Marylin Wethekam is one of several authors who penned articles for State Tax Notes regarding the U.S. Supreme Court's ruling in South Dakota v. Wayfair, Inc. that overturned Quill Corps v. North Dakota and altered the state tax landscape. The articles address the Wayfair decision and the issues that remain after the Supreme Court struck down the physical presence test in Quill.
The full article, "The Change of the Landscape" was written by Jeanne Rauch-Zender and published by State Tax Notes on September 10, 2018 for its subscribers.
Be careful what you wish for, because you may get it is a fitting epitaph for the Wayfair decision. In the prophetic words of Justice Byron White, the "vagaries of physical presence" were tested and the concept as applied in a sales tax context has been laid to rest. The Wayfair decision harmonized the commerce clause substantial nexus requirement with modern electronic commerce and technology. While the Court provided guidance with respect to what may constitute substantial nexus, it certainly did not provide the bright-line test that some had hoped for. In fact, the decision may have left the door ajar for commerce clause challenges based on the remaining three prongs of Complete Auto. Thus, based on what the Court did say, determining the current substantial nexus standard and how that will be applied when imposing a collection requirement is the immediate issue taxpayers must wrestle with. The focus of the analysis of the Wayfair decision has certainly been on sales tax collection requirements. But there is a broader question: What, if any, impact does the Court's broad interpretation of the substantial nexus requirement have in other areas of state tax?
The Court dismissed the administrative compliance burden argument that swayed the Court in Quill. In fact, the Court pointed out that, should an impermissible compliance burden arise, other doctrines may be invoked to address the issue. So, with the compliance burden argument cast aside by the Court, what are the three major take-aways from the decision? First and foremost, substantial nexus does not equate to physical presence. Rather, a substantial virtual or an economic presence is sufficient to meet the first prong of the Complete Auto test. What is "substantial"? The Court in Wayfair was faced with examining the South Dakota statute, which set a threshold for nexus of $100,000 of receipts or 200 transactions. Thus, it certainly can be argued that the Court accepted the South Dakota threshold as the floor for determining "substantial." The Court also indicated that the impermissible burden analysis is broader and should focus on the implementation of the state tax scheme. The Court's broad guidance does raise practical questions that taxpayers and tax administrators alike must attempt to answer. For example, does the threshold have to be met annually or if met once do the requirements remain, regardless of the nature of the business activities in subsequent years? Are state tax schemes that do not administer local taxes and simplified rates or have uniform definitions of taxable products and services suspect because they place a burden on interstate commerce? Could a state tax structure be challenged merely because it does not provide access to tax software? These types ofimplementation questions are likely to become the focus of the broader burden analysis articulated by the Court.
A second take-away from the decision is that a statute or policy that creates a bright-line test that treats two economically identical entities differently for an arbitrary reason creates impermissible market distortion and will not pass constitutional muster. Several states have enacted notice requirements rather than impose a collection requirement on the out-of-state seller. The unanswered question is: do these notice requirement statutes run afoul of this take-away? An argument may be made that an in-state retailer or service provider is economically identical to a retailer or service provider with virtual or economic presence in the state. Is the notice requirement equivalent to a collection requirement? If the answer is no, then it must be determined if the distinction between the identical entities is arbitrary or creates an impermissible market distortion. Although not explicitly stated by the Court, it appears the retroactive application of the Wayfair decision would raise issues in the eyes of the Court. The South Dakota statute specifically stated it would not be applied retroactively. The Court in reviewing the statute specifically pointed out that the South Dakota Act "ensures that no obligation to remit the sales tax may be applied retroactively." Thus, the third and possibly the most important take-away would be the prospective application by the states of the reversal of the Quill physical presence standard.
What has not been addressed in any depth is the impact the Court's commerce clause and due process clause analysis will have in other areas of state tax, particularly income taxes. The question is, has the Wayfair decision also changed the landscape for income and other tax taxes? Several states have enacted factor presence nexus standards for income tax purposes. The question that has been raised is: do the minimum sales, property, and payroll thresholds set forth in those statutes meet the substantial nexus prong of Complete Auto? Considering the thresholds analyzed by the Court in Wayfair, the answer is likely yes. The Court, when presented with the opportunity to weigh in on the economic nexus concept, has declined. However, it may be argued that Wayfair'scommerce clause analysis validates the economic nexus concept. The question which remains unanswered is how the jurisdictional concepts articulated by the Court will be applied to apportionment concepts. Specifically, will there be an impact on the "subject to tax" concepts found in the sales factor throwback and throwout rules? Be careful what you wish for - the analysis of Wayfair's impact on state taxes has only just begun.