State Sales and Use Tax Nexus After South Dakota v. Wayfair

State Sales and Use Tax Nexus After South Dakota v. Wayfair

May 14, 2021
State Sales and Use Tax Nexus After South Dakota v. Wayfair
In its 2018 decision in South Dakota v. Wayfair, Inc., the
Commerce Clause to include an implicit restriction, the
Supreme Court upheld a South Dakota law requiring out-of-
“Dormant” Commerce Clause, which limits state regulation
state sellers, or “remote sellers,” to collect and remit sales
of interstate commerce even absent congressional action.
taxes on goods and services delivered into South Dakota.
Thus, states may require participants in interstate commerce
For decades prior to Wayfair, the Court had construed the
to pay their fair share of state taxes so long as these taxes
Commerce Clause’s substantial nexus requirement only to
do not produce an effect forbidden by the Commerce
permit state sales and use tax collection duties on sellers
Clause.
with a physical presence in the taxing state. As a result,
states could not impose sales and use tax collection duties
As explained in Wayfair, two general principles guide
on remote sellers that competed with in-state sellers. In
courts adjudicating Commerce Clause challenges to state
Wayfair, the Court overturned its physical presence rule on
regulations of interstate commerce and “mark the
the ground that the rule produced market distortions and
boundaries” of those regulations: (1) “state regulations may
treated “economically identical actors differently for
not discriminate against interstate commerce;” and, (2)
arbitrary reasons.”
“[s]tates may not impose undue burdens on interstate
commerce.” In Wayfair, the Court reaffirmed:
Nearly every state has now enacted laws modeled after the
South Dakota act upheld in Wayfair in order to facilitate
State laws that discriminate against interstate
sales and use tax collection, stop the erosion of the sales tax
commerce face “a virtually per se rule of
base, prevent revenue losses, and increase funding for state
invalidity.” State laws that “regulat[e] even-
and local services. However, it remains possible that courts
handedly to effectuate a legitimate local public
might rule that laws that do not resemble the South Dakota
interest … will be upheld unless the burden
law violate Commerce Clause principles . In Wayfair, the
imposed on such commerce is clearly excessive in
Supreme Court only addressed the Commerce Clause’s
relation to the putative local benefits.”
substantial nexus requirement and concluded that several
features of the South Dakota tax system “appear[ed]
Congress has generally left it to the courts to determine
designed to prevent discrimination against or undue
whether a state action has discriminated against or unduly
burdens upon interstate commerce.” The Court stated that it
burdened interstate commerce.
did not consider whether other Commerce Clause principles
might have compelled it to invalidate the South Dakota law.
The Supreme Court set out the framework for determining
whether a state tax law violates the Commerce Clause in
This In Focus covers sales and use taxes, the Commerce
Complete Auto Transit, Inc. v. Brady. In Complete Auto, the
Clause, and the Commerce Clause’s substantial nexus
Court stated it would sustain a state tax law against a
requirement for state sales and use taxes before and after
Commerce Clause challenge
Wayfair.
when the tax is applied to an activity with a
Sales and Use Taxes
substantial nexus with the taxing State, is fairly
Most states impose a sales tax on the retail sale of goods in
apportioned, does not discriminate against interstate
their states, and many states impose a sales tax on the retail
commerce, and is fairly related to the services
sale of specified services. In general, sellers collect sales
provided by the State.
taxes from consumers at the time of purchase and remit the
The “substantial nexus” prong of this test is often the
amount collected to the taxing state. When sellers do not
collect and remit sales taxes, consumers in the taxing state
center of cases in which states have imposed sales and
are usually responsible for paying a use tax at the same rate.
use tax collection duties on out-of-state sellers.
Use taxes are taxes on goods or services for the use,
Sales and Use Tax Nexus Before South
storage, or consumption of goods or services in the taxing
Dakota v. Wayfair
state. As the Supreme Court observed in Wayfair, consumer
The Supreme Court has frequently stated that the
compliance with state use tax laws is “notoriously low,”
Commerce Clause’s substantial nexus requirement is
and the shift from in-person sales to online sales has led to
“closely related” to the Fourteenth Amendment’s Due
reductions in state revenues.
Process Clause nexus requirement that there must be “some
Commerce Clause
definite link, some minimum connection, between a state
and the person, property or transaction it seeks” to subject
The U.S. Constitution’s Commerce Clause is an affirmative
to a tax or a tax obligation. Until the Supreme Court’s 1992
grant of authority to Congress to regulate interstate
decision in Quill Corp. v. North Dakota, courts generally
commerce. The Supreme Court has interpreted the
regarded state laws imposing sales and use tax obligations
https://crsreports.congress.gov

