The Supreme Court Tackles the Internet – Remote Sellers and the Sales Tax

The Supreme Court Tackles the Internet – Remote Sellers and the Sales Tax

On June 21, 2018, the Supreme Court, in a 5-4 decision in South Dakota v. Wayfair, Inc., ruled in the particular circumstances presented that South Dakota could require an out-of-state retailer to charge and collect sales tax on sales to its South Dakota customers.

When the Supreme Court decides a tax case, a tax lawyer should take note and comment, and that is what I will do.  There will be dozens of law review articles published providing in-depth and erudite analysis, and there are a lot of scholarly things to say, but I will not attempt any of that here.  I just hope to point out some things about the case that I find interesting or curious, and maybe along the way provide some insight about what the Supreme Court has done and how we can think about that.

The case can be fairly simply stated:  South Dakota passed a law requiring out-of-state retailers to collect and pay over its sales tax if, on an annual basis, the retailer delivers to South Dakota customers more than $100,000 worth of goods or services, or engages in 200 or more separate transactions for the delivery of goods or services to South Dakota customers.   South Dakota knew that there would be a challenge, because it was seeking to have overturned or limited Supreme Court precedents decided more than 50 years ago, National Bellas Hess, Inc. v. Department of Revenue of Illinois (1967), which the Court refused to overturn 26 years ago in Quill Corp. v. North Dakota (1992).  Basically these cases held that the duty to collect and pay over sales tax could not be imposed by a state unless the retailer had a “physical presence” in the state.

If you went to law school or are a geek about the Constitution, you might ask, “Hey, it seems to me that this is a case about interstate commerce, and in Article I, Section 8 of the Constitution, Congress is given the authority ‘to regulate Commerce … among the several States…,’ and this case doesn’t involve an Act of Congress, so why does the Supreme Court have anything to say about it?”   And that would have been a very good question at the dawn of Constitutional time, in the 1820s.  See, the problem was, cases got to the Supreme Court where there was an alleged violation of the Commerce Clause (free and fair trade across states lines, no economic discrimination between or among states, that sort of thing) but no controlling Act of Congress.  So what to do?  The Court judged that if it refused to rule and waited for Congress, chaos would ensue, and so the doctrine of the “dormant Commerce Clause” was born.  Willson v. Black Bird Creek Marsh Co. (1829).  Ever since, there have been probably hundreds of cases decided on the basis of the dormant Commerce Clause, and in every one of them, including National Bellas Hess and Quill, and indeed Wayfair, the Court has said something like “Look, Congress, no offense, we’re only doing the best we can, and if you can get your act together and legislate on the matter, well that’s what the Constitution contemplates, and go ahead and forget we even said anything.”

Which raises one of the questions that is interesting to me:  What if the Congress legislated, and its judgment about where the line should be drawn differed wildly from the Court’s in Wayfair?  Do we suppose that the Court would easily surrender the prerogative that it carved out for itself in the dormant Commerce Clause cases?  We know that the Supreme Court can and has declared an Act of Congress unconstitutional.  Notwithstanding that Congress has the exclusive authority under the Constitution to regulate interstate commerce, do you suppose that they could get it so “wrong,” in the Court’s view, that the Court would find a way to strike it down?  Further than that, there have been any number of legislative proposals in Congress to address sales taxation in the internet age and adopt a national policy.  None of these proposals have gotten to the point of being enacted, but if you guess that this case will take the wind out of the sails of any attempt to enact a nation-wide policy, at least in the near term, I would say that you would be right.

Now let’s get back to Wayfair, and let me talk to the tax geeks a bit.  South Dakota argued, and the majority of the Court accepted, that it was losing millions of dollars of tax revenue every year because, under National Bellas Hess and Quill, out of state retailers did not have to collect and remit South Dakota’s sales tax.  But wait a minute, you might say, doesn’t South Dakota have a use tax?  And the answer is Yes.  Keep in mind, under the sales tax, more properly the sales/use tax, the consumer is the taxpayer; the retailer, if it is within the grasp of the state, is just the tax collector.  If the retailer is not within the grasp of the state, the consumer is supposed to pay the use tax, same rate on the same transaction, just a different way for the state to get its dough.

