On June 21, 2018, the U.S. Supreme Court issued a landmark decision in South Dakota v. Wayfair, Inc. that significantly expanded states' authority to require out-of-state sellers to collect sales tax. This overturned decades of precedent that restricted sales tax obligations to sellers with a physical presence in the taxing state.
The Wayfair case has profoundly impacted interstate commerce and sales tax compliance.
Understanding the Pre-Wayfair Physical Nexus Requirement
To appreciate the significance of Wayfair, it's important to understand the physical nexus standard that existed previously. The 1992 Supreme Court case Quill Corp. v. North Dakota established that a business must have physical presence in a state to be required to collect and remit sales tax in that state.
Physical presence was interpreted narrowly to mean things like retail stores, offices, warehouses, employees living in the state, etc. If a seller had no physical presence, they did not need to collect sales tax despite making sales into the state. This physical nexus rule arose from earlier Supreme Court cases limiting state tax powers under the Commerce Clause.
Over time, the rise of e-commerce exposed flaws in the physical nexus rule. Online sellers with no physical presence in a state could sell untaxed goods to residents, undercutting local brick-and-mortar businesses forced to collect sales tax. States were losing significant sales tax revenue as e-commerce grew.
South Dakota Leads the Fight Against Quill
South Dakota took aim at the Quill physical nexus standard by enacting a law in 2016 requiring out-of-state sellers to collect sales tax if they exceeded $100,000 in sales or 200 transactions in the state annually. Wayfair, Overstock, and Newegg contested South Dakota's law as violating Quill.
In South Dakota v. Wayfair, Inc., the Supreme Court agreed to reconsider Quill's physical nexus rule. South Dakota argued that Quill was outdated in the modern digital economy and caused harm to states dependent on sales tax revenue.
Ultimately, the Court agreed that the reasons behind Quill were no longer valid and the physical nexus rule imposed an arbitrary limit disconnected from economic realities. Overturning Quill, the Court upheld South Dakota's sales tax nexus law based on an economic rather than physical standard.
What the Wayfair Decision Means
The Court's 5-4 majority ruling in Wayfair carried several key implications:
- States can require out-of-state sellers to collect sales tax based on their economic ties to the state, overturning the Quill physical presence rule.
- An economic nexus threshold like South Dakota's $100,000 sales or 200 transactions establishes substantial nexus for Commerce Clause purposes.
- South Dakota's law appeared sufficiently crafted to prevent undue burdens on interstate commerce but this does not preclude challenges to other state laws.
- Physical presence is no longer required but remains a sufficient basis for requiring tax collection.
- The ruling does not impact seller requirements under state use tax laws. In essence, Wayfair overturned the physical presence standard and opened the door for states to tax remote sellers based on economic thresholds. But details like appropriate nexus thresholds were left unclear.
How States Have Responded to Wayfair
The Wayfair ruling triggered a cascade of responses from states:
- Many states quickly enacted economic nexus laws setting their own sales and transaction thresholds. By early 2020, over 30 states had economic nexus laws in effect.
- Thresholds range from $100,000 - $500,000 in sales with some states adding a transaction minimum. This lack of uniformity creates complexity for sellers.
- A key issue is determining sales sourcing - where a sale occurs for tax purposes. Many states shifted to destination-based sourcing for remote sales.
- Notice and reporting requirements were also added, compelling sellers to disclose sales that exceed thresholds.
- States continue refining their nexus laws after Wayfair with additional changes expected. Maintaining compliance as laws evolve is challenging.
It's clear states saw Wayfair as a green light to aggressively tax remote sellers. But businesses have struggled with the complex patchwork of economic nexus laws that followed.
Wayfair's Implications for Businesses
The effects of the Wayfair decision on businesses selling online, via mail order and across state lines have been far reaching:
- Sales tax filing obligations can now arise in states where a seller has no physical presence, dramatically expanding filing requirements.
- Sellers must closely monitor their sales into each state to identify when economic thresholds are exceeded.
- Added sales tax compliance costs and burden falls heavily on small and medium sized sellers.
- Nexus must be continually evaluated as state laws and seller sales evolve month-to-month.
- Poorly crafted laws face legal challenges regarding discrimination against interstate commerce.
- Opportunities exist to recover overpaid sales tax in states where sellers collected tax despite lacking physical nexus under old rules.
Wayfair brought sales tax nexus into the 21st century with a landmark economic standard. But navigating the new normal has proven complex for businesses both large and small.
Future Outlook Post-Wayfair
It's unlikely the pace of change in sales tax nexus laws will slow any time soon:
- States feeling budget impacts from the pandemic may pursue more aggressive nexus standards. Physical presence laws could also expand.
- The lack of uniformity across economic nexus laws will spur harmonization efforts by groups like the Streamlined Sales Tax Governing Board.
- The explosion in marketplace facilitator laws driven by Wayfair will lead to new business compliance obligations.
- More states will centralize administration of local sales taxes to ease remote seller burdens.
- With physical presence no longer key, expect more challenges to protections like PL 86-272.
Nearly 5 years later, Wayfair's transformation of the sales tax landscape continues evolving. Businesses must make sales tax nexus management a priority to keep pace with regulatory changes impacting their filing obligations.
The South Dakota v. Wayfair, Inc. Supreme Court ruling marked the beginning of a new era in sales and use tax nexus. Abandoning physical presence, the Court upheld an economic threshold for establishing substantial nexus.
In response, states raced to enact their own economic nexus regimes yielding a complex maze of compliance obligations for businesses both large and small. Mastering multi-state sales tax filing requires staying ahead of constant nexus changes triggered by legislative updates, business activities, and revenue department guidance.
Wayfair will continue fueling sales tax nexus uncertainty and complexity for years to come. But with vigilance and the right resources, businesses can adapt and thrive in the post-Wayfair marketplace.