The state tax community is in familiar territory before the Supreme Court of the United States. (1) We are in far less familiar territory, however, having captured the attention of nontax professionals, academics, the American public, and even the president of the United States. (2) The eyes of the nation are fixed on South Dakota v. Wayfair. (3) To some new followers, Wayfair merely raises questions about purchases made over the internet. It may also--heaven forbid--impose seemingly new taxes on purchases made on eBay and Amazon.
But we know better. We know Wayfairs origin dates to (at least) 1967--and that use tax has been due on internet purchases all along. So, to the state tax community, Wayfair means so much more. For over fifty years, states and businesses have struggled to understand when a "substantial nexus" exists between a state and a taxpayer, (4) leading to the unavoidable debate over two words: physical presence. The debate is best understood by asking two questions: what creates physical presence (an employee attending a tradeshow?) and who must be physically present (the taxpayer itself, or only a person with whom the taxpayer has a business relationship?). The Supreme Courts final word on nexus for sales and use taxes came in 1992, leaving state judiciaries as the primary arbiters when states and businesses have disagreed for the past twenty-five years. Naturally, state judiciaries have resolved identical questions with contradictory answers, creating ambiguity, uncertainty, and unpredictability. These issues were (and continue to be) exacerbated by the evolution of technology and its impact on the national economy.
Wayfair represents the culmination of this fifty-year debate by presenting the Court with a binary choice: affirm or reject the physical presence rule. The Court's having to make that choice-regardless of the option it chooses--stirs feelings of anticipation and hope. To many, Wayfair is good reason to hope for clarity in a landscape riddled with uncertainty. That hope is bolstered by the prospect of the Court clarifying not only questions dating to 1967 but also questions stemming from the growth of the internet and online shopping.
But is this hope misguided? Evidence suggests that it is--that whether the Court "kills Quill" or gives it new life, clarity will remain elusive. No matter the Court's decision, the substantial nexus debate will revolve around the same what and who questions. If Quill's physical presence is reaffirmed, state courts will continue to confront those questions through the lens of physical presence. And if Quill's physical presence rule is retired, state courts will ask the same questions, but through the lens of "economic nexus."
Oliver Wendell Holmes Jr. believed that "a page of history is worth a volume of logic." (5) This article takes Holmes' wisdom to heart and, by reviewing our history and experience in the nexus arena, demonstrates that the what and who questions will continue to dominate the nexus debate, regardless of the Court's decision in Wayfair.
From Bellas Hess to Wayfair
To the uninitiated, Wayfair appears to be solely a referendum on the physical presence rule affirmed by the Court in Quill v. North Dakota. (6) However, Wayfair is properly framed not by reference to a single case, but by the Court's jurisprudence dating to the nineteenth century. (7) In 1967, the Court synthesized its jurisprudence in National Bellas Hess v. Illinois. (8) The Bellas Hess Court held that a "substantial nexus" between a state and taxpayer exists when an out-of-state retailer is physically present in the state. Accordingly, without a substantial nexus, a state cannot require an out-of-state seller to collect and remit use tax for sales to in-state purchasers. (9)
In 1992, the Court was presented with an opportunity to overturn the physical presence rule in Quill v. North Dakota. (10) Quill Corporation, a Delaware-based corporation with offices in California, Illinois, and Georgia, sold office equipment and supplies to customers across the United States. To generate sales, Quill mailed catalogs and flyers to existing and potential customers, advertised in national periodicals, and engaged in phone solicitation. But it did so exclusively from business locations and warehouses outside North Dakota. Quill was "physically present" only in California, Illinois, and Georgia--where its employees, offices, and warehouses were located. Nevertheless, North Dakota asserted that it had the authority to impose a use tax collection obligation on Quill. Under state law, there was little question that it had that authority: the legislature amended its law to impose a use tax collection obligation if a retailer engaged in "regular or systematic solicitation of a consumer market in [North Dakota]." (11) The Department of Revenue adopted an administrative regulation interpreting "regular or systematic solicitation" to include three or more advertisements within a twelve-month period. (12) But under the Court's decision in Bellas Hess, North Dakota could impose on Quill an obligation to collect use tax only if Quill was physically present in the state.