But what a difference!  If the state has its mitts on, say Pizza Hut in a college town, it can have Pizza Hut collect sales tax on hundreds of thousands if not millions of transactions a year.  And there’s not much of a beef the customers can put up: if they don’t pay the price, including the sales tax, they ain’t gonna get their pizza.  So they are bound to be pretty indifferent, almost docile about the tax.  Contrast this with the state having to assess and chase every Pizza Hut customer.  A certain percentage are not going to be indifferent, docile or compliant.  The state is going to get a lot less tax revenue and it’s going to cost it a lot more to chase it down.

So Wayfair has to do with how far beyond its borders the state’s grasp exceeds, or what are the circumstances where the state’s grasp can exceed its borders?  And a while ago, I said that the retailer was just the tax collector, but this is putting it a little lightly: the retailer can be responsible for the tax, penalty, interest and other sanctions, such as losing its license to do business, personal liability of its officers, and so on, for not correctly and punctiliously doing its job as tax collector.  So not a small issue for those the state can impress into service as its tax collectors.

The Court’s majority opinion had some pretty unpleasant things to say about remote sellers.  The majority opinion, by now-departing Justice Kennedy, essentially accused remote sellers, particularly internet sellers, of competing unfairly with local “bricks and mortar” retailers that have to charge and collect the sales tax.  Beyond that, the majority accused the out-of-state retailers of abetting tax evasion by their South Dakota customers.  Now, let’s examine this a bit.  South Dakota has a use tax, and even if very few of its citizens voluntarily pay it, presumably South Dakota could have obtained information about the South Dakota customers from the remote retailers, by lawsuit if necessary, and gone after the South Dakota taxpayers.  After all, tax evasion is pretty serious.  But if South Dakota is anything like ennsylvania, and I expect most states are, it is probably not very much interested in pursuing hundreds of thousands of individual taxpayers for the use tax.  In fact, prior to 2011, there was hardly anything, least of all a form, to remind Pennsylvania use tax taxpayers to report and pay the use tax.  So even if you were perfect, and wanted to pay the use tax on goods you had purchased in Delaware and brought home to Pennsylvania in your station wagon, there was not even a form to do it.  And even now, I am not aware of any huge compliance push in Pennsylvania to capture more use tax or fine and sanction people for failing to comply with the form that is now, only since 2011, part of the Pennsylvania individual tax return.  So, can it really be tax evasion when the state seems relatively indifferent to enforcing its own tax?

How about that “unfair competition” argument?  Well, Wayfair certainly did not help itself by making a hallmark of its advertising that it was not required to charge a sales tax.  Years ago, I had a client with a retail facility in a tax-free zone in North Jersey.  It advertised this wonderful opportunity in the New York papers, and as a result had an army of New York revenue officers with binoculars in its parking lot, noting down all of the New York license plate numbers.  Getting your customers harassed: not a great business model.  On the other hand, we now have many people, maybe a couple of generations of young people and maybe another generation of older people, who are very comfortable shopping (and nearly everything else) online, and who would not or could not bear the inconvenience of going to the mall or trying to get help in some big box retail establishment or other.  I would say that it is delusional to suppose that hundreds of thousands of transactions are going to find their way back to local retailers because the online retailers now also have to charge sales tax.  Only a Government tax economist  would ignore or overlook the value of convenience to the consumer.

Back to the majority opinion in Wayfair.  It’s not surprising, I suppose, that it cites income tax cases, such as Complete Auto Transit, Inc. v. Brady (1977).  But the majority seems to say that from a Commerce Clause point of view, being a tax collector is not that much different from being a taxpayer.  To the contrary, it had been thought, prior to now, that somewhat more involvement, contact, presence, whatever, was required before the state could impress someone into service as its tax collector, than was required to impose a tax directly on a taxpayer.  After all, in this case, the use tax taxpayers are right there in South Dakota, you can get them without deputizing out-of-state retailers, not otherwise, until now, subject to your jurisdiction.  It seems that the majority has departed from fifty years of stare decisis, ordinarily thought to be a pretty important Supreme Court doctrine, to serve the convenience of South Dakota, which is too lazy or cowardly to enforce its own tax.

