Online sales taxes face high court test as states seek billions

Overstock.com has a small but unmistakable advantage for anyone looking to buy a three-cup Cuisinart Mini Prep Plus Food Processor for shipment to Germantown, Maryland: Purchasers don’t have to pay the 6 percent sales tax they’d owe at a local store.

That sort of discrepancy is at the heart of a multibillion-dollar U.S. Supreme Court case set for argument Tuesday. States and traditional retailers are asking the court to overturn a 26-year-old ruling that exempts many internet merchants from collecting billions of dollars in sales taxes. The 1992 decision says retailers can be forced to collect the tax only if they have a physical presence in a state, such as a store or warehouse.

“That rule doesn’t make sense anymore in today’s world of e-commerce,” said Deborah White, general counsel of the Retail Litigation Center, which represents the country’s largest merchants. “A retailer today can transact a significant amount of business in a state without ever being physically present in the state.”

A ruling for the states would put new pressure on internet retailers and marketplaces that don’t always collect taxes — including Overstock.com Inc., Wayfair Inc., Newegg Inc., EBay Inc., Etsy Inc. and thousands of smaller merchants.

The case will also affect e-commerce behemoth Amazon.com Inc., though less directly. The company now charges consumers in every state that imposes a sales tax, but only when selling products that come from its own inventory. About half of Amazon’s sales involve goods owned by third-party merchants, many of which don’t collect tax.

Broader taxing power would let state and local governments collect an extra $8 billion to $23 billion a year, according to various estimates. Forty-five states have a statewide sales tax.

Tax Disparities

Retailers fighting the states say they would be hit with heavy costs of complying with rules for thousands of products in thousands of cities, counties and even airports that serve as their own taxing jurisdictions. Overstock board member Jonathan Johnson says the available tax software only partially addresses the complexity.

"When you come to Overstock, I’ve got to know 12,000-plus tax jurisdictions," Johnson said. "And the more types of products I sell, the more difficult it is to map to the software that’s out there."

Maryland is one of the jurisdictions where Overstock doesn’t collect tax, including the $2.56 that would otherwise be due on the $42.63 Cuisinart food processor. Consumers must pay sales tax on the item at both the local Macy’s department store or on Amazon, which sells the appliance out of its own stock for $39.95, plus $2.40 in tax.

Amazon, which President Donald Trump accused of underpaying taxes, isn’t involved in the Supreme Court case.

Physically Present

The court showdown instead involves Wayfair, Overstock and Newegg, three retailers sued by South Dakota for not charging taxes to consumers there. Although all collect taxes in other parts of the country — 25 states for Wayfair, eight for Overstock and six for Newegg — they’ve been able to skirt South Dakota because they don’t have a physical presence there.

Under a 2016 law, South Dakota requires retailers with more than $100,000 in annual sales in the state to pay a 4.5 percent tax on purchases. The state enacted the measure with the explicit goal of overturning the 1992 Supreme Court ruling, known as Quill v. North Dakota.

The Quill ruling, involving a mail-order company, centered on the Constitution’s so-called dormant commerce clause, a judge-created legal doctrine that says states can’t unduly burden interstate commerce unless authorized by Congress.

Justice John Paul Stevens wrote for the court that the physical-presence requirement, despite its "artificiality," provided a clear standard for applying the dormant commerce clause. "Such a rule firmly establishes the boundaries of legitimate state authority to impose a duty to collect sales and use taxes and reduces litigation concerning those taxes."

Retroactivity Worries

South Dakota and its allies say "physical presence" is an increasingly elusive concept in the era of internet storefronts and smartphone apps. The state is urging the court to let sales taxes be imposed on companies with an "economic presence" in a state — a test South Dakota says its law would pass.

“This court’s outdated physical-presence rule now causes outsized harms to state treasuries and fundamental unfairness among retailers,” South Dakota argued in court papers. The state has the backing of the Trump administration.

Although South Dakota’s tax law applies only prospectively, critics say overruling Quill could open retailers to years of retroactive liability in other states.

“I think you’re going to see a flood not only of demands for ongoing tax collection but retroactive audits,” said Andy Pincus, a Washington lawyer who filed a brief on behalf of eBay and a group of small businesses that oppose the states.

In a court filing supporting South Dakota, more than 40 states said the retroactivity concern is overblown. The Colorado-led group said most states have safeguards to prevent retroactive application, or at least require advance notice. In addition, they said, the court can write a ruling that “applies prospectively only for all retailers and taxpayers.”

Skeptical Justices

The court’s decision to take up the case suggests that Quill may be on shaky ground. Three current justices — Clarence Thomas, Anthony Kennedy and Neil Gorsuch — have already expressed doubts about the precedent.

Kennedy said in 2015 that Quill had produced a “startling revenue shortfall” in many states, as well as “unfairness” to local retailers and their customers. Gorsuch, who recently marked his one-year anniversary as a justice, suggested skepticism about Quill as an appeals court judge.

And Thomas said in a 2007 case involving waste disposal that he would jettison the entire dormant commerce clause. It “has no basis in the Constitution and has proved unworkable in practice,” he wrote.

No matter what the court decides, Congress gets the final word — if lawmakers want it. Amazon and Overstock are among the companies that say they support a nationwide law addressing internet sales taxes that would relieve retailers from dealing with a patchwork of state measures.

But Congress also could have acted any time since 1992. Its inaction is why White and other opponents of the physical-presence rule say the court needs to step in.

"We have waited more than 25 years for Congress to act and they haven’t," White said.

The case is South Dakota v. Wayfair, 17-494.

Employees work at the Overstock.com Inc. distribution center in Salt Lake City, Utah.
Employees work at the Overstock.com Inc. distribution center in Salt Lake City, Utah, U.S. Photographer: Ken James/Bloomberg

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