Supreme Court to Weigh Internet Sales Tax Issue of Interest to Schools, States

By Mark Walsh — January 12, 2018 3 min read

The U.S. Supreme Court on Friday agreed to take up a major case about sales taxes on Internet purchases, one that will have enormous consequences for the states and for school districts and other local governments.

The justices agreed to take up a challenge from the state of South Dakota to two precedents—from 1967 and 1992—which held that states could not collect sales tax from out-of-state retailers unless that retailer had a physical presence in the state. In that era before and the boom in Web retailing, out-of-state sales meant catalog and telephone ordering.

Three major education groups—the National School Boards Association, AASA: the School Superintendents Association, and the National Elementary School Principals Association—joined a friend-of-the-court brief supporting the appeal by South Dakota.

“States and local governments lost an estimated $26 billion in 2015 from uncollected sales and use taxes from out-of-state sellers” under the precedents, says the brief by the education associations and other state and municipal groups in South Dakota v. Wayfair Inc. (Case No. 17-494). “The states’ current inability to collect use taxes from remote sales ... cuts off a vital source of support for state services related to public safety, infrastructure, education, and other government services.”

The 1967 precedent was National Bellas Hess Inc. v. Department of Revenue of Illinois, and the 1992 decision was Quill Corp. v. North Dakota. In Bellas Hess, the court held that under its commerce clause jurisprudence, states could not collect sales or use taxes from out-of-state retailers unless the retailer had a physical presence such as facilities or sales representatives. A quarter-century later in Quill, which involved what was then a mail-order office-supply business, the court somewhat reluctantly upheld the rule from Bellas Hess as a matter of stare decisis.

In 2015, in a case related to state sales and use taxes, Justice Anthony M. Kennedy called for the court to “reexamine” the two precedents.

“There is a powerful case to be made that a retailer doing extensive business within a state has a sufficiently ‘substantial nexus’ to justify imposing some minor tax-collection duty, even if that business is done through mail or the Internet,” Kennedy wrote in a sole concurrence in Direct Marketing Association v. Brohl. “This argument has grown stronger, and the cause more urgent, with time.”

Kennedy, who had joined the result in Quill, noted that e-commerce sales were now totaling more than $3 trillion a year in the United States.

“Because of Quill and Bellas Hess, states have been unable to collect many of the taxes due on these purchases,” Kennedy continued. “States’ education systems, health-care services, and infrastructure are weakened as a result.”

In 2016, South Dakota took up Kennedy’s call by passing a law that requires out-of-state sellers to collect and remit sales tax based not on their physical presence in the state but on economic connections. (The law would be triggered by $100,000 in sales or 200 transactions.)

The law also gave only the state a right to sue under the law, and South Dakota itself sued several Web retailers with no physical presence in the state—Wayfair Inc., Inc., and Newegg Inc.—that failed to comply. Those courts, including the South Dakota Supreme Court, all ruled against the law, saying it was incompatible with Bellas Hess and Quill.

In its appeal to the U.S. Supreme Court, the state said it is particularly dependent on its sales tax, “and can ill-afford the losses Quill engenders. Indeed, at the very moment it enacted the law at issue, the legislature was forced to increase the sales-tax rate substantially to help pay teacher salaries.”

The state has estimated that for its 2018 fiscal year, its Quill-related losses will be $50 million.

In response, the retailers urged the justices not to take up the case, arguing among other things that Congress should be the branch to resolve the issue. And while and many of the other largest Internet retailers have voluntarily agreed to collect sales taxes, many other retailers rely on Quill.

“The physical presence rule has permitted start-ups and small businesses access to the Internet as a means to grow their companies, without exposing them to the daunting complexity and expense of nationwide sales tax collection,” the retailers’ brief says.

The Supreme Court’s decision to take up the case comes just at the deadline when the justices could still schedule the case for the last argument session of its current term, in April. But there is no certainty that the case will be heard this term.

A version of this news article first appeared in The School Law Blog.