The Way Forward After Wayfair: Sorting Through the Constitutional Limits on State Sales and Use Taxes.

• Author: Carlson, Austin R.

1. INTRODUCTION 515 II. BACKGROUND 516 A. The Physical Presence Rule 516 B. Internet Retailers and the Court's Response in Wayfair 519 C. The Dormant Commerce Clause 521 D. The Due Process Clause 522 III. ANALYSIS 524 A. The Requirements of the Commerce and Due Process Clauses 524 B. Policies Coloring Taxation of Sales by Foreign Companies 527 1. The States' Need for Revenue 527 2. The Double-Tax Issue 528 3. The Compliance Burdens of Multi-State Taxation 528 4. The Importance of Protecting Small and Startup 529 Businesses IV. RECOMMENDATIONS 529 A. The Policy Debate: Should the States Attempt to Reach 530 Every Sale? B. General Adherence to the Commerce and Due Process Clauses 531 1. Adhering to the Dormant Commerce Clause 532 2. Adhering to the Due Process Clause 535 V. CONCLUSION 536 I. INTRODUCTION

   Arriving amid a field of groundbreaking and attention-catching decisions, the recent Supreme Court case South Dakota v. Wayfair, Inc. garnered little public attention relative to how important the decision was. The Court in Wayfair, over a four-justice dissent, eliminated the 50-year-old physical presence rule established in National Bellas Hess, Inc. v. Department of Revenue of Illinois. (1) This physical presence rule prevented states from requiring sellers to collect and remit state sales and use taxes unless those sellers had some kind of physical presence in-state. (2) In the absence of the physical presence rule, there is a noteworthy amount of uncertainty regarding the constitutional limits of a state's power to require purely out of state sellers to collect sales taxes. This Note's aim is to sort out some of this uncertainty.

   In Part II, this Note will examine the creation and development of the physical presence rule, outline and report some of the key language from South Dakota v. Wayfair, Inc., and evaluate the background requirements that the Dormant Commerce Clause and the Due Process Clause of the 14th Amendment place on state sales and use tax laws. Then, in Part III, this Note will lay out the restrictions on the states' power to require a seller to collect sales and use taxes for them in a more detailed fashion, first focusing on the constitutional restrictions and then evaluating the policy arguments surrounding sales and use taxation. Finally, in Part IV, this Note will present and attempt to answer the question of whether states ought to try to make their tax laws reach as many transactions as possible, then lay out what states should do to create their new tax laws within the bounds of these constitutional limits.

2. BACKGROUND

   1. The Physical Presence Rule

      A historian could trace the story of South Dakota v. Wayfair, Inc. back centuries before the actual ruling. one could begin the story with McCulloch v. Maryland, the Supreme Court's well-remembered early foray into the limits on the States' power to tax. (3) Another option is to begin this tale with the imperial crisis and the American Revolutionary War. (4) One could even choose to look back as far as Magna Carta. (5) However, the most direct starting point for this story, and the most appropriate for the limited scope of this Note, is the original pronouncement of the physical presence rule: the Supreme Court's decision in National Bellas Hess, Inc. v. Department of Revenue of Illinois.

      A brief restatement of the facts in Bellas Hess is useful to understand the origins of the physical presence rule. National Bellas Hess, Inc. was a mail order sales company, incorporated in Delaware, which maintained a single operation center in North Kansas City, Missouri. (6) The company was not licensed to do business in Illinois, maintained no property in Illinois, did not advertise its products through any business operations (such as newspapers, television or radio stations, or billboard lessors) in Illinois, and did not support any agents or employees in Illinois. (7) The only connection Bellas Hess had with Illinois was the company routinely sending its advertisements and catalogues to Illinois residents through the United States Postal Service or other common carriers (Bellas Hess filled their orders through the same distribution methods). (8)

      In Illinois, at the time, the use tax applied to all sellers which advertised in the state for the purposes of soliciting orders. (9) The law also allowed for service of process on and through the Illinois Secretary of State for tax claims brought against out-of-state sellers. (10) Illinois sued Bellas Hess under this law to require the company to collect use taxes on their sales to Illinois customers. (11) Bellas Hess in turn challenged the law on the basis that applying the tax against an out-of-state seller in their position violated the united States Constitution under the Commerce Clause of Article I, Section 8 and the Due Process Clause of the 14th Amendment. (12)

