Last month we reported that a pending U.S. Supreme Court case, South Dakota v. Wayfair, Inc. (U.S. S.Ct., Dkt. No. 17-494, 06/21/2018), might expand the rights of states to impose their sales and use taxes on out-of-state sellers.  The Court’s June 21, 2018 Wayfair decision has done exactly that.

The decision overturned the physical presence requirement, a 51-year-old standard for determining when remote sellers must collect sales or use taxes on behalf of states other than their own.  Now, a state may impose registration and collection requirements even if there is no physical presence inside the destination state in which the products are delivered.  The physical presence standard was first established by the Supreme Court in National Bellas Hess v. Illinois, 386 U.S. 753 (1967).  Invoking the Due Process and the Commerce Clauses of the U.S. Constitution, the Bellas Hess Court determined that Illinois could not require an out-of-state business to collect Illinois sales or use tax on sales made into the state from an out-of-state location unless the seller had an in-state physical presence.  Such a presence might be established by maintaining in-state offices or other property, resident employees or agents, or out-of-state employees or agents who made frequent visits into the state.  Once established, the presence would be regarded as creating a connection, called nexus, which would permit the state to require collection and reporting of its tax.

Twenty-five years after Bellas Hess, the Supreme Court reaffirmed and clarified its physical presence standard in Quill Corporation v. North Dakota, 504 U.S. 298 (1992).  The Quill Court held that the Due Process clause of the Constitution did not provide a sufficient basis for asserting nexus, but the Commerce Clause did provide such a basis if the selling entity had an in-state physical presence that was more than minimal. The Court also noted that Congress, which is solely responsible for regulating interstate commerce, could later expand upon, clarify, or redefine nexus standards as it wished.  Congress, of course, took no such subsequent action (nor had it taken such action after Bellas Hess), so the physical presence test continued to define nexus for another quarter-century until Quill was overturned by Wayfair on June 21, 2018.

Over the years, each state that has enacted a sales and use tax law (45 states plus the District of Columbia) has established its own definition of physical presence.  In recent periods, some of those definitions have pushed the limits of credibility.  Connecticut, Iowa, Ohio, and Massachusetts have ruled that remote sellers whose websites leave cookies and applications on in-state customers’ hard drives and phones have established nexus because cookies and applications constitute “property.”  (Interestingly, the Wayfair Court stated in passing that cookies and apps may be considered to create “almost” a physical presence.  The Justices did not opine on when or if cookies or apps could actually be regarded as establishing nexus.)

Other pre- Wayfair stretches of the physical presence standard include “click-through” and affiliate nexus, both of which are targeted by the laws and regulations of several states.  Under “click-through” theories, nexus may be asserted when an out-of-state seller enters into an agreement with an in-state representative to refer potential customers to the seller’s website in exchange for compensation.  Affiliate nexus, in turn, may be asserted based on the in-state activities or holdings of “affiliates” of out-of-state entities.  Neither click-through nor affiliate nexus theories have been reviewed by the Supreme Court.

Some states (Colorado, Georgia, Louisiana, Oklahoma, Pennsylvania, Rhode Island, South Carolina, South Dakota, Texas, Vermont, and Washington) have attempted to circumvent the physical presence test by creating onerous notice and reporting requirements for out-of-state sellers lacking nexus.  When these sellers reach a specified threshold of taxable sales into the state, they are required to report voluminous details about each sale to the state.  They also must notify their in-state customers of their use tax obligations and the fact that the sale is being reported to the state.  Penalties for noncompliance can be draconian.  To avoid these requirements and penalties, companies are “invited” to voluntarily register to collect and report the state’s tax.  Such notice and reporting provisions will not be affected by the Wayfair outcome.

In addition to granting Congress the sole authority to regulate interstate commerce, the Commerce Clause of the U.S. Constitution has been interpreted as prohibiting states from interfering with or unduly burdening such commerce.  This interpretation is known as the “dormant” or “negative” Commerce Clause.  The Supreme Court has established a four-point test for determining whether a state tax has violated the dormant Commerce Clause.  The test, outlined in Complete Auto, Inc. v. Brady, 430 U.S. 274 (1977), provides that a state tax will not violate the Commerce Clause if all four of the following criteria are met:

  1. The tax is applied to an activity that has a substantial nexus with the taxing state;
  2. The tax is fairly apportioned;
  3. The tax does not discriminate against interstate commerce; and
  4. The tax is fairly related to the services provided by the state.

The relevant nexus criterion is the first one, which actually makes no mention of physical presence despite the fact that the Court has considered the latter a mandatory component of any successful nexus assertion.  Although Wayfair now eliminates physical presence as a required component, nexus still will be asserted whenever such a presence exists.

