On June 21, 2018, the U.S. Supreme Court decided that states may now collect sales tax on out-of-state online sales in the case South Dakota v. Wayfair, Inc. The Supreme Court upheld the South Dakota law that requires out-of-state online retailers to collect sales taxes on the sales they make into the State as long as a retailer makes 200 or more separate sales transactions or more than $100,000 worth of sales into the State on an annual basis. This overruled the Supreme Court’s decision, Quill Corporation v. North Dakota, 504 U.S. 298 (1992), which required a retailer to have a “physical presence” in a state in order for them to be required to collect sales or use taxes. While the Supreme Court’s decision in Wayfair applies only to the South Dakota law at issue, the significant tax revenue at stake will encourage other states to pass similar laws.
Wayfair involved three prominent online retailers: Wayfair, Newegg, and Overstock. They argued that the increasing number of state and local tax systems has made it overly burdensome to comply with all the different rules when making sales online, which can end up being shipped anywhere in the nation. The online retail giant Amazon solved this problem by developing software which automatically applies the correct tax rate based on the shipping address input by the purchaser, but developing or purchasing such software will no doubt be a costly barrier to entry for smaller online businesses. Amazon does pay sales taxes in all 45 states that have sales and use taxes for roughly half of its sales, i.e., the sales done directly by Amazon but it does not pay sales taxes for the other half that involve third party vendors. These purchases are free from sales tax in every state except Washington, where Amazon has its headquarters.
The 1992 Quill decision was grounded partially in the Supreme Court’s respect for the precedent it set down in National Bellas Hess v. Department of Revenue, 386 U.S. 753 (1967). Bellas Hess held that both the Due Process Clause and the Commerce Clause of the Constitution prohibited states from collecting sales and use taxes from businesses that did not have a “physical presence” within the state where the goods were shipped. Quill overruled the Due Process holding of the Bellas Hess decision but not the Commerce Clause holding; thus, it reaffirmed the physical presence rule.
In Wayfair, the Supreme Court overruled both Quill and Bellas Hess concluding that the physical presence rule is unsound and incorrect. In its absence, the Court relied on Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) and its substantial nexus test to hold that South Dakota’s law requiring out-of-state online retailers to collect sales taxes on the sales they make into the State as long as a retailer makes 200 or more separate sales transactions or more than $100,000 worth of sales into the State on an annual basis does not violate either the Commerce Clause or Due Process Clause.
Currently, California law requires that when an out-of-state online retailer does not collect sales tax on goods sold and delivered to California residents, the purchaser must pay California use tax instead. However, voluntary compliance rates with such use taxes are extremely low. Absent individuals and businesses voluntarily reporting, the California Department of Tax and Fee Administration (CDTFA) cannot effectively track all online sales into California from the purchaser’s side. Going after the big out-of-state online retailers would be more feasible, but until Wayfair this was constitutionally forbidden. On June 22, 2018, the CDTFA announced that all out-of-state retailers that have 200 or more individual sales transactions of tangible personal property annually to California residents or cumulative sales of tangible personal property exceeding $100,000 delivered to California residents annually must register with the CDTFA by August 1, 2018. These figures track the South Dakota law at issue in Wayfair and will therefore likely pass constitutional scrutiny as well if challenged. The statewide sales and use tax rate in California is 7.25%, which is comprised of a 6% state and 1.25% local rate; but, local jurisdictions, i.e., cities, counties, city counties and districts, may also charge additional sales, use and transaction taxes. These tax rates vary widely throughout the state so the CDTFA has a tool found here that can be used to look up the tax rate for any given address in California.
If you are an online retailer that think you may be affected by the changing law mentioned above, it is important to make sure you are prepared by August 1, 2018. The professionals at Rex Halverson & Associates have over 40 years of sales and use tax experience. We can help you deal with sales and use tax issues ranging from registering with the CDTFA to dealing with audits and appeals. For a free initial consultation, call us today at (916) 444-0015.