Green splash


Supreme Court may reassess Quill’s physical presence standard

Michael Bryan, Snowden Rives, and Sara Clear of Deloitte Tax analyze the oral arguments made before the US Supreme Court in April in 'South Dakota v. Wayfair Inc.' regarding whether a state can require a remote seller to collect sales tax based on "economic presence." The authors discuss the justices' concerns with the burden on small businesses of retroactive application of such an obligation and the constitutionality of prospective application.

Reproduced with permission from Daily Tax Report, 108 DTR 12, 6/5/18. Copyright © 2018 by The Bureau of National Affairs, Inc. (800-372-1033)


As states have expanded the notion of what is ‘‘physical presence,’’ and are trending towards adoption of economic presence sales and use tax nexus thresholds, the US Supreme Court (court) recently addressed the Quill physical presence nexus standard (Quill Corp. v. North Dakota, 504 US 298 (1992)) in oral arguments held last month in South Dakota v. Wayfair, Inc. et al., 901 N.W.2d 754 (S.D. 2017), cert. granted (US Jan. 12, 2018) (No. 17-494).

While there had been initial speculation as to whether the granting of cert in Wayfair signaled the court’s readiness to overturn the decades-old physical presence nexus standard required in order for a state or locality to impose a sales or use tax collection responsibility upon a remote seller, much of the questioning by the justices during the oral arguments focused on the burdens and fairness of doing so.

While the court’s decision is not anticipated until late June 2018, the issues discussed in the oral arguments highlight various sales and use tax readiness considerations for taxpayers, such as:

  • Degree of operational preparedness should Quill be overruled,
  • Need for evaluation of current filing positions, and
  • Identification of potential exposures in light of nexus expanding legislation and the associated impact on financial statements.

Other states directly challenge ‘Quill’

South Dakota’s disputed law at issue in the Wayfair litigation, along with the enactment of nexus expanding legislation in other states, has not been unexpected in light of comments by Justice Kennedy in the court’s 2015 decision in Direct Marketing Association v. Brohl, 135 S. Ct. 1124, 1134-35 (2015) (Kennedy, J. concurring). In a concurring opinion, Justice Kennedy stated:

‘‘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. After all, ‘interstate commerce may be required to pay its fair share of state taxes.’ This argument has grown stronger, and the cause more urgent, with time. When the court decided Quill, mail-order sales in the United States totaled $180 billion. But, in 1992, the Internet was in its infancy. By 2008, e-commerce sales alone totaled $3.16 trillion per year in the United States.’’

‘‘Given these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the court’s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier. It should be left in place only if a powerful showing can be made that its rationale is still correct.’’ Id.

Justice Kennedy’s remarks in the 2015 DMA decision directly challenged the physical presence nexus requirement for sales and use tax nexus purposes. Since then, more than 10 states have enacted sales and/or transaction-based economic nexus provisions imposing a sales and use tax collection duty on an out-of-state seller who makes retail sales of tangible personal property into the state if (1) the out-of-state seller’s retail sales exceed a certain monetary threshold set by the state, or (2) the out-of-state seller reaches a certain number of transactions in one year as set by the state. As of this article’s authorship, those states include Alabama, Indiana, Maine, Massachusetts, Mississippi, North Dakota, Ohio, Pennsylvania, Rhode Island, South Dakota, Tennessee, Vermont, Washington, and Wyoming. South Dakota’s enacted S.B. 106 legislation, which is at the center of the Wayfair litigation, is one such example.

Additionally, numerous other states have enacted statutes in the last decade which expand the definition of ‘‘physical presence’’ in order to impose sales and use tax collection (or reporting) requirements on remote sellers. These laws typically fall into one of three categories: click-through nexus, affiliate nexus, or notification and information reporting. A more detailed analysis of these three approaches is beyond the scope of this article. It is important to note that whether the court overturns or upholds Quill, these expanded nexus statutes may be expected to remain in place.

An overview of ‘South Dakota v. Wayfair’

By way of background, in 1992 the court in Quill affirmed that before a state or locality may impose a duty to collect use tax on a remote vendor, substantial nexus under the Commerce Clause requires the existence of physical presence. In a direct challenge to the physical presence requirement of Quill, the state of South Dakota enacted legislation in 2016 (S.B. 106) which requires sellers—without a physical presence in South Dakota—to collect South Dakota sales tax on sales into South Dakota if, in the previous or current calendar year, the seller’s sales into South Dakota exceed $100,000 or the seller had 200 or more separate transactions into South Dakota. Senate Bill 106, 2016 Legislative Assemb., Reg. Sess. (S.D. 2016), as codified under S.D. Codified Laws Section 10-64-1 through Section 10-64-8.

