Supreme Court Victory for Brick and Mortar

Yesterday the Supreme Court of the United States issued a landmark decision allowing states to tax online purchases even when the seller has no physical presence in the state where the transaction occurs. This victory for brick and mortar stores goes a long way toward leveling the playing field with their online competitors.

Writing for a 5-4 majority in South Dakota v. Wayfair, Justice Kennedy overruled prior precedent requiring the seller to have a “physical presence” in the taxing authority’s jurisdiction, holding that, “Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.”

The Court, split along unusual lines with Justices Ginsburg, Alito, Thomas, and Gorsuch joining Kennedy’s majority opinion, decided that the prior rule, “has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a state’s consumers—something that has become easier and more prevalent as technology has advanced. This Court should not prevent states from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the state.”

Chief Justice John Roberts wrote a dissent that was joined by Justices Breyer, Sotomayor and Kagan, pointing to the lack of Congressional action as a reason not to overrule the Supreme Court’s prior decisions. “E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule,” Roberts said. “Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.”

The true impact of this decision is hard to measure at this stage. Amazon, the leading online retailer by a large measure, already had begun collecting sales tax regardless of its physical presence in a buyer’s state, and other major online retailers have followed suit. However, last year, the Government Accounting Office estimated that state and local governments were losing between $8 billion and $13.4 billion a year in uncollected taxes for online sales. State officials put their revenue losses even higher and 41 states joined South Dakota in taking on retailers Wayfair, a seller of home goods; Overstock.com, a general retailer; and Newegg.com, which specializes in tech products, in the suit to uphold South Dakota’s 2016 tax law, which imposes an “economic presence test” on out-of-state retailers to subject them to sales tax liability. The measure applies to any retailer with at least $100,000 in sales or at least 200 individual transactions in the state, regardless of “physical presence.”

“That [the physical-presence rule] allows remote sellers to escape an obligation to remit a lawful state tax is unfair and unjust,” Kennedy said. “It is unfair and unjust to those competitors, both local and out of state, who must remit the tax; to the consumers who pay the tax; and to the states that seek fair enforcement of the sales tax, a tax many states for many years have considered an indispensable source for raising revenue.”

The majority cited marketing materials from Wayfair. “Its advertising seeks to create an image of beautiful, peaceful homes, but it also says that ‘one of the best things about buying through Wayfair is that we do not have to charge sales tax.’ What Wayfair ignores in its subtle offer to assist in tax evasion is that creating a dream home assumes solvent state and local governments.”

“The Internet’s prevalence and power have changed the dynamics of the national economy,” Kennedy said, noting that mail-order sales in the United States in 1992 totaled some $180 billion, while e-commerce sales last year were estimated to be $453.5 billion. This expansion has increased the revenue shortfall faced by the states, he continued, citing estimates that range from $8 billion to $33 billion.

Part of the problem with implementing this decision is that there are complex distinctions made in more than 10,000 taxing jurisdictions, which can have a disparate impact on small businesses. As Chief Justice Roberts noted in his dissent, “New Jersey knitters pay sales tax on yarn purchased for art projects, but not on yarn earmarked for sweaters,” Roberts said, while Texas imposes a sales tax on plain deodorant but not on deodorant with antiperspirant, and Illinois treats Twix and Snickers bars differently for sales-tax purposes.

So far, approximately twenty states have either enacted statutes, or have legislation pending, that impose tax burdens on online retailers similar to South Dakota’s. Now that the Supreme Court has spoken, we can expect many more states to follow suit.