Supreme Court Strikes Down Quill Physical Presence Rule

In a 5-4 decision, the United States Supreme Court eliminated the physical presence test that determined if a state can force a seller to collect its sales and/or use tax  In the case of South Dakota v. Wayfair, USSC Case No. 17-494 all of the Justices agreed that the physical presence test applied previously in the cases of National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U. S. 753, and Quill Corp. v. North Dakota, 504 U. S. 298 was inappropriate.  However, the four Justices making up the minority in the dissenting opinion argued that the physical presence rule should have remained in place due to the fact that entities have acted for years in reliance on that standard.

The Court had limited states to imposing sales and use tax collection responsibilities only on sellers that had a physical presence in the state in the National Bella Hess case.  Twenty five years after that case, the Court again agreed that physical presence was necessary in the Quill case.  Now, 26 years later, the Court, visiting the issue for the third time has reversed that position –and two of the five Justices in the majority had previously ruled for the opposite result in the Quill case.

The beginnings of this case actually can be traced back to Colorado’s tattletale use tax law and the challenge to it.  That case, discussed previously in this blog (see Colorado Law Requiring Out of State Sellers to Report on Colorado Customers Who May Owe Use Tax Upheld by Tenth Circuit) resulted in two concurring opinions, one in a U.S. Supreme Court case that held federal courts could rule on the validity of the law and the other in the Tenth Circuit case that decided Colorado’s rule did not violate the Quill requirements, that all but stated that Quill used an outdated standard. 

The Supreme Court concurring opinion was written by Justice Kennedy, while the Tenth Circuit concurrence was penned by now-Justice Gorsuch.  The state of South Dakota read those opinions as an open invitation to pass a law to get the Supreme Court to revisit and, hopefully overturn, the holding in Quill.

Under the South Dakota law, a party that either sells more than $100,000 into South Dakota or has more than 200 sales is required to collect the state’s sales tax.  The law’s specific omission of any need to show physical presence was, as the authors of the law knew, at odds with Quill.  The law was meant to draw the scrutiny of the Supreme Court and the Court took up the challenge.

Physical Presence Requirement for Substantial Nexus

Even in the Quill decision, the opinion noted that the physical presence test for sales tax collections was at odds with the requirements that the Court had developed generally to determine if a state can tax an activity that was outlined in Complete Auto Transit, Inc. v. Brady, 430 U. S. 274 (1977).

The Complete Auto tests, as described in the Wayfair majority opinion are as follows:

The Court will sustain a tax so long as it (1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides.

Outside of the sale tax context, substantial nexus has not required that the entity being taxed meet a physical presence test.  But due to the existing precedent, the Court in Quill found that such a presence was required to meet the nexus requirement in Complete Auto.

The new opinion rejects that view.  The Quill court worried that subjecting an entity without physical presence to sales tax collection might be an excessive burden on interstate commerce.  However, in the Wayfair opinion the Court did not find a reasonable link between a mere physical presence and the burden on interstate commerce.

In the current ruling, the majority states:

But the administrative costs of compliance, especially in the modern economy with its Internet technology, are largely unrelated to whether a company happens to have a physical presence in a State. For example, a business with one salesperson in each State must collect sales taxes in every jurisdiction in which goods are delivered; but a business with 500 salespersons in one central location and a website accessible in every State need not collect sales taxes on otherwise identical nationwide sales. In other words, under Quill, a small company with diverse physical presence might be equally or more burdened by compliance costs than a large remote seller. The physical presence rule is a poor proxy for the compliance costs faced by companies that do business in multiple States.

The opinion goes on to lay out an example of what the majority sees as the arbitrary nature of the physical presence test which it finds must be eliminated:

Consider, for example, two businesses that sell furniture online. The first stocks a few items of inventory in a small warehouse in North Sioux City, South Dakota. The second uses a major warehouse just across the border in South Sioux City, Nebraska, and maintains a sophisticated website with a virtual showroom accessible in every State, including South Dakota. By reason of its physical presence, the first business must collect and remit a tax on all of its sales to customers from South Dakota, even those sales that have nothing to do with the warehouse. See National Geographic, 430 U. S., at 561; Scripto, Inc., 362 U. S., at 211–212. But, under Quill, the second, hypothetical seller cannot be subject to the same tax for the sales of the same items made through a pervasive Internet presence. This distinction simply makes no sense.

