On April 16, the U.S. Supreme Court heard oral argument in North Carolina Department of Revenue v. The Kimberly Rice Kaestner 1992 Family Trust (transcript available here). At issue in Kaestner Trust is whether a state can impose income tax on an out-of-state trust based solely on a discretionary beneficiary being an in-state resident. While it’s a seemingly esoteric trust taxation case, it’s expected to set the stage for future tax jurisdiction challenges under the 14th Amendment’s Due Process Clause.
Constitutional Limits on Sales Tax Nexus
A state’s ability to impose a sales or use tax collection obligation on a seller is limited by both the Commerce Clause and Due Process Clause of the U.S. Constitution. In Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the Court held that these two standards are distinct and, thus, a seller could have contacts sufficient to meet the Due Process limitations but not sufficient for substantial nexus under the Commerce Clause (which was determined by physical presence at that time). Last year, the Court, in South Dakota v. Wayfair, 585 U.S. ___ (2018), examined Quill’s Commerce Clause argument and ultimately overturned the physical presence nexus requirement, holding that economic and virtual contacts can create substantial nexus.
Since Wayfair, states have acted quickly to adopt economic nexus thresholds that base sales tax collection requirements on the seller’s in-state gross receipts or transaction volume – typically $100,000 or 200 transactions. While the Court tacitly approved of these thresholds under the Commerce Clause (at least as to the large retailers involved), these policies have yet to be tested under the Due Process Clause. Kaestner Trust offers the first post-Wayfair view into the justices’ thinking on Due Process in a tax context.
Minimum Contacts and Purposeful Availment
In Quill, the Court stated “due process centrally concerns the fundamental fairness of governmental activity…. We have, therefore, often identified ‘notice’ or ‘fair warning’ as the analytic touchstone of due process nexus analysis.” Under Quill‘s Due Process analysis, a taxpayer must have “minimum contacts” with a state and “purposefully avail itself of the benefits of an economic market” in the state in order for the state to have jurisdiction to require sales or use tax collection.
In the context of sales taxation, it’s relatively easy to make a case that a seller has purposefully directed its activity to the state when it regularly engages directly with in-state customers for the sale of tangible personal property physically delivered into the state. However, the situation may be different if economic nexus is based on a single sale that passes the state’s gross receipts threshold. Moreover, states are increasingly taxing (and/or measuring nexus thresholds based on) sales of digital goods and services, which may not have such a straightforward structure or sourcing methodology.
In the Wayfair oral argument, South Dakota argued that a single sale would create sufficient nexus under the Commerce Clause (and presumably also under the Due Process Clause). This theory is in tension with existing Due Process cases. In a 2011 case in a product liability context, J. Mcintyre Machinery v. Nicastro, 564 U.S. 873, Justice Breyer’s concurring opinion stated: “None of our precedents finds that a single isolated sale, even if accompanied by the kind of sales effort indicated here, is sufficient.” In that case, the plurality held that an intent to target the U.S. market as a whole was not equivalent to an intent to target New Jersey specifically and a “stream-of-commerce metaphor cannot supersede either the mandate of the Due Process Clause or the limits on judicial authority that Clause ensures.” (Those interested in exploring the interactions of Nicastro and Wayfair in depth should read Allan Erbsen’s recent essay in the Yale Law Journal, Wayfair Undermines Nicastro: The Constitutional Connection Between State Tax Authority and Personal Jurisdiction, available here.)
The Council on State Taxation’s amicus brief in Kaestner Trust also notes that in reaching the conclusion in Nicastro, the Court focused on the “entity’s activities, as opposed to the activities of a third-party.” If Kaestner Trust shifts that lens, it may have implications for those selling through third parties like marketplace facilitators or national retailers, even where there is no activity directed specifically at the forum state. In fact, in a recent case involving the Ohio Commercial Activity Tax, Greenscapes Home and Garden v. Testa, Dkt. No. 17AP-593 (2019), an Ohio appeals court held that the Due Process Clause is satisfied when a company “has purposefully taken advantage of the distribution ability of national retailers and knows that its products are shipped to Ohio.”
Kaestner Trust will hopefully shed light on how the current Court thinks about Due Process in a tax context. The oral argument in the case touched only briefly on Due Process as such, with the bulk of the time spent on an exploration of trust law, fiduciary duty, and the accretion-to-wealth concept. Since Kaestner Trust deals with trust income taxation, any rule that emerges from the case may not ultimately be transferable to the sales tax context. But, it will serve as a pressure test of Due Process tax limitations among the Court as currently constituted.
A decision is expected in June.
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About the Author: Melissa A. Oaks is a Proposition Manager for Indirect Tax at Thomson Reuters. Prior to this role, Melissa was the Managing Editor of State & Local Tax for Checkpoint Catalyst, where she specialized in complex nexus, apportionment, and e-commerce issues. Before joining Thomson Reuters in 2013, Melissa practiced law in New York. Melissa is a graduate of Cornell University and Columbia Law School and earned an LL.M. in Taxation from NYU School of Law. Twitter: @melissaaoaks