The Court’s scolding of itself for having established its 51-year, two-case precedent in the first place was downright amusing.  In his majority opinion, Justice Kennedy indignantly wrote that the physical presence rule of Quill was “unsound and incorrect,” adding that “the rule has long been criticized as giving out-of-state sellers an advantage.  Each year, it becomes further removed from economic reality and results in significant revenue losses to the States.  These critiques underscore that the rule, both as first formulated and as applied, is an incorrect interpretation of the Commerce Clause.”  (Emphasis added.)  Kennedy characterized Quill as “a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers” and then stated, “It is inconsistent with this Court’s proper role to ask Congress to address a false Constitutional premise of this Court’s own creation.”

Of course the Court and most of the states have been asking Congress to address nexus criteria for the past 51 years.  Given Congressional authority to regulate interstate commerce, it does not appear “inconsistent with the Court’s proper role” for it to have expressed a hope that Congress would fulfill its responsibilities.  In fact, the dissenting Justices made this very point, once again observing that Congress is the appropriate venue for setting nexus standards.  Unfortunately, expecting Congress to rise up and assume its proper role after 51 years of floundering might be overly optimistic.

In any case, states may now apply economic nexus as an additional standard for determining whether an entity can be compelled to collect and report a foreign state’s sales and use tax.  It’s important to note that the new standard does not replace any of the others already in existence.  Neither does it change any existing state laws, beyond rendering valid any economic nexus laws that have already been enacted in anticipation of the Wayfair outcome.

Although South Dakota’s law is now expressly approved, such approval should not be assumed to extend automatically to every other state with economic nexus provisions.  The Court cited three features that helped keep South Dakota within Commerce Clause protection.  The features are:

  1. The state’s safe harbor provision for entities whose in-state activities fall below a specified threshold, in this case its $100,000 sales/200 transactions cut-offs (see table below);
  1. The fact that its law is not retroactive; and
  1. South Dakota’s membership in the Streamlined Sales and Use Tax Agreement, a pact that currently includes 24 states.  The Agreement reduces administrative and compliance burdens for taxpayers who register with all of the member states.

Regarding the effects of these features:

  1. Safe harbor thresholds are included in every state sales and use tax economic presence provision enacted to date.  Most either conform to South Dakota ’s minimums or exceed them.  Such provisions are almost certain to be included in any forthcoming legislation as well.
  1. The possibility of retroactive application was briefly addressed – and sidestepped – by the Court, although the Court did seem to regard it as problematic.  No state has yet attempted to make an economic presence standard retroactive, but that does not preclude the possibility of it happening.  Obviously, such an interpretation would be challenged in court almost immediately.
  1. South Dakota’s membership in the Streamlined Sales Tax Agreement raises a potential issue for nonmember states.  The level of importance assigned by the Court to such membership is impossible to determine at this point.  Accordingly, membership in the Agreement may or may not become a significant factor in determining whether the economic nexus standards approved for South Dakota will be permitted for nonmember states.

The sixteen states that have already enacted economic nexus provisions are listed below:

State   Eff. Date         Min. Sales Thresholds                      Streamlined Sales Tax Member?


GA      In effect           $250,000 sales or 200 transactions                 Yes (full)

IL        10/1/2018        $100,000 sales or 200 transactions                 No

IN        In effect           $100,000 sales or 200 transactions                 Yes (full)

TN       In effect           $500,000 sales                                                Yes (associate member)

WY     In effect           $100,000 sales or 200 transactions                 Yes (full)

CO      In effect           $100,000 sales                                                No

AL       In effect           $250,000 sales                                                No

IA        1/1/2019          $100,000 sales or 200 transactions                 Yes (full)

MA     In effect           $500,000 sales or 100 transactions                 No

CT       12/1/2018        $250,000 sales or 200 transactions                 No

HI        7/1/2018          $100,000 sales or 200 transactions                 No

KY      7/1/2018          $100,000 sales or 200 transactions                 Yes (full)

SD       In effect           $100,000 sales or 200 transactions                 Yes (full)

ND      6/21/2018        $100,000 sales or 200 transactions                 Yes (full)

ME      N/A                 $100,000 sales or 200 transactions                 No

VT       7/1/2018          $100,000 sales or 200 transactions                 Yes (full)

Depending on the circumstances of each particular business, it may now be necessary for businesses meeting or exceeding any of the above sales thresholds to now register with the applicable state(s), this may be true regardless of whether the state has subscribed to the Streamlined Sales Tax Agreement.  Similar state legislation may be expected to follow, along with related challenges.

This information does not constitute legal or tax advice, please contact your consultant at McClellan Davis with any specific questions, or you may contact us at, if you do not have an assigned consultant.  Among other services, we offer registration, multistate taxability studies and return preparation services.

Dan Davis, CPA RET.

Dan Davis, CPA RET.

Dan has practiced in the tax field for over 35 years. His career started with the California State Board of Equalization, where he worked as a senior sales tax auditor, branch office supervisor, and district audit reviewer. In addition to nearly two dozen articles, Dan has written two major reference books on sales and use tax matters. The books, which are published online by CCH, Inc. and updated annually, include the Multistate Guide to Sales and Use Tax Audits and the Multistate Guide to Sales and Use Tax: Construction. Dan has also taught and lectured on a variety of tax and auditing topics at graduate and postgraduate levels.

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