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Monday, June 25, 2018

South Dakota v. Wayfair: Not the Final Word on Internet Sales Tax

UPDATED 6/27/18 (see bold)

On June 21, 2018, the United States Supreme Court issued a ruling in the case South Dakota v. Wayfair that has been hailed as a landmark decision regarding the ability for states to tax interstate transactions.  While it is a very important decision that overturned decades old precedent, there are three reasons why it is not the final word on the authority for states to tax the sale of goods over the Internet.

It is an Incomplete Result

First, the case is a narrow decision that only addresses part of the analysis required to approve the taxation of interstate sales.  The basic legal question is whether a state’s assessment of taxes on out-of-state transactions substantially burdens interstate commerce.  Under the U.S. Constitution, only the federal government has the power to regulate interstate commerce.  As a result, the Constitution implicitly prohibits state laws which either discriminate against or substantially burden interstate commerce.  For state tax laws to be approved under these guidelines, the U.S. Supreme Court has said the tax must:

(1) apply to an activity with a substantial nexus with the taxing State,
(2) be fairly apportioned,
(3) not discriminate against interstate commerce, and
(4) be fairly related to the services the State provides.

The reason the Wayfair case is so important is because for 50 years no state tax that applied to out-of-state sales could get past the first test.  Previously, to meet that first test (the company has a substantial nexus to the state levying the tax), it had to have a physical presence in that state.  In Wayfair, a 5-4 majority of the Court decided that a physical presence is no longer required to satisfy the substantial nexus test.  That is the important but limited decision made by the Court.

The Court did not reach a decision on the final three factors because the underlying South Dakota courts did not have a chance yet to evaluate those questions. So, the case goes back to the lower courts to determine if the plan satisfies the remaining tests so that South Dakota actually can levy sales tax against out-of-state sales.

Nevertheless, the Court made some important observations.  The majority decision expressed concern for how interstate taxation could burden startups and small businesses and questions whether such companies could have a substantial nexus to the state if they do not engage in a significant amount of commerce in the state.  The Court favorably commented on the South Dakota tax plan under review in this case – that plan restricts the application of sales tax to out-of-state companies that have at least $100,000 in sales per year or more than 200 separate transactions per year with state residents.  The Court also indicated that the ease with which companies could comply with a state’s taxing scheme would weigh on whether it created a substantial burden on interstate commerce.  South Dakota and more than twenty other states have adopted the Streamlined Sales and Use Tax Agreement, which is designed to make it much easier for out-of-state retailers to comply with an Internet tax program.

Illinois has no Internet Tax Law

Second, Wayfair only addresses a South Dakota state law.  Even if the case had gone further and approved the tax plan implemented by South Dakota, Illinois does not have a parallel tax law.  Before Illinois can levy taxes against Internet sales it would have to amend its current sales tax laws.  As we know, the General Assembly has a difficult time reaching an agreement on such important issues.  In addition, Illinois is not one of the states to adopt the Streamlined Sales and Use Tax Agreement.  So, before Illinois and local governments could benefit from the holding in Wayfair, the General Assembly would have to take action in a way which complies with the Commerce Clause.

The Fiscal Year 2019 Budget which was adopted as Public Act 100-0587 does make amendments to the Use Tax Act and Service Use Tax Act.  The amendments are designed to mimic the tax regulations on out-of-state purchases adopted in South Dakota.  Currently, the amendments only authorize the collection of the State Use Tax and not any local use tax.  The amendments are not designed to become effective until October 1, 2018.  Nonetheless, the Illinois sales tax paradigm remains different from South Dakota’s because Illinois is not a party to the Streamlined Sales and Use Tax Agreement.

The Federal Government Can Preempt the Field

Third, as mentioned above, the federal government has exclusive authority to regulate interstate commerce.  As the Court states, “when Congress exercises its power to regulate commerce by enacting legislation, the legislation controls.”  So, the federal government could preempt a patchwork of different state Internet tax laws by adopting comprehensive legislation to govern the field.  To-date, Congress has been unable to reach an agreement on this issue.  Various versions of the Main Street Fairness Act, designed to place local businesses on a level playing field with Internet businesses, have been debated for several years with no action – the very motivation for South Dakota to adopt its plan in the first place.  Some people have speculated that the Wayfair decision will jump start the legislative process and result in a nationwide sales tax program.  Only time will tell.

Post authored by Adam Simon, Ancel Glink


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