The opinion also touches on the lengths to which the concept of “physical presence” can be taken—making a reference to the “cookie nexus” concept that has been adopted by Massachusetts and Ohio.

For example, a company with a website accessible in South Dakota may be said to have a physical presence in the State via the customers’ computers. A website may leave cookies saved to the customers’ hard drives, or customers may download the company’s app onto their phones. Or a company may lease data storage that is permanently, or even occasionally, located in South Dakota. Cf. United States v. Microsoft Corp., 584 U. S. ___ (2018) (per curiam). What may have seemed like a “clear,” “bright-line tes[t]” when Quill was written now threatens to compound the arbitrary consequences that should have been apparent from the outset. 504 U. S., at 315.

The opinion later specifically notes the lengths states have gone to in the search for a Quill physical presence, rendering the test far less than the obvious bright line test:

Attempts to apply the physical presence rule to online retail sales are proving unworkable. States are already confronting the complexities of defining physical presence in the Cyber Age. For example, Massachusetts proposed a regulation that would have defined physical presence to include making apps available to be downloaded by in-state residents and placing cookies on in-state residents’ web browsers. See 830 Code Mass. Regs. 64H.1.7 (2017). Ohio recently adopted a similar standard. See Ohio Rev. Code Ann. §5741.01(I)(2)(i) (Lexis Supp. 2018). Some States have enacted so-called “click through” nexus statutes, which define nexus to include out-of-state sellers that contract with in-state residents who refer customers for compensation. See e.g., N. Y. Tax Law Ann. §1101(b)(8)(vi) (West 2017); Brief for Tax Foundation as Amicus Curiae 20–22 (listing 21 States with similar statutes).

The majority concludes that this requirement is also no longer even a practical test based on reliance on a flawed, but clear, standard, holding:

Reliance interests are a legitimate consideration when the Court weighs adherence to an earlier but flawed precedent. See Kimble v. Marvel Entertainment, LLC, 576 U. S. ___, ___–___ (2015) (slip op., at 9–10). But even on its own terms, the physical presence rule as defined by Quill is no longer a clear or easily applicable standard, so arguments for reliance based on its clarity are misplaced.

Impact of the Internet

The majority also finds that today’s marketplace is very different from the one in place when Quill was decided in 1992.

The Quill Court did not have before it the present realities of the interstate marketplace. In 1992, less than 2 percent of Americans had Internet access. See Brief for Retail Litigation Center, Inc., et al. as Amici Curiae 11, and n. 10. Today that number is about 89 percent. Ibid., and n. 11. When it decided Quill, the Court could not have envisioned a world in which the world’s largest retailer would be a remote seller, S. Li, Amazon Overtakes Wal-Mart as Biggest Retailer, L. A. Times, July 24, 2015, (all Internet materials as last visited June 18, 2018).

This new factor in the economy is large as the majority notes:

The Internet’s prevalence and power have changed the dynamics of the national economy. In 1992, mail-order sales in the United States totaled $180 billion. 504 U. S., at 329 (opinion of White, J.). Last year, e-commerce retail sales alone were estimated at $453.5 billion. Dept. of Commerce, U. S. Census Bureau News, Quarterly RetailE-Commerce Sales: 4th Quarter 2017 (CB18–21, Feb. 16, 2018). Combined with traditional remote sellers, the total exceeds half a trillion dollars. Sales Taxes Report, at 9. Since the Department of Commerce first began tracking e-commerce sales, those sales have increased tenfold from 0.8 percent to 8.9 percent of total retail sales in the United States. Compare Dept. of Commerce, U. S. Census Bureau, Retail E-Commerce Sales in Fourth Quarter 2000 (CB01–28, Feb. 16, 2001),, with U. S. Census Bureau News, Quarterly Retail E-Commerce Sales: 4th Quarter 2017.And it is likely that this percentage will increase. Last year, e-commerce grew at four times the rate of traditional retail, and it shows no sign of any slower pace. See ibid.

