News & Publications

Jun 29th, 2018

Eliminating the Physical Presence Rule in Collecting State Sales Tax

Eliminating the Physical Presence Rule in Collecting State Sales Tax: Modern E-Commerce Following South Dakota v. Wayfair

 Amy Bhatt

J.D. Candidate, Florida State University College of Law

In a far-reaching decision whose importance is just being absorbed, the United States Supreme Court ruled that a state can tax internet sales delivered to its residents even if the internet seller has no physical presence in the state.

Following the decision, we may see a flurry of activity in legislatures as states may need to change their laws to take advantage of this ruling. Although the South Dakota law does not address seeking sales taxes retroactively, the Court’s decision left open the possibility of doing so, a path we may see states trying to pursue. While online retailers may not have a physical presence in some States, in many ways, the Internet has brought the average consumer closer to most major retailers.

During the Supreme Court’s oral arguments, South Dakota’s attorney general argued that “states are losing massive sales tax revenues that we need for education, health care and infrastructure. Our small businesses on Main Street are being harmed because of the unlevel playing field created by Quill, where out-of-state, remote sellers are given a price advantage.” In an unusual voting lineup, with Justices Thomas, Ginsburg, Alito, and Gorsuch joining Justice Kennedy in the majority, the Court agreed and ruled that the physical-presence rule was unsound and incorrect, and that Quill and Bellas Hess were overruled.

The decision is a reversal of long-standing Court precedent. In Quill Corporation v. North Dakota, the Court re-affirmed its 1967 decision in National Bellas Hess Inc. v. Illinois Department of Revenue, holding that only businesses with a physical presence had to add sales tax to purchases. A state could not require out-of-state sellers with no physical presence in the state to collect and remit sales taxes on goods the seller ships to consumers in the state. However, this ruling came during a time when out-of-state shopping consisted of shopping through mail-order catalogs. Now, the out-of-state shopping experience has shifted to e-commerce companies, such as Wayfair and, that do not have traditional brick-and-mortar stores.

In light of the dramatic change in the economic landscape, members of the Court previously indicated their willingness to reconsider the Quill decision. Specifically, in a 2015 concurring opinion in Direct Marketing Association v. Brohl, Justice Kennedy seemed to call for a challenge, stating that “[t]he legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.”

That decision prompted South Dakota, which does not have state income tax and relies heavily on its sales and use taxes, to enact a new law in 2016. The statute imposed an “economic presence test” on out-of-state retailers. It required all merchants to collect a 4.5% sales tax if they had more than $100,000 in annual sales or more than 200 transactions in the state. State officials sued three large online retailers—Wayfair, and Newegg—for violating the law. However, citing the Quill decision, lower courts ruled for the online retailers.

Quill puts both local businesses and many interstate businesses with physical presence at a competitive disadvantage relative to remote sellers,” Justice Kennedy wrote. “Remote sellers can avoid the regulatory burdens of tax collection and can offer de facto lower prices caused by the widespread failure of consumers to pay the tax on their own.” Justice Kennedy said that the physical-presence rule as defined and enforced in Bellas Hess and Quill “is an extraordinary imposition by the judiciary on states’ authority to collect taxes and perform critical public functions.” The law, as Justice Kennedy wrote, effectively incentivized businesses to “avoid physical presence” in states and led to “a judicially created tax shelter.”

Justice Thomas, in his concurrence, said that he should have joined Justice Byron White’s dissent in Quill in 1992. Justice Roberts, in his dissent, said he agreed that Bellas Hess was wrongly decided, but he went on to state that the majority’s view that the “‘Internet’s prevalence and power have changed the dynamic of the national economy’ . . . is the very reason that I oppose discarding the physical-presence rule.” He continued to note that he would leave it to Congress to decide whether to depart from the physical-presence rule.

The long and the short of the opinion is that the legal landscape has changed, and practitioners need to counsel their clients accordingly.