In state court, North Dakota argued that its law still met the constitutional requirement for a substantial nexus, although its law did not comply with the Bellas Hess' physical presence rule. The North Dakota Supreme Court agreed, emphasizing that "wholesale changes in both the economy and the law made it inappropriate to follow Bellas Hess... '' (13) Specifically, the North Dakota Supreme Court noted the growth of the mail-order business from a "relatively inconsequential market niche" in 1967 to "a goliath" with annual sales reaching the "staggering figure" of $183.3 billion in 1989. (14)
The Supreme Court of the United States disagreed that these changes necessitated the death of the physical presence rule. But its disagreement lacked the vigor typical of its decisions that reject blatant state efforts to rescind precedent. In fact, the Court even acknowledged that the physical presence rule "appears artificial at its edges: whether or not a State may compel a vendor to collect a sales or use tax may turn on the presence in the taxing State of a small sales force, plant, or office." Nevertheless, the rule "firmly establishes the boundaries of legitimate state authority," "encourages settled expectations and, in doing so, fosters investment by businesses and individuals," and "reduces litigation concerning those taxes." (15) These benefits, the Court held, supported reaffirming Bellas Hess and the physical presence rule.
Quill spurred states to tirelessly pursue new ways to abrogate the physical presence rule. From "attributional nexus" (16) to "click-through nexus," (17) states have asserted aggressive theories of nexus, with varying degrees of success. For the most part, those theories accepted Quil's holding that the physical presence rule limits their jurisdiction to tax.
States' begrudging acceptance of Quill is over. Now, states enact "economic nexus" laws in direct conflict with Bellas Hess and Quil's physical presence rule--and make no bones about their disregard for precedent. This brings us to Wayfair, which represents the culmination of state efforts to abrogate physical presence in favor of economic indicia to define their jurisdiction to tax. On March 22, 2016, the South Dakota legislature enacted S.B. 106, requiring a remote seller to collect and remit tax for sales made to South Dakota purchasers if its gross revenue exceeds $100,000 or, alternatively, it makes 200 or more separate transactions for delivery to South Dakota. (18) Admirably, the law prohibited the Department of Revenue from enforcing the economic nexus regime until the law was held constitutional by the Supreme Court of the United States.
To begin its journey to the Supreme Court of the United States, South Dakota filed a declaratory action against Wayfair, Newegg, Systemax, and Overstock.com. On September 13, 2017, the Supreme Court of South Dakota held that Quill prohibited South Dakota from enforcing its economic nexus provision. South Dakota subsequently filed a petition for a writ of certiorari with the Supreme Court of the United States, which was granted on January 12, 2018.
What Will the Court Do?
Predicting how nine justices will decide a case is a risky endeavor, one this article desperately avoids. Instead, this article--which was written after the oral arguments in Wayfair but before the Court issues a decision--undertakes a marginally less risky endeavor to predict the various ways in which the Court may decide the case.
First, the Court can choose to affirm the decision of the Supreme Court of South Dakota, effectively affirming the physical presence rule from Bellas Hess and Quill. It is easy to forget that Wayfair heads to the high court as the victor at every stage of litigation. (19) This is notable for several reasons. For one, it is not every day that we can commend state courts for correctly applying Supreme Court precedent. (20) Second, the majority of commentary since the Court granted cert focuses not on whether the Court will abandon Quill's physical presence rule, but how it will do so. Arguably, the Court's easiest route is to uphold the South Dakota Supreme Court's decision in favor of Wayfair, reaffirm Quill's physical presence rule, and punt the question back to Congress for a more comprehensive, policy-based resolution. It even has a template for doing so--consider the following excerpt from the Court's majority opinion in Quill:
[Affirming the physical presence rule] is made easier by the fact that the underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve. No matter how we evaluate the burdens that use taxes impose on interstate commerce, Congress remains free to disagree with our conclusions. Indeed, in recent...