress could always act to alleviate any adverse impacts.
Nevertheless, the Court said, the potential for these small business concerns to arise in some later case “cannot justify retaining this artificial, anachronistic rule that deprives States of vast revenues from major businesses.” Meanwhile, several other states already have some form of “economic nexus” sales tax laws like South Dakota’s, and those that don’t undoubtedly will be playing catch up to get their fair share of the new “tax rush” unleashed by the Court’s decision. At least for now, therefore, the e-commerce powerhouses and the states are the big winners under Wayfair, and the “little guy” is the big loser. Good luck to him or her in discharging their new duties as nationwide tax collectors.