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The Supreme Court Eliminates the Physical Presence Requirement for Sales Taxation: The Effect On Idaho Law

Added by Richard Smith in Articles & Publications, Tax Law on August 7, 2018

On June 21, the U.S. Supreme Court reversed the Quill decision that limited the ability of States to impose sales tax on out-of-state sellers. The Quill case, decided in 1992, reaffirmed an earlier decision that required, before a State could impose sales tax on such “remote sellers,” that they must have some physical presence in the State. Thus, while purchases of goods by Idaho residents from out-of-state retailers are subject to the Idaho sales or use tax, the Quill case limited the State’s ability to collect that tax from the retailer, and instead must rely on the consumers to report and pay use tax on these purchases. Few taxpayers do so.

The case last week of South Dakota v. Wayfair was a 5-4 decision authored by Justice Anthony Kennedy (who just announced his retirement). The Court held that in the modern internet age, a physical presence requirement is an anachronism that has no place in Constitutional jurisprudence. The Commerce Clause of the Constitution requires that a tax may not be assessed if it imposes an unreasonable burden on interstate commerce. One test used in determining whether a burden is unreasonable comes from the landmark 1977 case of Complete Auto Transit: the activity sought to be taxed must have a “substantial nexus” to the taxing State. In Quill, the Court held that “substantial nexus” required a physical presence. The Court in Wayfair overruled that case, and held that the substantial nexus requirement can be satisfied without requiring a physical presence in the State.

In his dissent, Chief Justice Roberts argued that overruling Quill could impose a significant burden on remote sellers, particularly smaller businesses, in complying with the laws of each State in which the business’s products are sold. The majority opinion acknowledged that such burdens could “pose legitimate concerns” and that “[c]omplex state tax systems could have the effect of discriminating against interstate commerce.” Thus, there could be litigation in the future over whether a particular State’s tax regime imposes an unreasonable burden on remote sellers. In this case, however, South Dakota’s new tax law is triggered only if the remote seller sells goods worth more than $100,000 per year in the state, or engages in more than 200 separate transactions in a year. The law was not retroactive. The Court noted that issue of the reasonableness of South Dakota’s law was not being litigated in that case (other than the absence of a physical presence requirement), but suggested that the safe harbor and prospective treatment would protect this statute from further challenges.

The Wayfair decision should provide a positive impact on sales tax revenue in Idaho, and the greater equity that has long been sought between “brick and mortar” local businesses that have always collected the tax and the remote sellers that have not. However, two developments may mitigate the fiscal effect of Wayfair. First, some remote sellers, including Amazon,* are now collecting the tax voluntarily.

Second, many states have enacted laws that extend a State’s ability to impose tax if the seller has any connection with the State through an affiliate or a referral source located in the state. The Idaho legislature passed such a law in 2018, with an effective date of July 1, 2018. Under the new law, if a retailer has an affiliate located in Idaho or an agreement with an Idaho resident that refers potential business, and if sales are more than $10,000 in a 12-month period, the retailer is subject to tax.

The fiscal note for this bill estimated a potential increase in sales tax revenue of $22 million to $37 million. Further legislation will be needed if Idaho seeks to maximize the increase in sales tax revenue as a result of Wayfair, since there will be remote sellers who might be taxable under Wayfair but who would not be taxable pursuant to this new law – all the retailers who have neither a physical presence nor affiliate relationships in Idaho. The Idaho legislature will need to consider carefully whether the threshold in the 2018 bill — $10,000 – is suitable for the broader coverage of the sales tax on remote sellers. It may want to follow the lead of South Dakota with a higher safe harbor, so that the tax is not imposed unless there are at least $100,000 in annual sales in Idaho, or at least 200 transactions.

The Wayfair decision is an important one that will affect many businesses and all the states. If the tax on remote sellers is fairly administered, it should provide greater equity among sellers and additional revenue for states.

*It is our understanding that Amazon collects Idaho sales tax on sales of its products in Idaho. It does not necessarily collect such tax on sales by third parties made through the Amazon website.