You had to get up pretty early to get admitted to last week’s Supreme Court hearing on the Wayfair case. “I was on line at 4:53 a.m.,” said Jamie Yesnowitz, principal and SALT National Tax Office leader at Grant Thornton.

At issue was the Supreme Court’s 1992 decision in Quill, which established the physical presence test for sales and use tax nexus. It concluded that a state could not require an out-of-state seller to collect sales tax on a sale to a resident of the state. That was before the surge of online sales, and states have been trying since then to find constitutional ways to collect tax revenue from remote sellers into their state.

In 2016, South Dakota enacted legislation that was clearly unconstitutional by Quill standards, implementing an economic nexus test that requires remote sellers without a physical presence in the state to collect sales tax if certain gross revenue or transaction thresholds were met—more than $100,000 of goods sold or 200 transactions. The state court held the legislation to be unconstitutional, and the U.S. Supreme Court granted South Dakota’s petition for a writ of certiorari (asking for a rehearing).

Despite the prevailing opinion beforehand, “Wayfair had a good day,” said Yesnowitz. “South Dakota made the argument that a state could subject a remote seller to collect tax even if they had only one sale in the state, despite the conditions in their statute for $100,000 in sales or 200 transactions. Within the first minute, Justice Sotomayor strongly criticized the South Dakota position. She said that Quill was not the problem, but that the states do not have an adequate mechanism.”

Justices Alito and Roberts also appeared to favor Wayfair, while Kagan and Breyer seemed to be on the fence, according to Yesnowitz.

“Based on what we’ve seen in the past, and what we saw at the hearing, four justices are inclined to vote for South Dakota, three for Wayfair, and two are undecided. It could be close either way,” he said. “The court could say simply that South Dakota’s legislation is good, or that Quill is gone. Or it could set its own standards in this area and evaluate the South Dakota legislation in terms of its own standard. As a final alternative, the court could say the legislation is bad because it’s up to Congress to decide the question.”

Yesnowitz doesn’t expect the court to speak with one voice on the issue. “Courts have been very divided on this issue; it doesn’t fall neatly within political lines,” he said. “As a result, there may be a lot of concurring opinions and dissents.”

Turning to Congress?

Kirsten Gulotta, tax managing director at Deloitte Tax, was surprised by the dialogue at the oral argument: “A lot of people thought that because the Supreme Court decided to hear the case, it was clear that Quill would be overturned. But it’s not that clear now.”

The question of applying any decision retroactively is an important issue, she noted. “Thirty-eight states indicated they would disallow retroactivity, and 45 state attorney generals indicated they saw constitutional issues with retroactivity. However, various state departments of revenue suggested otherwise. Those are uncertainties, especially given the dialogue as to retroactivity being permitted.”

The cost of compliance with any new nexus standard was a concern, Gulotta observed. “The range was between $12 and a quarter of a million dollars,” she said.

Gulotta noted the discussion regarding the possibility of Congress acting on the matter: “If Congress acts, did they hold off on acting in anticipation of Quill being overturned?”

And Justice Alito noted, “As things stand now, it seems that both the states and internet retailers have an incentive to ask for a congressional solution to this problem … but if Quill is overruled, what incentives do the states have to ask for any kind of congressional legislation?”

“There was also a discussion as to whether Wayfair should be decided based on stare decisis,” [following precedent] Gulotta said. “Some of the largest retailers have a physical presence in all states, so do we really want to change this even if it’s wrong, based on reliance on it in the past?”

Analyzing the dialogue

The tenor of questions asked by the justices doesn’t always indicate the way they’re leaning, Gulotta cautioned. “Some of them may have asked questions not for their own purposes but because they wanted to ask a question that would be related to what they thought another justice’s concern might be.”

“Overall, the court’s questions suggest a group of justices with a lot of uncertainty about the magnitude and allocation of the benefits and burdens of the existing physical presence test versus the economic nexus standard under South Dakota’s enacted law,” said Clark Calhoun, a partner at Alston & Bird. “My impression was that for several justices, their uncertainty about the costs and benefits of replacing the physical presence standard with South Dakota’s new thresholds makes them very cautious about throwing out the status quo for a new test, especially when the state and federal government attorneys both contended that South Dakota’s threshold does not represent the constitutional minimum.”

“While some justices were dismissive of the taxpayers’ argument that the physical presence rule 'protects' smaller businesses, my impression was that most justices are reluctant to change the status quo, when it is far from clear that a ruling for South Dakota will resolve the debate, there are numerous uncertainties as to how states would apply a ruling in favor of South Dakota, and Congress has already been engaged in a debate of potential solutions,” he added.

