By Melissa A. Oaks (Managing Editor, Checkpoint Catalyst)
This article is the third in a special series of articles dedicated to recent nexus developments. The author of this article was one of only a few dozen members of the press granted credentials to observe the oral argument.
On Tuesday, April 17, 2018, the U.S. Supreme Court heard oral argument in South Dakota v. Wayfair. The case is a direct challenge to the “physical presence” nexus standard, under which a state cannot impose sales or use tax collection obligations on out-of-state companies that lack a physical presence in the state.
In March 2016, South Dakota passed S.B. 106 (now S.D. Codified Laws § 10-64-2). The law imposes sales tax registration and collection obligations on sellers lacking a physical presence in the state if the seller, in the current or previous calendar year, had gross revenue from sales of taxable goods and services delivered into South Dakota exceeding $100,000, or sold taxable goods and services for delivery into South Dakota in 200 or more separate transactions. After passage of S.B. 106, the state sued four out-of-state retailers, seeking equitable relief affirming the validity of the law. While one company chose to register and collect sales tax, the other three moved for summary judgment, which the Supreme Court of South Dakota granted after determining it was bound by the Supreme Court’s holding in Quill Corp v. North Dakota. In January 2017, the U.S. Supreme Court shocked the tax world by granting certiorari in the case.
States’ taxing power is limited by the Commerce Clause of the U.S. Constitution, which prohibits states from discriminating against interstate commerce. Thousands of jurisdictions across 47 states and the District of Columbia impose a sales or use tax. In recent years, many states have toed the line by imposing various sales and use tax collection or reporting requirements on out-of-state sellers making sales to in-state customers. While the case before the Court originates from a South Dakota law, it will have nationwide impact.
The state faces an uphill battle in trying to convince the Court to overturn the physical presence standard. The precedent challenged in Wayfair was established in 1967 in National Bellas Hess v. Dept of Rev. of Illinois, and later affirmed in 1992 in Quill Corp. v. North Dakota. Under the stare decisis principle, overturning a prior precedent requires a demonstration of “special justifications.” Quill itself was decided largely on this basis: “the continuing value of a bright line rule in this area and the doctrine and principles of stare decisis indicate that the Bellas Hess rule remains good law.”
In determining whether the time has come to abandon the Bellas Hess precedent, as affirmed in Quill, the Court will weigh a number of factors. First, whether the holding is inconsistent with other decisions or is particularly harmful, important, or detrimental to the doctrine at issue or its ends. The Court will also consider reliance issues and whether Quill is unsupported because of a change in circumstances, increasingly unworkable, and routinely criticized. Whether the principle derives from statutory or constitutional interpretation will also factor into the determination. Finally, the Court will consider whether the Wayfair facts are distinguishable from the facts in Quill. 
Tax practitioners and state tax officials traveled from around the country to attend Tuesday’s oral argument, with some arriving before dawn to secure a place in line. Senator Heidi Heitkamp (D-ND), who represented the North Dakota Department of Revenue in Quill 26 years ago, was also in the courtroom.
The oral argument opened with South Dakota’s Attorney General, Marty J. Jackley arguing in support of S.B. 106’s economic nexus provisions. Justice Sotomayor quickly turned the discussion to the broader implications, saying “I’m not concerned about your scheme as such. I’m concerned about the many unanswered questions that overturning precedents will create a massive amount of lawsuits about.”
The state argued that the tax assessment should be evaluated under Complete Auto’s four-prong test, but that any wider economic impact on interstate commerce should be evaluated using a balancing test from Pike v. Bruce Church, Inc. Under Complete Auto, Jackley argued, “the minimum [threshold] would be one sale…that creates the nexus.” Arguing for the United States as amicus curiae, Deputy Solicitor General Malcolm L. Stewart agreed with the one-sale threshold, stating further “there’s no constitutional minimum.”
Many of the questions focused on the role of Congress and how the Court’s ruling might impact Congress’ ability (or motivation) to provide a solution for the compliance burden concerns. Justice Alito asked Jackley whether it would be preferable to overrule Quill and have states do whatever they want, or for Congress to act on the issue. Citing congressional inaction, Jackley replied that overruling Quill was the only option. Justice Kagan cautioned, however, that congressional inaction “gives us reason to pause, because Congress could have addressed the issue and Congress chose not to.” She also suggested that congressional inaction in the 26 years since Quill may raise the bar for overturning the Court’s precedent.
Stewart stressed that, regardless of how the Court rules, Congress can act to protect states, business, and consumers from any negative consequences. But Justice Sotomayor was unconvinced that congressional action is a panacea, commenting “that doesn’t do anything in the interim period and for the dislocation and lawsuits…it will engender until there is a congressional settlement.”
