In the May/June 2018 edition of Tax Executive, TEI graciously published my article titled "Why Wayfair Won't Matter." Admittedly, the title was a bit deceiving, what millennials disparagingly refer to as "clickbait." Contrary to the title's suggestion, I did not argue that the palpable buzz around Wayfair was unwarranted. Instead, I played it safe: I posited that no matter the outcome of Wayfair, which was still some weeks in the future, the state tax community would continue to light over the "substantial nexus" prong of Complete Auto for years to come--an argument not nearly as radical as the one suggested by the title. Consider this article my mea culpa, and rest assured that it delivers on (or at least earnestly pursues) the promise of its title.
As I write this, now eighteen months removed from the Court's decision in Wayfair, it may be too soon to tell whether my seemingly safe prediction was correct. Forced to pass judgment today, I'd consider the possibility that my prediction could very well be wrong. There is no active litigation challenging the application of Wayfair, state legislatures are not (for the most part) debating whether to follow South Dakota's lead, and the nexus debates that dominated the state tax community have quieted down. But be patient. A close examination of Wayfair suggests that the Court's decision will play a central role in future litigation, perhaps in ways none of us anticipate.
Quill Is Dead. But What Has Replaced It?
On June 21, 2018, the United States Supreme Court announced its decision in South Dakota v. Wayfair Inc. et al. (1) By a five-to-four vote, the Court: 1) overruled Quill's physical presence rule and 2) held that South Dakota Senate Bill 106--as applied to Wayfair Inc.--satisfied the "substantial nexus" prong of Complete Auto. (2) This section briefly highlights the Court's reasoning so as to set the stage for our exploration into the unknown: the future of litigation around the "substantial nexus" prong of Complete Auto.
PHYSICAL PRESENCE: 'UNSOUND,' 'INCORRECT,' AND 'OVERRULED'
The Court's decision in Wayfair begins by describing the Court's longstanding role as the adjudicator of Commerce Clause disputes for nearly two centuries, from Gibbons v. Ogden (3) to Granholm v. Heald. (4) The Court describes its role as ensuring the "necessary balance between state and federal power." (5) On the one hand, Congress has broad authority to regulate interstate commerce. On the other, when Congress does not act, states can, in certain circumstances, regulate interstate commerce. Accordingly, "the power to regulate commerce in some circumstances [is] held by the States and Congress concurrently." (6)
The Court's historical discussion in Wayfair lays the foundation for its overruling of Quill. After explaining that the federal government and state governments share the power to regulate interstate commerce, the Court recounts its role in balancing state sovereignty and the inherent power to tax against the need to promote a national economy premised on free trade and cross-border commerce. Of course, Congress has the primary authority to regulate this sphere--but when it does not act, states can exercise their taxing power to the extent that doing so does not violate the four prongs of Complete Auto. (7) But, the Court notes, the physical presence rule did not originate through this federalism-driven process. Rather, the Court itself adopted the physical presence rule as a limit on state power because, at the time, the Court believed the rule was needed to protect interstate commerce from undue burdens imposed by various state tax laws.
In the Court's view, times have changed since Bellas Hess (1967) and Quill (1992), in that with the rise of the internet, the physical presence rule no longer fulfills its intended purpose. For example, the Court emphasizes that "[i]n 1992, less than 2 percent of Americans had Internet access. Today that number is about 89 percent." (8) This increase reflects the extent to which the "Internet's prevalence and power have changed the dynamics of the national economy." (9) Today, "buyers are closer to most major retailers than ever before--regardless of how close or far the nearest storefront." (10) This closeness is created through "targeted advertising and instant access to most consumers via any internet-enabled device," and results in a "virtual showroom [that] can show far more inventory, in far more detail, and with greater opportunities for consumer and seller interaction than might be possible for local stores." (11) The physical presence rule renders these contacts "simply irrelevant," and the Court "should not maintain a rule that ignores these substantial virtual connections to the State." (12)
In striking down the physical presence rule, the Court's decision provided general comments regarding bright-line rules generally and their proper role in constitutional interpretation. The Court expressly acknowledged that its modern Commerce Clause jurisprudence "eschew[s] formalism for a sensitive, case-by-case analysis of purpose and effects." (13) But the physical presence rule embodies the formalism the Court disavows by "treat[ing] economically identical actors differently, and for arbitrary reasons." (14) The physical presence rule--like every other bright-line rule--necessarily applies to taxpayers detached from "functional, marketplace dynamics." (15) The Court abandoned bright-line rules in other areas of its Commerce Clause jurisprudence, and it saw no reason not to do so here--particularly when the bright-line rule is outdated and detached from modern economic realities.
The Court noted that the disconnect between the physical presence rule and the modern economy is not harmless; indeed, it creates "an extraordinary imposition by the Judiciary on the States' authority to collect taxes and perform public functions." (16) It infringes on the sovereignty of the states, particularly with respect to their "reasonable choices in enacting their tax systems." (17) The physical presence rule "in effect... has come to serve as a judicially created tax shelter" for remote sellers and their customers. (18) It is fundamentally unfair to the states "that seek fair enforcement of the sales tax, a tax many States for many years have considered an indispensable source for raising revenue." (19) And according to the Court, "[i]f it becomes apparent that the Court's Commerce Clause decisions prohibit the States from exercising their lawful sovereign powers in our federal system, the Court should be vigilant in correcting the error." (20) In some respects, the Court's repudiation of the physical presence rule reflects its...