The End of Physical Presence Nexus

On June 21, 2018, the Supreme Court of the United States issued its widely anticipated decision in South Dakota v. Wayfair, et al. No. 17-494. In a 5-4 decision, the Court held that the physical presence requirement for state sales and use tax jurisdiction is incorrect and not a requirement under the Commerce Clause of the U.S. Constitution.

Key Takeaways

  • The Court found that the physical presence rule has no relationship to compliance costs. The Court used the example of a retailer with one salesperson in each state compared to an Internet retailer with a central warehouse and 500 employees located in one state. The former retailer would have a physical presence and tax collection obligation in multiple states, while the latter would not.
  • Heavy emphasis was placed on the belief that Quill created market distortions and that they physical presence rule was arbitrary and formalistic. Echoing the arguments of many states (and traditional retailers), the Court viewed the physical presence rule as placing local businesses and interstate businesses with physical presence at a competitive disadvantage compared to internet retailers.
  • The court viewed the various state laws seeking to push the envelope of physical presence from “click-through nexus” to “cookie nexus” to use tax notice and reporting statutes as demonstrative examples of the difficulty in applying the physical presence rule (and illustrating that it is not clear or easy to apply and generates controversy and litigation).

What is the Impact?

The U.S. Supreme Court’s Wayfair decision is most likely the most significant U.S. Supreme Court decision on state taxation issued in the last 50 years. The decision will have wide-ranging implications for all businesses, not just internet retailers, as well as consumers, and state and local governments. The ruling now allows states to levy sales tax on purchases made through out-of-state online retailers, which could result in billions of dollars in additional taxes for big and small retailers alike. This will have a sweeping impact on the way companies handle sales tax, including what its filing requirements may be in every state where it has taxable sales and how to manage the compliance process.  It is now up to state agencies to define what the presence threshold may be.  For example, in the Wayfair case, South Dakota put a $100k threshold on sales.  In that instance, where any out of state company has greater than $100k of sales into that state, that out-of-state company now has a sales tax collection requirement in that state.

There is still more to come in terms of effective dates and how each state will handle this.

If you have questions about how your company handles State and Local Tax or how the outcome of this court decision affects your business, please connect with us.

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