Continuing trends in state tax litigation: nexus and challenging state tax laws in federal courts.

• Author: Harris, Brian R.
• Position: Tax Law

Sales and use tax nexus remains one of the hot topics in state tax litigation. The jurisprudence in this area traces back to a trilogy of U.S. Supreme Court cases--National Bellas Hess, Inc. v. Dept. of Revenue of Ill., 386 U.S. 753 (1967); Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977); and Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Bellas Hess struck down a state's attempt to require that an out-of-state mail order seller, whose only connection with the taxing state was shipping goods into the state by U.S. Mail, collect and remit use tax to the state. (1) The Court found that such a requirement would be a burden on interstate commerce and violate the Commerce Clause. (2) The use of the Commerce Clause in this manner is called the dormant or negative Commerce Clause.

As the Court noted in Bellas Hess, even in 1965, there were more than 2,300 localities (e.g., states, municipalities, school districts, political subdivisions, etc.) that could potentially impose sales taxes. (3) Even just determining the tax rate that applied to a particular sale could be a difficult endeavor, but the out-of-state seller would also have to comply with the applicable rules for filing tax returns and remitting taxes, something that could also vary from locality to locality. As an out-of-state seller made sales into more localities, its compliance burden would increase. The burden would be even greater for an out-of-state seller who sold into a large number of localities, but that only made a small number of sales in any one locality.

Complete Auto provided some additional guidance for determining whether a tax is permissible under the Commerce Clause. The tax must 1) be applied to an activity with a substantial nexus with the taxing state; 2) be fairly apportioned; 3) not discriminate against interstate commerce; and 4) be fairly related to the services provided by the state. (4) The taxpayer in Complete Auto had challenged a state tax on the "privilege of doing business" in the state on the ground that such a tax may not be applied to an activity that is part of interstate commerce. (5) In contrast to Bellas Hess, the taxpayer in Complete Auto was physically delivering goods into the state using its own trucks. (6) The Court upheld the tax and found that it did not violate the Commerce Clause. (7)

Quill clarified the interplay between the Due Process Clause and the Commerce Clause when evaluating the constitutionality of applying state taxing statutes to out-of-state sellers. Such taxes must pass muster under both the Due Process Clause and the Commerce Clause. (8) The due process analysis focuses on whether the seller has the "minimum contacts" with the jurisdiction. This is the same due process analysis that is described in International Shoe Co. v. Washington, 326 U.S. 310 (1945). (9) The Commerce Clause, however, requires more than just minimum contacts in order to impose a tax collection burden on a remote seller. Specifically, and among other things, it requires the "substantial nexus" described in the Complete Auto test. (10) At least with respect to sales tax, though not with respect to state income taxes, substantial nexus is a physical presence. (11)

While these three cases seemingly provide a bright-line test for nexus, there nevertheless continues to be significant litigation in this area. This is partly driven by emergent issues, such as click-through nexus and others, but it is also because departments of revenue continue to be aggressive in trying to find nexus and impose taxes, as illustrated by a recent Florida appellate decision. (12) In American Business USA Corp. v. Department of Revenue, 151 So. 3d 67 (Fla. 4th DCA 2014), the court considered the constitutionality of the Florida Department of Revenue's assessment of sales tax on a Florida corporation's out-of-state sales.

American Business is a Florida corporation that initiated all of its sales online. (13) It sold flowers, gift baskets...