“It’s hard to make any kind of prognostication, but it’s fair to say that South Dakota and its allies thought they would have a smooth path to winning, and it’s clear that the justices had a number of questions that showed significant skepticism about South Dakota’s position,” said Andrew Pincus, a partner at Mayer Brown. Pincus authored an amicus brief on behalf of eBay and 51 small businesses that in part sell through the eBay platform.

“Legislation involves negotiation and give and take, but as [Judiciary Committee] Chairman Goodlatte noted, if South Dakota thinks it can get total victory from the Supreme Court, it has no incentive to compromise. But if the Supreme Court closes the door, then the states have more incentive for negotiation leading to a legislative solution,” he said.

“If Quill is overturned, it obviates the possibility of Congress going ahead and acting because of the number of representatives from states that want Quill overturned,” Pincus continued. “South Dakota argued that if the Court were to rule in its favor and states overreached, Congress could act and protect small business. But there could be years of litigation, and in the meantime those businesses will have to comply or carry the risk that if they don’t win some federal protection, they will be liable for back taxes and penalties that will be crippling.”

Personalities on the court

“A petition to the Supreme Court needs four votes for the court to hear the case, and they got it,” Mike Bernard, chief tax officer of Transaction Tax at Vertex, and former tax counsel at Microsoft. “We saw why at the hearing. Some of the justices believe that Quill is still a good standard to apply, while others feel a new rule should be fashioned.”

“Sotomayor thinks the mechanism to collect is already in place – states that have a sales tax also have a use tax. Even though compliance is extremely low, she believes that’s not the court’s problem,” he explained. “Alito feels that the physical presence test is a bright line that can be followed easily, and he’s concerned about the retroactivity. And Kagan believes this is an issue that Congress ought to solve.

From their comments, Bernard would put Justices Kennedy, Gorsuch, Ginsburg and Thomas on the side of overturning Quill. That leaves Justice Breyer and Chief Justice Roberts as unknowns.

“I was rather surprised that the case dealt more with policy than the law,” he said. “There are currently four cases sitting in state courts — Alabama, Tennessee, Wyoming and Indiana — that are waiting on Wayfair.

“In the tax community, many wonder if physical presence is upheld, will there be a better opportunity to work with Congress to fashion a different rule?” he noted. “At least one state administrator believes it won’t be easy, because Congress will come out with its own set of rules. Over the past 25 years, Congress hasn’t been responsive to state departments of revenue.”

The U.S. Supreme Court building on Capitol Hill in Washington, D.C.
The U.S. Supreme Court building on Capitol Hill in Washington, D.C. Al Drago/Bloomberg

The vote will be close, and will have huge implications, according to Natalie Kotlyar, national leader of the retail & consumer products practice at BDO, and Katherine Gauntt, a sales & use tax senior manager at the firm.

Taxpayers who may be affected should plan ahead against the possibility of something being passed by the states or Congress, they warned.

“Congress has had quite a few bills before it,” observed Gauntt. “The Streamlined Sales Tax Project originally was intended for the states to come to the table and work out the complexity, but the largest states never participated.”

“The ta-related issue may not be completely resolved even if the court overturns Quill,” said Harley Duncan, leader of the State and Local Tax Group of the Washington National Tax Practice of KPMG LLP. “Retailers and the states also need to keep an eye on any congressional efforts to move forward legislation regarding online commerce.”

“If the court overturns Quill, there could be a complete lack of uniformity among the states on what constitutes nexus, which will leave retailers with no clear guidance on their sales tax collection responsibilities,” Duncan said. “Congress might decide to step in and consider a national standard for economic nexus to help address that situation.”

“The justices asked hard questions, but South Dakota made the hard request,” added Scott Peterson, vice president of U.S. tax policy & government relations at Avalara, and former executive director of Streamlined Sales Tax.

“The status quo is easy to defend,” he said. “The justices are being asked to overturn 51 years of history. I don’t understand South Dakota’s spokesperson not answering ‘zero’ to how much it will cost if South Dakota were to prevail. Streamlined Sales Tax guidelines allow businesses to use a certified service provider, including Avalara, for free, and SST pays the CSPs for this service.”

“If SCOTUS doesn’t side with South Dakota, every state will likely go the way of Colorado’s use tax reporting law, under which departments of revenue will try to collect use tax from residents based on lists supplied by retailers,” he said. “If I were a retailer right now, I’d be looking at how Colorado collects use tax from consumers. I’d be looking at what could happen if either Wayfair or South Dakota prevails, and consult with my CPA to determine next steps for becoming compliant as states pass their own legislation, with or without a federal guideline from SCOTUS.”

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