S.B. 106 provides that South Dakota may initiate a declaratory judgment action in order to provide the ‘‘most expeditious possible review of the constitutionality of this law.’’ S.D. Codified Laws Section 10-64-3. Soon after enacting the law, South Dakota filed a declaratory action on April 28, 2016; this action initiated an injunction during the pendency of the action and prohibits South Dakota from enforcing S.B. 106’s ‘‘economic nexus’’ collection provisions. If the constitutionality of the South Dakota statute is ultimately upheld, any injunction against the enforcement of this law is lifted. If injunctions are lifted, then S.B. 106 allows the South Dakota to assess and apply its tax collection obligations ‘‘from that date forward with respect to any taxpayer covered by the injunction.’’ S.D. Codified Laws Section 10-64-7.

On Sept. 13, 2017, the South Dakota Supreme Court affirmed the lower circuit court’s 2017 holding; the lower circuit struck down S.B. 106 as unconstitutional in violation of the Quill physical presence requirement. In its petition for writ of certiorari, the State of South Dakota presented the single question of whether the US Supreme Court should ‘‘abrogate Quill’s sales-tax-only, physical-presence requirement.’’ Petition for Writ of Certiorari, South Dakota v. Wayfair, Inc., 901 N.W.2d 754 (S.D. 2017), cert. granted (US Jan. 12, 2018) (No. 17-494). The court granted certiorari on Jan. 12, 2018, and oral arguments in the case were heard on April 17, 2018.

Oral arguments highlighted concerns from the bench

The issues discussed highlighted the concerns of a number of justices as to the implications of overturning Quill, notably, what should be the constitutional minimum for establishing sales and use tax nexus, the risk of retroactive application of state legislation, whether the issue is more appropriately resolved through congressional action, and the potential burden on small businesses.

If not Quill’s physical presence requirement, then what?

South Dakota attorney general began his argument stating that the physical presence standard results in states ‘‘losing massive sales tax revenues.’’ Transcript of Oral Argument at p3, ln 13-14, South Dakota v. Wayfair, Inc., et al., No. 17-494 (2018). Justice Sotomayor and Chief Justice Roberts challenged the South Dakota attorney general to define the constitutional minimum contacts necessary to impose the sales tax on remote sellers. Transcript of Oral Argument at p5, ln 1-3; p6, ln 10; p8, ln 17-20, Wayfair, Inc., No. 17-494. The South Dakota attorney general responded that ‘‘the minimum would be one sale’’ into a state is enough to establish nexus under Complete Auto, but the doctrines of Complete Auto and Pike control whether constitutional limits of a state’s legislation. Transcript of Oral Argument at p5, ln 14-16, 23-25; p6, ln 11-12, Wayfair, Inc., No. 17-494.; see Complete Auto Transit, Inc. v. Brady, Chairman, Mississippi State Tax Commission, 430 US 274 (1977), Pike v. Bruce Church, Inc., 397 US 137 (1970).

The South Dakota attorney general also contended that the Quill bright line nexus is not required as Complete Auto and Pike provide the requisite constitutional protection for state sale and use tax legislation. Transcript of Oral Argument at p56, ln 2-11, 21-25; p57, ln 22-25. The South Dakota attorney general expounded on this jurisprudence in his rebuttal arguing that state tax assessment statutes must pass muster under Complete Auto, which requires a state ‘‘to look for the discrimination, to look for apportionment, to look at the substantial nexus.’’ Transcript of Oral Argument at p5, ln 14-16, Wayfair, Inc., No. 17-494; Complete Auto Transit, Inc., 430 US at 279. He further posited that Pike provides ‘‘a balancing test by which courts may measure the ‘‘collection side and concerns with burden’’ on taxpayers. Transcript of Oral Argument at p56, ln 10-11, Wayfair, Inc., No. 17-494.

In response, Wayfair’s counsel argued that under the constitutional minimum contacts standard in Quill, physical presence is required for a state to impose sales and use tax on remote sellers, illustrating that ‘‘there’s been a clear explanation of what the standard is for tax jurisdiction.’’ Transcript of Oral Argument at p51, ln 3-9, Wayfair, Inc., No. 17-494. Physical presence provided a standard ‘‘where you have a whole industry that has understood what the rules are,’’ (Id. at p53, ln 10-12) a standard that has been in place for almost 30 years and upon which businesses have relied and built their business practices. Id. at p51, ln 3-9; p52, ln 7-10.

Retroactive vs. prospective application

Justices Sotomayor, Breyer, and Alito voiced concern regarding the effect of retroactive application if the court were to overturn Quill. Id. at p4, ln 18-21; p10, ln 1-7; p28, ln 24-25; p29, ln 1. Generally, the court’s rulings apply retroactively, thus the potential exists for states to enact or enforce retroactive sales and use tax legislation, subjecting taxpayers to a potentially significant liability. Id. at p51, ln 22-25, referencing Harper v. Virginia Dept. of Taxation, 509 US 86, 97-98 (1993); Id. at p4, ln 18-21; p27, ln 9-13. In an amicus brief filed by the Tax Executives Institute, it was noted that 28 states enacted economic presence sales and use tax statutes that either do not have safeguards against the retroactive application or permit retroactive application should the Quill be overturned. Brief for the Tax Executive Institute, Inc. as Amicus Curiae, p6-11, Wayfair, Inc., No. 17-494.