      The Supreme Court ruled in favor of Bellas Hess. (13) In doing so, the Court first noted that the Commerce Clause and Due Process Clause considerations limiting the states' power to tax are similar. (14) Specifically, the Court announced that the Commerce Clause prohibits a state from taxing interstate commerce unless the tax is "designed to make such commerce bear a fair share of the cost of the local government whose protection it enjoys." (15) Meanwhile, the Due Process Clause limits a state to only taxing interstate commerce if "the state has given anything for which it can ask return." (16)

      The Court further elaborated that "the Constitution requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax." (17) With these standards in mind, the Court noted there was a sharp distinction between foreign sellers employing agents or representatives in the taxing state or maintaining offices or warehouses in the taxing state and sellers who only interact with a state by advertising within the state. (18) Thus, the Court established that any state sales or use tax collection obligation applied to an interstate seller "who do[es] no more than communicate with customers in the State by mail or common carrier as part of a general interstate business" is a per se violation of the Commerce Clause. (19)

      In the years following the Supreme Court's ruling in Bellas Hess, various courts wrestled with the meaning of the physical presence rule. Perhaps most prominent among these rulings during this formative period was National Geographic Society v. California Board of Equalization. This case established that a company with multiple, distinct operations and offices in a state devoted to one operation--but not to a separate sales operation--would still be subject to sales and use taxation in that state. (20) Another important development was courts not applying the rule when an otherwise exclusively out-of-state company used its own delivery trucks to fulfill orders in the taxing state. (21) However, the physical presence rule was generally straightforward and easy to apply--if the seller had any physical connection with the taxing state, the rule had no effect. (22)

      Twenty-five years after the Court handed down its decision in Bellas Hess, the Court revisited the physical presence rule in Quill Corp. v. North Dakota. North Dakota sought to require an out-of-state mail-order seller with no agents or property in the state to collect and remit a use tax on goods sold in that state. (23) The seller relied only on common carriers to deliver its goods to customers in North Dakota. (24) The similarities between the facts of Bellas Hess and Quill are readily apparent; thus, Quill rose as a direct challenge to the continued application of the physical presence rule from Bellas Hess. (25) The North Dakota Supreme Court determined that the Bellas Hess rule was no longer correct in light of significant legal and societal changes. (26) Specifically, North Dakota pointed to the explosive growth of the mail-order business, the innovations of computer technology reducing compliance costs for businesses facing taxation in multiple states, the Court's ruling in Complete Auto Transit, Inc. v. Brady, and the change in due process analysis generally, no longer requiring a company's physical presence in a state before that state could exercise power over a company. (27)

      The United States Supreme Court, reviewing North Dakota's decision in Quill, first established that there is an essential difference between the constitutional analysis of a state tax under the Due Process Clause and the analysis under the Commerce Clause. (28) After doing this, the Court reconsidered Bellas Hess under each branch of the analysis individually. (29) First, the Court ruled that Bellas Hess was wrongly decided with regard to the Due Process Clause. (30) The Court pointed to the changes in due process analysis concerning personal jurisdiction over corporations which had developed since International Shoe Co. v. Washington to justify overruling Bellas Hess on this point. (31)

      The Court then went on to explain that despite the fact they overruled Bellas Hess on the due process question--and despite any changes to how the Commerce Clause analysis was conducted after Complete Auto--the physical presence rule would remain in effect for Commerce Clause purposes. (32)

   2. Internet Retailers and the Court's Response in Wayfair

      In the quarter century following the Court's decision in Quill, the country's economic landscape changed even more dramatically than it did in the years between Bellas Hess and Quill. This is primarily due to the enormous success and expansive reach of internet-based retailers. (33) These online sellers have the substantial advantage of reaching customers all over the country while maintaining incredibly few physical facilities relative to the amount of business they conduct. Because of the states' inability to tax internet sales, which were rapidly becoming a major element of the economy's retail sector...