The lack of a developed factual record was a recurring theme throughout the argument. For example, each side disagreed on which type of seller is actually disadvantaged by remote sales tax collection – small businesses, brick and mortar shops, online retailers? Justice Breyer seemed exasperated with the lack of agreed-upon factual findings about things like the cost of compliance and the impact on state tax revenues: “So why is it… you have wildly different estimates of costs, revenues, and what states are losing or not?…How do I find out?… [T]here are empirical questions that I think…would help me reach an answer. And if you know them, tell me.”
Arguing for the respondents (Wayfair, Inc.; Overstock, Inc.; and Newegg, Inc.), George S. Isaacson, pointed to a 2017 report from the General Accountability Office as a reliable source for compliance burden estimates. But both Isaacson and Jackley claimed the GAO report supported their respective legal arguments. Responding to Breyer’s request for clear estimates, Jackley said: “Use respondents’ numbers…Use respondents’ activity. We know…Wayfair collects in 22 states. They do this. In fact, Quill.com now collects in every state….Companies do this every day.” Justice Gorsuch raised an interesting point, noting that “we have to compare apples to apples… we wouldn’t compare it [sales tax compliance] necessarily against a baseline of nothing. We’d have to compare it against the reporting requirements of a state like Colorado’s.”
Breyer expressed concern over the barriers to entry for small businesses and the potential for oligopoly. Meanwhile, Justice Ginsberg wasn’t convinced that there was interstate discrimination at all: “[A]nyone who wants to sell in-state, whether an in-state shop, an out-of-state shop, everybody is treated to the same tax collection obligation. All who exploit an in-state market are subject to the in-state tax. Why isn’t that equalizing rather than discriminating?”
Notably, Justice Kennedy, whose DMA v. Brohl concurrence inspired South Dakota to pass S.B. 106, asked relatively few questions. Kennedy interjected only twice – to ask Isaacson if congressional action would depend on whether Quill is deemed to be correct or incorrect. Justice Thomas, as expected, didn’t speak during the argument, but has consistently declined to recognize the dormant Commerce Clause.
It’s rarely wise to predict how the Justices will rule based on oral argument, but especially so in this case where the issues don’t break down along traditional ideological lines. A decision is expected in June and practitioners should be planning for a range of possible outcomes.
Regardless of the decision in Wayfair, states are likely to continue expanding use tax enforcement via notice and reporting regimes (like those in Rhode Island or Pennsylvania) and recordkeeping laws (as in Connecticut). If the physical presence test survives in some respect, we can expect more states to pursue so-called “Quill-consistent” policies that treat digital cookies stored on an in-state customer’s computer as “physical presence” in the state.
With many states struggling to balance budgets, and the fiscal uncertainties presented by the Tax Cuts and Jobs Act, states are unlikely to shy away from remote sales tax collection and use tax reporting obligations in the near future.
This is an excerpt of an article appearing in Checkpoint State & Local Tax Update on Wednesday, April 18, 2018. For an in-depth, state-by-state discussion of these issues, see Checkpoint Catalyst, Topic #1050, Sales and Use Tax: Nexus.
 State v. Wayfair Inc., (2017, S.D.) 2017 S.D. 56, 901 N.W.2d 754, cert. granted, U.S. S.Ct., Dkt. No. 17-494, 01/12/2018.
 Quill Corp. v. North Dakota By and Through Heitkamp, (1992, U.S.) 504 U.S. 298, 112 S. Ct. 1904, 119 L. Ed. 2d 91.
 S.D. Codified Laws § 10-64-2.
 Delaware, Oregon, and New Hampshire decline to impose a general sales or use tax at the state or local level. Alaska and Montana do not impose a state-level sales or use tax, but local jurisdictions are permitted to impose sales and use taxes.
 Kimble v. Marvel Entertainment, LLC, 576 U.S. ___ (2015).
 Sen. Heitkamp joined an amicus brief with Sens. Alexander (R-TN), Durbin (D-IL), and Enzi (R-WY), urging the Court to overturn Quill.
 Pike v. Bruce Church, Inc., 397 U.S. 137 (1970)
 See Comptroller of the Treasury of Maryland V. Wynne, 135 SCt 1787, 05/18/2015.
 See Mass. Regs. Code 830 CMR § 64H.1.7(1)(b)(2); Crutchfield Corp. v. Harding, et. al., Complaint for Declaratory Judgment, Va. Cir. Ct. (Albemarle County), Dkt. No. CL17001145-00,10/24/17.