Retailers and Consumers: Be Prepared for Increased Aggression in Sales Tax Nexus

By Ashley G. White, JD, CPA

On June 21, 2018, the U.S. Supreme Court held in South Dakota v. Wayfair, Inc., Dkt. No. 17-494, that physical presence in a state is no longer required in order to establish sales tax nexus.  Previous to the holding in Wayfair, substantial nexus with a state required some kind of actual tangible presence in the state, such as employees, property or some similar factor.  The previous Supreme Court decisions found physical presence necessary to uphold the Commerce Clause of the U.S. Constitution, which is intended to prevent an undue burden on the national economy, i.e. interstate commerce, as a result of regulation by the states.      

The Wayfair decision concerned a South Dakota statute that required out-of-state retailers to collect South Dakota sales tax if the retailer had either (1) annual gross revenue of more than $100,000 from sales in South Dakota or (2) completed more than 200 sales annually in South Dakota.  The U.S. Supreme Court’s holding states that the old physical presence rule is outdated and does not adequately account for the virtual economy that exists in today’s age.  Specifically, Justice Kennedy writing for the majority stated that “[m]odern e-commerce does not align analytically with a test that relies on the sort of physical presence defined in [the earlier cases] . . . . And the Court should not maintain a rule that ignores substantial virtual connections to the State.”  Furthermore, the Court states that the physical presence rule actually creates distortions in the market by giving some online retailers an “arbitrary advantage over their competitors” and provides an incentive to avoid physical presence in states where development might otherwise be encouraged.

The expectation resulting from the Wayfair decision is that states will begin to immediately amend their sales tax statutes to broaden their reach to include sellers without a physical presence in the state.  As an example, Kentucky has made an effective date of July 1, 2018 for its new sales tax nexus thresholds that match those at issue in Wayfair.  Despite the Wayfair decision, states must still limit their sales tax statutes to only those sellers that have a substantial nexus with the state.  Presumably, some states will push the envelope to see how far they can stretch the parameters to decrease the amount of annual gross revenue required and/or the number of sales that must be completed before substantial nexus is achieved or possibly even create additional, far-reaching factors that pull in as many sellers as possible.  As a result, the courts will likely have to address what exactly will constitute a substantial nexus outside of physical presence.  Alternatively, Congress could pass legislation overturning the decision at some point.  Whatever happens, it seems clear that changes in sales tax nexus are on the horizon in the near future.