State Sales and Use Tax Nexus After South Dakota v. Wayfair
on sellers without a physical presence in the taxing state as
whether or not Quill’s physical presence rule is
barred by the Due Process Clause and the Commerce
satisfied.
Clause. Before Quill, the Supreme Court had not explained
precisely how the Due Process Clause is analytically
The Court concluded that the physical presence rule was an
“unsound
distinct from the Commerce Clause in sales and use tax
and incorrect” interpretation of the Commerce
cases. Then, in Quill, the Court explained that Due Process
Clause and that physical presence was unnecessary to
Clause challenges require courts to ask if the out-of-state
satisfy Complete Auto’s substantial nexus prong.
seller has the minimum contacts with the taxing state
necessary to legitimate the state’s exercise of power over
The Court explained in Wayfair that the purpose of the
the seller. The primary concern is whether the imposition of
Commerce Clause is to prevent economic discrimination,
the tax on the out-of-state seller satisfies the “traditional
not create “market distortions,” and that the effect of Quill
notions of fair play and substantial justice.” Thus, the Due
was “a judicially created tax shelter for businesses that limit
Process Clause’s minimum contacts requirement serves as a
their physical presence.” Remote businesses were at a
competitive advantage because they could avoid regulatory
proxy for “notice” or “fair warning” to out-of-state sellers.
burdens and sell goods and services at lower prices. The
Even though the remote seller in Quill was a mail-order
Court observed that modern e-commerce and the ability of
business, the Court ruled that the Due Process Clause did
out-of-state sellers to maintain a “continuous and pervasive
not bar enforcement of North Dakota’s use tax collection
virtual presence” in a taxing state only exacerbated the
obligations. The Court reasoned that “modern commercial
problem. In Quill, the Court focused on the benefits of
life” warranted a different outcome. At the time of Quill,
bright-line rules and was concerned about the
businesses no longer needed to have a physical presence in
administrative costs arising from nationwide sales tax
the taxing state in order to conduct business across state
compliance. Nearly 30 years later, the Court reasoned in
lines. The Court explained that out-of-state sellers operating
Wayfair that the physical presence rule was a “poor proxy
for compliance costs”
exclusively through mail and wire communications should
faced by interstate businesses and
have fair warning that they might be subject to a taxing
predicted that the burden of nationwide sales tax collection
state’s jurisdiction when they are “engaged in continuous
could be reduced by software available at a reasonable cost.
and widespread solicitation within” the taxing state. The
Court held that the Due Process Clause did not bar
Thus, for purposes of the sales and use tax substantial nexus
enforcement because the seller had “purposefully directed
analysis under the Commerce Clause, the Court in Wayfair
its activities” at the state’s residents, “the magnitude of [the
replaced the physical presence rule with an economic nexus
seller’s] contacts” were “more than sufficient” for due
rule. It held that substantial nexus is established when a
remote seller has “availed itself of the sub
process, and the state’s use tax was “related to the benefits”
stantial privilege
of carrying on business” in the taxing state. The Court held
the seller received from state access.
that the South Dakota law at issue satisfied this test because
The Court then examined the Commerce Clause, explaining
(1) the law only applied to sellers who, on an annual basis,
“deliver more than $100,000 of goods or services int
that the Commerce Clause’s substantial nexus requirement
o
is concerned with the effects of a state sales or use tax on
South Dakota or engage in 200 or more separate
transactions for the delivery of goods and services into”
the national economy. It is a means to limit state
interference with interstate commerce. For Commerce
South Dakota; and (2) the remote sellers were large national
online retailers that maintained an “extensive virtual
Clause purposes, the Court expressed support for the bright-
presence.”
line physical presence rule because it “firmly establishe[d]

the boundaries of legitimate state authority to impose a duty
to collect sales and use taxes and reduce[d] litigation
The Court acknowledged in Wayfair that the burden of
nationwide sales tax collection “
concerning those taxes.” The Court reasoned that the
may pose legitimate
bright-line rule fostered business and individual investment
concerns,” particularly for small businesses making a few
sales across many states. It noted that “Congress may
by providing clarity and settling expectations.
legislate to address these problems .” However, the Court
South Dakota v. Wayfair
also concluded that the South Dakota law provided these
In South Dakota v. Wayfair, Inc., the Supreme Court
small businesses with a “reasonable degree of protection”
overruled the physical presence rule set forth in Quill. Thus,
as (1) the law included a safe harbor limiting its application
a business need not have a physical presence in a taxing
to businesses that did considerable business in South
state in order for the state to impose a duty on the business
Dakota; (2) the law was not retroactive; and (3) South
to collect and remit sales and use taxes. The Court
Dakota was a party to the Streamlined Sales and Use Tax
Agreement that more than 20 states had joined, which
determined
“standardizes taxes to reduce administrative and
[t]he reasons given in Quill for rejecting the
compliance costs.” The Court stated that these features of
physical presence rule for due process purposes
the South Dakota tax system “appear[ed] designed to
prevent discrimination against or undue burdens upon
apply as well to the question whether physical
interstate commerce.” Still, because the Commerce
presence is a requisite for an out-of-state seller’s
Clause’s substantial nexus requirement was the only
liability to remit sales taxes. Other aspects of the
Court’s doctrine can better and more accurately
Commerce Clause issue before the Court in Wayfair, the
Court underscored that another “principle in the Court’s
address potential burdens on interstate commerce,
Commerce Clause doctrine might invalidate” the law.
https://crsreports.congress.gov

State Sales and Use Tax Nexus A fter South Dakota v. Wayfair

IF11832
Milan N. Ball, Legislative Attorney

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