Thanks to the United States Supreme Court, internet retailers no longer have an unfair financial advantage over brick-and-mortar businesses. Until June of this year, an internet retailer was not required to collect sales taxes from out-of-state customers ordering merchandise or services, unless the retailer had a “physical presence” within the state where the purchaser resided. A seller was required to have property, employees, or some other physical presence within a state before it could be required to collect and remit state sales taxes.
Accordingly, retailers like Amazon, L.L. Bean, Land’s End, Newegg, and many other companies, large and small, did not charge their out-of-state customers sales taxes, or remit sales taxes to states where those customers resided. In 2016, the State of South Dakota enacted legislation to require out-of-state retailers to collect and remit sales tax “as if the seller had a physical presence in the state.” The South Dakota legislation would apply only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the state or engage in 200 or more separate transactions for the delivery of goods or services into the state.
South Dakota filed suit in state court against Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc., three major online retailers, none of which had a physical presence in South Dakota, and none of which had collected sales taxes from its customers. Those defendants filed a motion for summary judgment, which was granted. On appeal, the South Dakota Supreme Court affirmed, citing two earlier US Supreme Court cases, Quill Corporation v. North Dakota(1992) and National Bellas Hess, Inc. v. Department of Revenue of Illinois (1967), in both of which the Court had held that a physical presence was required before a state could require an out-of-state seller to collect and remit sales taxes.
The Supreme Court’s decision issued in June was considered a landmark decision, as it expressly overruled Quill and National Bellas Hess. In South Dakota v. Wayfair, et al, the Supreme Court, in a 5-4 decision, held that out-of-state sellers with no physical presence in a state must collect and remit that state’s sales tax when a consumer purchases goods or services in that state. Writing for the majority, Justice Kennedy addressed the physical presence rule and concluded that “modern e-commerce does not align analytically” with the physical presence test articulated by the Court in Quill. The majority went on to state that it would be unfair to allow out-of-state sellers to avoid collecting and remitting sales taxes and to only impose that tax burden on competitors with a physical presence in the state.
In lieu of a physical presence standard, the Supreme Court held that sellers and service providers with a “substantial nexus” existence with a state must collect and remit sales taxes. In this case, South Dakota’s new law requiring a remote seller delivering annual value of goods and/or services of at least $100,000 or at least 200 annual transactions take place before being required to collect and remit sales taxes, was deemed to satisfy the “substantial nexus” test.
As of today, many states have adopted similar “substantial nexus” or “economic nexus” tests in anticipation of improving their sales tax revenues from internet and other out-of-state sellers. Connecticut’s General Assembly enacted a substantial nexus test that becomes effective December 1, 2018. Under that law, an out-of-state seller must collect and remit sales taxes if it has at least $250,000 in annual gross receipts from sales to buyers residing in Connecticut and has 200 or more separate sales transactions with Connecticut residents (100 or more prior to December 1, 2018). As of this writing, New York State has not adopted a “substantial nexus” test to replace its “physical presence” test, although legislators are likely to do so.
Consumers should not rush to complete their online holiday shopping before Dec. 1 in the mistaken belief that doing so will legally avoid payment of sales tax on their purchases. If the seller does not collect a sales tax, the consumer is still obligated to pay a use tax on goods and some services purchased out of state and delivered in the state where they reside.