Economic Nexus is Constitutional: Supreme Court Overturns the Quill Physical Presence Test

With the continued proliferation of online sales projected to reach $414 billion by the end of 2018, the states, eager to capture their share of this online revenue, have reached for businesses that have no physical contact with the state.

Until the U.S. Supreme Court’s ruling last week in South Dakota v. Wayfair, 2018 WL 3058015 (Sup. Ct. June 21, 2018), physical contact was the traditional hallmark for establishing “nexus.”  Nexus is the link between an out-of-state business and a given state that provides that state with the jurisdiction under the U.S. Constitution to impose sales tax on businesses participating in inter-state commerce.

The Supreme Court finally caught up to the changing market place last week overturning in Wayfair the “physical presence” test established in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).  The Court ruled that the physical presence test is “unfair and unjust” to the brick and mortar businesses competing against virtual competitors.  To level the playing field, South Dakota passed an “economic nexus” law requiring out-of-state sellers to collect sales tax if they derive more than $100,000 of gross revenue from the state or conduct more than 200 transactions in the state.  South Dakota prevailed on the constitutional challenge brought by the e-commerce company Wayfair even though the law imposed sales tax without requiring a business to have physical presence in the state.

The Court in Wayfair expressed that the states should be allowed to “seek long-term prosperity” through economic nexus legislation (estimates indicate the physical presence test has cost states billions of dollars in uncollected sales tax).  In fact, many states’ laws had already blurred the once bright-line Quill physical presence rule.  For example, New York passed click-through nexus legislation in 2008, creating a presumption of physical presence for online retailers that had referral agreements with residents of the state as a result forcing online retailers to collect sales tax on New York shipments.  The online retailers Overstock and Amazon challenged this law but it was upheld by New York’s highest court.  In the aftermath of this decision, New Jersey passed its own similar law and also entered into a tax collection and job creation agreement with Amazon.  The online giant conceded having nexus with the state and then, as an apparent concession, built fulfillment distribution centers in New Jersey in conjunction with collecting sales tax on its online sales.

Under this new Supreme Court precedent, New York, New Jersey and other states do not need to prove physical presence by indirect means, but can move forward with implementing legislation to directly impose sales tax on online businesses on receipts generated from the state.

In light of the Supreme Court decision and the liberation of the states from the yoke of the physical presence test, online and other hybrid businesses should not delay conducting “nexus studies” of their business practices, which we regularly conduct for our clients.  This helps companies determine and plan for potential exposure in an audit, including the personal liability exposure for owners and officers for uncollected sales tax that is not dischargeable in bankruptcy.

 

As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.

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