The dissenting opinion, by Chief Justice Roberts, does a very understandable and straightforward job with stare decisis, by the way, in a little over 7 pages.  Particularly as this case involves the Commerce Clause, where Congress has the primary if not exclusive Constitutional authority to draw lines and make rules, it seems that the majority has stretched pretty far to avoid stare decisis.   I commend the dissenting opinion to the attention of anyone interested in the stare decisis doctrine, even if you agree with the majority.

At least now the matter of sales tax on internet sales is settled for all 50 states, right?  Uh, no.  Hang onto your hat, every state will have to enact a law imposing a sales tax obligation on out-of-state sellers.  Well, at least then the rules will be uniform, since every state will do exactly what South Dakota did, with respect to dollar and transaction limits and the like, right?  Uh, no.  Just as the sales tax has always been, with state-by-state differences in rate, exemptions, and the like, this will be a crazy quilt and the full effect of this will take several years to play out.

Here are a couple of observations.  This is going to involve significant compliance costs for start ups, small businesses who hope to get a foothold on the internet.  Pretty easy to comply with one state’s laws, pretty much of a nightmare to comply with 50 states’ laws.  The proof of this is that Amazon, don’t get any bigger than this, has already uniformly been charging sales tax at the customer’s residence state’s rate.  Amazon can afford the systems required to comply.  For small and even medium sized businesses, the cost is likely to be more significant as a percentage of sales.  The tax compliance systems industry is about to get a boost.

The majority is at pains to lament that the “physical presence” rule of National Bellas Hess and Quill was an “extraordinary imposition by the Judiciary on States’ authority to collect taxes …” and it has to be corrected forthwith.  But does it recognize that what it has done is an “extraordinary imposition by the Judiciary…” on the way the relationship among business, its customers, and the states has been ordered probably since sales taxes were enacted and approved by the Court for at least 50 years?  Who says that the state’s interest should be paramount in the ordering of this relationship?  The majority, I guess.

So the winners were the states and their power to enlist others to collect their taxes; probably big, big internet sellers because they can easily absorb any cost entailed; and in-state, Mom and Pop, bricks and mortar retailers if you believe that Millennials will eschew the internet and flood back downtown or to the mall, because they will have to pay 6% more or so online, or alternatively, if you believe in the Tooth Fairy.  Oh, and let’s not forget the purveyors of tax compliance software.  The losers?  Small business, naturally, and anyone interested in Congress actually doing its job in an area where the Constitution invites and expects them to do so

Finally, there will be a lot of commentary about how the Justices voted.  Kennedy, thought to be a moderate swing vote, wrote the majority opinion, joined by Ginsburg, and the so-called conservatives, Alito, Thomas and Gorsuch, the latter two writing short concurrences.  The Chief Justice dissented, joined by so-called liberal Justices Breyer, Sotomayor and Kagan.  Very interesting.  Do we suppose that the so-called liberal Justices were opposed to this little bit of an extension of state power, or were looking out for small business?  I’m guessing that it was all about stare decisis, THE CASE that’s being bandied about in the news regarding the near-religious primacy of stare decisis, and the fact that the Justices can count.  This little grimy tax case ain’t what it’s about, but they could not risk being inconsistent on stare decisis, in case THAT CASE comes up in the near future.  But you don’t think the Supreme Court takes political considerations into account?  Me neither.

Written by E. Morgan Maxwell

E. Morgan Maxwell

Since beginning his own firm, Mr. Maxwell has continued a tax-law oriented practice encompassing a wide range of transactions, planning and dispute resolution. His dispute resolution experience includes involvement at all levels of the Internal Revenue Service (Examinations, Appeals, Collections, Office of Professional Responsibility, the U.S. Tax Court), the Pennsylvania Department of Revenue, the Tax Litigation Section of the Pennsylvania Attorney General’s Office, Pennsylvania Commonwealth Court, Common Pleas Court and local taxing jurisdictions in southeastern Pennsylvania.

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