On this retroactivity issue, Justice Alito challenged the US Deputy Solicitor General whether he had ‘‘any doubt that states that are tottering on the edge of insolvency and municipalities which may be in an even worse position have a strong incentive to grab everything they possibly can?’’ Id. at p27, ln 9-13. He also asked whether the retroactive application of state laws in this context ‘‘would be constitutional?’’ Id. at p29, ln 1. In response, the Deputy Solicitor General argued that states would have an incentive to apply their laws retroactively and states would likely ‘‘adopt regimes that are less hospitable [than South Dakota] to retailers unless they were stopped from doing so by Congress.’’ Id. at p27, ln 21-23.

Additionally, the Deputy Solicitor General argued that retroactive application of these laws would be constitutional because he didn’t find ‘‘Quill to have issued an advertent holding with respect to Internet presence,’’ (Id. at p29, ln 3-6) and that concern over retroactive application the court could ‘‘simply leave open the possibility of additional Pike-type challenges to back taxes.’’ Id. at p29, ln 13-16; the oral argument transcript indicates that the Deputy Solicitor General says ‘‘an inadvertent holding with respect to the Internet presence,’’ but the oral argument recording audit indicates he immediately corrects himself and says ‘‘an advertent holding with respect to Internet presence.’’ Audio of Oral Argument at 25:38-25:48, South Dakota v. Wayfair, Inc., et al., No. 17-494 (2018). The South Dakota attorney general, however, argued that the fear of retroactive legislation is unfounded as laws of 38 states prevent retroactive legislation and referenced an amicus brief filed on behalf of 45 state attorney generals citing ‘‘significant constitutional concerns’’ (Id. at p59, ln 25) regarding retroactive application of state laws. Id. at p16, ln 22-24; p59, ln 19-25.

There was also discussion about whether the court has the ability to make their ruling prospective, thus removing any concern of retroactivity. Id. at p29, ln 18-21. Justice Ginsburg asked the Deputy Solicitor General what was ‘‘the government’s position on the prospect of the prospective overruling of Quill?’’ Id. The Deputy Solicitor General responded by stating that he thought ‘‘the court eschewed prospective announcement of constitutional rules’’ (Id. at p29, ln 23-24) and that a prospective ruling would be beyond the court’s role ‘‘to interpret the Constitution, not amend it.’’ Id. at p30, ln 2-3.

Wayfair’s counsel agreed that the court’s decisions would have to be applied retroactively. He stated that the court in Harper found that ‘‘a purely prospective ruling is inconsistent with its view of the law and made that very clear. . .’’ (Id. at p51, ln 22-25, referencing Harper, 509 US 97-98) and supporting that by stating that ‘‘[i]f Congress were to address the issue, I think there would be no doubt that it would be purely prospective.’’ p51, ln 17-21. It was also noted that only Congress has the ability to overturn Quill on a prospective basis. p51, ln 17-21.

This uncertainty as to the retroactive application of a court decision overruling Quill presents a similar question as to whether state attorney generals would maintain the position expressed in their amicus brief as to the ‘‘significant constitutional concerns’’ with retroactively enforcing sales and use tax legislation upon remote sellers. Id. at p16, ln 22-24; p59, ln 19-25.

Looking out for small business

Another concern expressed by Justices Sotomayor, Breyer, and Gorsuch was the potential impact that overturning Quill could have on small businesses. The South Dakota attorney general stated that small businesses are hurt most by Quill’s physical presence requirement as it creates an ‘‘unlevel playing field...where out-of-state remote sellers are given a price advantage.’’ Id. at p3, ln 16-20. Wayfair’s counsel countered that by stating the ‘‘substantial expense that’s associated with’’ the cost of installing, integrating, and maintaining software to comply with economic nexus for the sales tax would cause smaller businesses to ‘‘be deterred from entering that market’’. Id. at p45, ln 25; p46, ln 5-13; p54, ln 24-25; p55, ln 1-2.