Under this system, states are losing out on large amounts of taxes that are clearly due, but are never collected:

This expansion has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes. In 1992, it was estimated that the States were losing between $694 million and $3 billion per year in sales tax revenues as a result of the physical presence rule. Brief for Law Professors et al. as Amici Curiae 11, n. 7. Now estimates range from $8 to $33 billion. Sales Taxes Report, at 11–12; Brief for Petitioner 34–35. The South Dakota Legislature has declared an emergency, S. B. 106, §9, which again demonstrates urgency of overturning the physical presence rule.

Granting an Unfair Advantage and Encouraging Tax Evasion

The majority also noted that the current system gives a large advantage to businesses that are not required to collect sales taxes.  While their customers are almost always supposed to voluntarily remit sales taxes, very little is actually collected based on voluntary payment of use taxes by citizens.

As Justice Gorsuch states in his concurring opinion:

Our dormant commerce cases usually prevent States from discriminating between in-state and out-of-state firms. National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U. S. 753 (1967), and Quill Corp. v. North Dakota, 504 U. S. 298 (1992), do just the opposite. For years they have enforced a judicially created tax break for out-of-state Internet and mail-order firms at the expense of in-state brick-and-mortar rivals. See ante, at 12–13; Direct Marketing Assn. v. Brohl, 814 F. 3d, 1129, 1150 (CA10 2016) (Gorsuch, J. concurring). As Justice White recognized 26 years ago, judges have no authority to construct a discriminatory “tax shelter” like this. Quill, supra, at 329 (opinion concurring in part and dissenting in part).

The majority opinion notes one the defendants in this case effectively encourages its customers to shirk their use tax payment responsibilities, noting:

In essence, respondents ask this Court to retain a rule that allows their customers to escape payment of sales taxes—taxes that are essential to create and secure the active market they supply with goods and services. An example may suffice. Wayfair offers to sell a vast selection of furnishings. Its advertising seeks to create an image of beautiful, peaceful homes, but it also says that “‘[o]ne ofthe best things about buying through Wayfair is that we do not have to charge sales tax.’” Brief for Petitioner 55. What Wayfair ignores in its subtle offer to assist in tax evasion is that creating a dream home assumes solvent state and local governments. State taxes fund the police and fire departments that protect the homes containing their customers’ furniture and ensure goods are safely delivered; maintain the public roads and municipal services that allow communication with and access to customers; support the “sound local banking institutions to support credit transactions [and] courts to ensure collection of the purchase price,” Quill, 504 U. S., at 328 (opinion of White, J.); and help create the “climate of consumer confidence” that facilitates sales, see ibid. According to respondents, it is unfair to stymie their tax-free solicitation of customers. But there is nothing unfair about requiring companies that avail themselves of the States’ benefits to bear an equal share of the burden of tax collection. Fairness dictates quite the opposite result. Helping respondents’ customers evade a lawful tax unfairly shifts to those consumers who buy from their competitors with aphysical presence that satisfies Quill—even one warehouse or one salesperson—an increased share of the taxes. It is essential to public confidence in the tax system thatthe Court avoid creating inequitable exceptions. This is also essential to the confidence placed in this Court’sCommerce Clause decisions. Yet the physical presence rule undermines that necessary confidence by giving some online retailers an arbitrary advantage over their competitors who collect state sales taxes.

Limits on a State’s Ability to Require Tax Collection

The majority notes that states do not have an unfettered ability to impose collection of tax requirements if the physical presence test is removed.  While physical presence may have been required under Bella Hess and Quill for a business to have nexus, physical presence is not the only factor to establish nexus—if the requirements are overly burdensome compared to the benefits received from the state, the state will be barred from imposing the tax.

The majority notes:

Respondents argue that “the physical presence rule has permitted start-ups and small businesses to use the Internet as a means to grow their companies and access a national market, without exposing them to the daunting complexity and business-development obstacles of nationwide sales tax collection.” Brief for Respondents 29. These burdens may pose legitimate concerns in some instances, particularly for small businesses that make a small volume of sales to customers in many States. State taxes differ, not only in the rate imposed but also in the categories of goods that are taxed and, sometimes, the relevant date of purchase. Eventually, software that is available at a reasonable cost may make it easier for small businesses to cope with these problems. Indeed, as the physical presence rule no longer controls, those systems may well become available in a short period of time, either from private providers or from state taxing agencies themselves. And in all events, Congress may legislate to address these problems if it deems it necessary and fit to do so.

