Supreme Court reversal on state sales tax deals major blow to ecommerce businesses

More than 25 years ago, the US Supreme Court passed down a decision that would come to have far-reaching implications as ecommerce has evolved. The ruling in Quill v. Heitkamp in 1992 meant that online retailers without any physical presence in a state did not have to collect sales tax from customers in that state.

Now, just a week ago, the Court reversed that stance. With its decision on South Dakota v. Wayfair, the court overruled Quill v. Heitkamp and paved the way for states to introduce legislation that will require e-tailers to collect sales tax.

Not a new battle

Traditional retailers have long sought to reverse the 1992 decision, claiming that it gave ecommerce vendors an unfair pricing advantage. In 1993, Congress introduced the Marketplace Fairness Act, which would require remote sellers, including online businesses, to collect sales tax in qualifying states, but it never went anywhere.

Prior to the Court’s recent decision, online businesses were required to collect sales tax from online sales if they had a nexus — a physical presence — in that state. The case decided this week centered around South Dakota expanding the meaning of to include a financial nexus, which exists if a company hits a certain revenue level.

Just this month, ahead of the final ruling, Illinois passed a budget bill that adopted South Dakota’s economic nexus standard; Iowa did the same in May.

This isn’t the first time the meaning of nexus has been reinterpreted. California successfully extended the concept to include affiliate marketers, leading several other states to implement affiliate nexus laws.

Technically, taxpayers in most states are supposed to pay a Use Tax on items they bought online from out-of-state businesses. But only a small number of taxpayers pay it. According to this 2013 NPR article, only about 1.6 percent of the taxpayers in the 45 states that require it pay up, and if all that tax were collected, the states could recoup an extra $11.4 billion a year.

Big win for states, big blow to SMBs

Sylvia Dion, founder and managing tax partner at state and local tax (SALT) consulting firm PrietoDion Consulting Partners LLC, told me that the “decision is a huge win for the states, [but it] won’t be the Amazonian e-tailers that will be most impacted — it will be the small and/or medium-sized online retailers.”

“States are definitely not wasting any time,” Dion said. “Many of the economic nexus laws in [states that are adopting them] assert nexus based on an out-of-state taxpayer making sales into the state of more than $100,000 or in 200 or more separate transactions — they’re almost exactly like South Dakota’s law.”

Dion said that these financial nexus laws can spell trouble for SMBs:

While the $100,000 is a fairly high sales threshold — I’m most concerned about the “200 or more separate transactions,” as this means many smaller online retailers could be impacted by these laws. Also, most of these laws say that if either the revenues OR the number of transactions threshold is met, the out-of-state retailer has nexus and is subject to registration, reporting, collection and remittance duties. Now consider a small online retailer whose product sells for $10 — 200 transactions would only be $2,000 in sales. I think lots of people aren’t focusing on the “OR” language in these economic laws.

Could it lead companies back to brick and mortar?

Neel Grover, founder of engagement platform Indi.com, which also includes physical stores, said that this move could give e-tailers incentive to move into traditional stores.

“I have been expecting this change for some time now,” Grover told me. “This will benefit the largest ecommerce players, like Amazon, as they have already been charging state sales tax as they have established distribution centers throughout the country to get closer to the customer. I believe this will also accelerate other pure-play e-tailers to create brick-and-mortar stores and expand their affiliate relationships as physical presence will no longer be an issue. What is still needed to be seen is if anything will change with marketplaces (Amazon, eBay, Etsy, Rakuten), as generally they support smaller long-tail sellers.”

Not as easy as it looks

Dion says that there’s a lot more than just “plugging in software and pushing numbers and payments to a state.”

Dion says:

You see, states’ sales tax laws are complex and not uniform — and I’m not just talking about rates being different — it’s differences in how states tax certain items.

For instance, clothing might be fully taxable, partially exempt, or fully exempt depending on a state. Massachusetts, for example, exempts single articles of clothing with a sales price of up to $175; Connecticut’s partial clothing exemption has changed several times in the past few years, and Pennsylvania generally exempts clothing, but not all types. Another issue is that in states that exempt clothing, how does each state define clothing — are belts, watches, caps considered clothing too?

Dion said that being registered in multiple states could cause headaches.

“An out-of-state online clothing retailer with nexus in a far-away state would need to contend with these rules and nuances,” Dion said. “And once a business is registered, states will send notices of tax rate changes (and yes, there are over 10,000 taxing jurisdictions in the US), notices of filing frequency changes, nexus questionnaires to determine if a newly registered taxpayer has nexus for taxes other than sales taxes, etc.”

The true outcome remains to be seen

Not surprisingly, the National Retail Federation (NRF) applauded the move.

In a press release, NRF President and CEO Matthew Shay said:

Retailers have been waiting for this day for more than two decades. The retail industry is changing, and the Supreme Court has acted correctly in recognizing that it’s time for outdated sales tax policies to change as well. This ruling clears the way for a fair and level playing field where all retailers compete under the same sales tax rules whether they sell merchandise online, in-store or both.

It’s fair to say that e-tailers knew this day would come. Ever since the original decision in 1992, states have been steadily finding new ways to expand the definition of nexus to recoup the sales tax they believe they deserve from online retailers. But now that the states have gotten their way, only time will tell how this will truly affect the e-tailers’ bottom lines.