Justices Sotomayor and Breyer noted the inconsistent and often contradictory data provided by both parties and their amici regarding the impact on small businesses. This disparate information caused the justices to question whether either party could quantify the impact on small business. Id. at p31, ln all; p36, ln 13-21; p37, ln 21-23. Justice Breyer directly challenged Wayfair’s counsel on this issue indicating that his briefs are ‘‘filled with stuff’’ (Id. at p30, ln 19) about the cost and the unreliability of sales tax software, whereas he references that South Dakota’s briefs simply states that taxpayers ‘‘[w]e’ll do it on software.’’ Id. at p31, ln 15. Justice Breyer conceded that ‘‘[b]oth are logical’’, but questions ‘‘[h]ow do I decide who’s right?’’ Id. at p32, ln 17-18. Justice Sotomayor voiced concern over either side not being at to provide a definition of ‘‘what constitutes a small business in America’’ (Id. at p53, ln 19-20) to begin to quantify a constitutional minimum of sales. Id. at p53, ln 24-25; p54, ln 1-5.

Wayfair’s counsel challenged the perception that sales and use tax software was the ‘‘silver bullet’’ that would alleviate the burden compliance for all taxpayers. Id. at p45, ln 20-24; p47, ln 5-8. Regardless of the cost, Wayfair’s counsel argued that ‘‘[t]here’s no software solution’’ (Id. at p47, ln 12) to other aspects of compliance with economic nexus such as record retention, and state audit implications that accompany sales and use tax compliance; implications that could substantially impact small businesses. Id. at p45, ln 25; p46, ln 1-13; p47, ln 5-12.

Is federal legislation the more appropriate solution?

The notion that overturning Quill should be addressed through federal legislation was also the subject of discussion. Justice Kagan indicated that ‘‘Congress is capable of crafting compromises and trying to figure out how to balance the wide range of interests involved’’ for imposing the sales tax upon remote sellers. Id. at p23, ln 17-20. The Deputy Solicitor General agreed stating ‘‘that Congress has a broader range of options available to it than does the court and an ability to devise more nuanced solutions.’’ Id. at p24, ln 3-6.

To bolster the belief that this issue is best left to Congress, Wayfair’s counsel added that the principle of stare decisis pushes this issue into the legislative arena. Stare decisis highlights the value in ‘‘settled expectations’’ (Id. at p43, ln 20-22) and that stare decisis is ‘‘not dependent upon the correctness of the decision which is being followed.’’ Id. at p43, ln 20-25; p44, ln 1-2; p52, ln 24-25; p53, ln 1-3. Additionally, Wayfair’s counsel also contended that the application of stare decisis is more powerful when ‘‘Congress has the ability to correct an error if that error existed.’’ Id. at p43, ln 23-25.

The South Dakota attorney general countered that this was an issue for the court, stating that determining a minimum is a ‘‘constitutional issue’’ (Id. at p11, ln 8-9) and ‘‘Congress has had 26 years to address this issue. And it’s not Congress, but it’s Quill, it’s this court’s decision, that is striking down our state statutes.’’ Id. at p10, ln13-17. Justice Alito highlighted that both states and retailers have incentives to lobby Congress for a solution. States want ‘‘to require...Internet retailers to collect the tax’’ for remittance to the state. Conversely, retailers want a physical presence requirement to avoid ‘‘aggressive moves by the states to bring taxation within Quill in some way’’ or ‘‘statutes like the Colorado reporting statute’’ which impose reporting and notification requirement on remote sellers.

On the topic of the reporting statutes, Justice Gorsuch asked Wayfair’s counsel ‘‘whether the Colorado regime might be more burdensome to clients like yours who do sales over the Internet than just simply collecting the sales tax itself?’’ Wayfair’s counsel answered that type of ‘‘regime is much less burdensome,’’ (Id. at p38, ln 17-18) but he referenced that because the law just went into effect in 2018 there’s no ‘‘empirical evidence.’’ Id. at p38, ln 22-25; p39, ln 1-2.

Challenging the notion that overturning Quill is a legislative issue, Justice Ginsburg posited ‘‘why are we...ask[ing] Congress to overturn our obsolete precedent?’’ Id. at p11, ln 19-25; p44; ln 11-12. Justice Breyer, however, suggested that the responsibility of the court lessens when Congress has authority under the dormant commerce clause to address or correct the issue legislatively. Id. at p12, ln 4-6. He stated that the court says it is ‘‘more willing to overturn a constitutional case is because Congress can’t act. But, here, they can act.’’ Id.

The discussion then turned to Congress’ lack of action on the issue as both legislative bodies have had 26 years to implement a response to Quill, but have yet enacted anything. Id. at p10, ln 18-23.


If the physical presence requirement of Quill is overturned, the sales and use tax nexus landscape will dramatically change, and as a result, companies large and small may require significant changes to their internal systems and processes. In this respect, a delay in planning for and addressing the outcome of Wayfair may result in additional costs and/or business interruptions considering the potential expedited and compressed solution timelines. Companies, therefore, are encouraged to consult with their indirect tax advisors to review the many technical and logistical considerations that should be addressed prior to the court’s holding in Wayfair this summer.

Did you find this useful?