Supreme Court tells E-commerce it must collect and pay more taxes

In a huge constitutional favor for cash-short state governments’ treasuries and for struggling brick-and-mortar retail stores, a deeply divided Supreme Court on Thursday gave the states the power to require out-of-state sellers that peddle goods via the Internet to collect and hand over billions more in sales taxes.

The historic 5-to-4 decision in a case that the South Dakota legislature set up explicitly to test the scope of its taxing power overturned a half-century old doctrine that had insulated “remote sellers” from taxes on their sales to in-state consumers.

The majority ruling applied a decades-old constitutional doctrine that states may not discriminate against companies doing business across state laws, making clear that this approach has new meaning and power in the massively changed consumer economy in which millions of Americans shop by clicking a computer mouse in their living rooms, kitchens or home offices, without having to go to a mall or a downtown – or even neighborhood – store.

Today, the Court noted, the biggest retail business in America is one that only sells goods via the Internet – Amazon.  It was one of the ironies of the ruling, though, that Amazon voluntarily opts to collect and pay over to states the taxes on goods it sells via the Internet.  Three big retailers who sell only online, however, were directly targeted by South Dakota, and they will now have to collect and pay.

Justice Anthony M. Kennedy, who wrote the majority ruling, admitted that the Court itself was wrong in maintaining – for 51 years – the constitutional rule that a state government may not collect sales tax from an out-of-state retailer unless that company had a “physical presence” in the state – a store, a staff of employees, or a warehouse, for example.

Kennedy said that the part of the Constitution that controls business activity in America – the Commerce Clause in Article I – did not give the courts the power “to create market distortions.”

At an economically practical level, the decision means that Internet sellers lose a competitive advantage they had over traditional retailers to sell at lower prices, and they now lose the right to claim that their sales are free of sales tax.  That is a marketing tool, the Court noted, used by one of the big firms involved – Wayfair, Inc., a major seller of home goods.  Also involved were another large seller of home goods and jewelry, Overstock, Inc., and Newegg, Inc., a major seller of consumer electronics.

Although Congress for years has been hearing the complaints of state governments and of an increasing challenged retail store industry about the Court’s protection of out-of-state sellers, the lawmakers on Capitol Hill have never been able to forge an answer. 

Four members of the Court, dissenting in an opinion written by Chief Justice John G. Roberts, Jr., argued in vain that the problem should have been left to Congress to solve.  The change made by the majority, the dissenters said, has “the potential to disrupt the development of such a critical segment of the economy.”  (The dissenters did agree that the half-century old precedent struck down Monday was decided wrongly, but they said any remedy should have been up to Congress.”)

There is no doubt that state governments have the authority, under the national Constitution, to impose a sales tax on goods sold in the state; that was not at issue on Thursday.  A shopper in a state with a sales tax must pay that at the time of the purchase from an in-state store, and the store then passes on the tax revenue to the state.

There is a companion tax – the “use” tax – that many states use to collect the tax on goods sold by out-of-state retailers, so that the state does not have to try to get the revenue from the remote seller.  But, the Court noted, consumers largely ignore paying “use” taxes, paying it personally only about 4 percent of the amount they should.

States thus have long wanted to be able to compel out-of-state retailers to collect the money themselves and then send it to the states.  They have recently estimated that, if they could do that, they could collect somewhere between $8 billion and $33 billion more in retail taxes every year.

But the Supreme Court has blocked the states from reaching any remote seller who did not have a “physical presence” in the state.  That idea first originated in a 1967 decision when “remote” sales were made by large retailers who sold goods by catalogue – companies like Sears Roebuck and Montgomery Ward.  That decision was National Bellas Hess v. Illinois Department of Revenue.

Always frustrated by that ruling, states continued to pursue lawsuits that they hoped might lead the Court to change its mind.  They failed, most notably, in a 1992 decision, in the case of Quill Corp. v. North Dakota.  The Court, following its reluctance to overturn prior precedents, reaffirmed the “physical presence” requirement for state sales taxes.  Even though in later years the Court would allow states to put taxes on business firms that had a significant link to the state, the Justices kept in place the requirement for remote sellers that the states wanted to target with sales taxes.

Almost every year, states would return to the Supreme Court, seeking to challenge the two prior rulings.  Finally, South Dakota got its challenge accepted for review this term, with the specific result that both the 1967 and the 1992 decisions were explicitly overruled.

Justice Kennedy’s opinion for the Court had the support of the three most conservative Justices – Samuel A. Alito, Jr., Neil M. Gorsuch and Clarence Thomas – and one of the most liberal, Ruth Bader Ginsburg.  (Gorsuch and Thomas each wrote a separate, concurring opinion, expressing anew their skepticism about the doctrine that was the key to the decision – that the Commerce Clause, besides being a grant to Congress to pass laws to regulate commerce, also was a ban on state discrimination against interstate business.)

Chief Justice Roberts’ dissenting opinion was joined by three of the Court’s liberal Justices, Stephen G. Breyer, Elena Kagan and Sonia Sotomayor.  (The Chief Justice often lines up with the Court’s conservative bloc, but now and then aligns with liberals.)

There was no indication in Thursday’s ruling why the Court had at last agreed to reopen the state tax issue, but that may have been due to the fact that the case (South Dakota v. Wayfair) was a case without factual complications, set up as a clear-cut test of the continuing validity of the two prior precedents.

Lawyers worked with state officials in South Dakota to pass a law in 2016 explicitly aimed at compelling collection of the state’s sales tax (the tax that produces 60 percent of state revenues) from large, out-of-state retailers.  The law is limited to firms that annually sell at least $100,000 worth of goods to at least 200 buyers.  The law does not seek to collect back taxes for prior years, and it postponed the imposition of the collection duty while a court case on its constitutionality went forward.

That court case, of course, was bound by the two Supreme Court precedents requiring proof of an actual physical presence, so a virtual presence would not be enough.  The state Supreme Court struck down the tax, and the case then moved to the Justices.

While the outcome was a clear decision against continued immunity for large “remote sellers,” Justice Kennedy’s opinion left open the possibility that smaller retailers seeking to sell only via the Internet might be able to mount other kinds of challenges, such as their lack of funds to buy computer software to allow them to know what taxes they had to collect for what states.   The Kennedy opinion did express some confidence that fairly inexpensive software to help out will be forthcoming.

The Court opinion denounced the prior precedents, especially the one from 1992, on a variety of grounds, but the main thrusts were that the “physical presence” requirement was simply out-of-date the modern digital age, and that its continuation was skewing the competitive environment in the nation’s retail sector.

Legendary journalist Lyle Denniston has written for us as a contributor since June 2011 and has covered the Supreme Court since 1958. His work also appears on lyldenlawnews.com.