…[O]ther aspects of the Court’s Commerce Clause doctrine can protect against any undue burden on interstate commerce, taking into consideration the small businesses, startups, or others who engage in commerce across state lines. For example, the United States argues that tax-collection requirements should be analyzed under the balancing framework of Pike v. Bruce Church, Inc., 397 U. S. 137. Others have argued that retroactive liability risks a double tax burden in violation of the Court’s apportionment jurisprudence because it would make both the buyer and the seller legally liable for collecting and remitting the tax on a transaction intended to be taxed only once. See Brief for Law Professors et al. as Amici Curiae 7, n. 5. Complex state tax systems could have the effect of discriminating against interstate commerce. Concerns that complex state tax systems could be a burden on small business are answered in part by noting that, as discussed below, there are various plans already in place to simplify collection; and since in-state businesses pay the taxes as well, the risk of discrimination against out-of-state sellers is avoided. And, if some small businesses with only de minimis contacts seek relief from collection systems thought to be a burden, those entities may still do sounder other theories. These issues are not before the Court in the instant case; but their potential to arise in some later case cannot justify retaining this artificial, anachronistic rule that deprives States of vast revenues from major businesses.

The majority even stops short of holding that South Dakota’s law does not otherwise violate the Commerce Clause and could still be found invalid.  As the opinion notes:

The question remains whether some other principle in the Court’s Commerce Clause doctrine might invalidate the Act. Because the Quill physical presence rule was an obvious barrier to the Act’s validity, these issues have not yet been litigated or briefed, and so the Court need not resolve them here.

South Dakota Act as a Template for the States

That said, while the Court may have sent the case back down for a finding of whether other issues may block the tax, the opinion seems to clearly telegraph that the majority does not really believe that is true. 

The opinion continues:

That said, South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce. First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively. S. B. 106, §5. Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement. This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability. See App. 26–27.

What these comments leave open is the question of whether a state needs to meet all of those requirements to impose collection responsibilities.

A major question that arises is whether a state that has not adopted the Streamlined Sales and Use Tax Agreement may find itself denied the ability to force collection of taxes by out of state sellers. 

The states that have adopted the Streamlined Sales and Use Tax Agreement are:

  • Arkansas
  • Georgia
  • Indiana
  • Iowa
  • Kansas
  • Kentucky
  • Michigan
  • Minnesota
  • Nebraska
  • Nevada
  • New Jersey
  • North Carolina
  • North Dakota
  • Ohio
  • Oklahoma
  • Rhode Island
  • South Dakota
  • Utah
  • Vermont
  • Washington
  • West Virginia
  • Wisconsin
  • Wyoming

Similar questions arise if the state’s de minimis exceptions do not rise to $100,000 or 200 transactions, the state seeks to collect taxes retroactively under this decision or provide protection for vendors using approved software.

Will Congress Act?

While the Court has removed the physical presence test, it was the Court that created that test to begin with.  As the opinion notes, Congress can write rules that would limit the abilities of states to impose tax collection requirements that are more restrictive than those that will exist after this ruling if Congress does not act.

The Quill opinion invited Congress to solve this problem—but Congress failed to do so in the years since.  Now, however, the nature of the pressure on Congress to act will change as small businesses protest that they are being subjected to oppressive requirements.

What Will the States Do?

Regardless of whether Congress acts or not, states will also have to decide their reactions to this ruling and any Congressional action in this area.  Some states may be able to expand their collection requirements merely by issuing modified rules, others may require new statutes to be passed into law, while some may argue their current rules already impose this requirement—and they may even attempt to argue that they should have a right to retroactively collect these taxes for prior periods.

Article modified after original posting to correct South Dakota's dollar amount of sales limit, which is $100,000.  The original article had the amount at $200,000.