Supreme Court Rules Online Businesses Now Subject to Sales Tax

By: Ifrah Law

In a ruling announced today, the Supreme Court held that online businesses can be subjected to sales tax even in states where they do not have any brick-and-mortar operations. The case, South Dakota v. Wayfair, Inc., overturns longstanding precedent requiring “physical presence” to subject a seller to state sales tax, representing a big change for e-commerce.

In the opinion of the Court, Justice Kennedy gave careful consideration to precedents dating back a half-century that, in the absence of Congressional authorization, prohibited states to subject businesses to sales-tax requirements unless they had a “physical presence” in the state.  In so doing, he concluded that the rule “created an inefficient ‘online sales tax loophole’ that gives out-of-state businesses an advantage.” By favoring online businesses over local ones, the physical presence rule creates market distortions that disfavor states and state businesses.

The Court justified its overruling of past precedent by focusing on the precipitous growth of e-commerce over the last few decades, which has fundamentally changed how commerce takes place in the U.S. and caused remote transactions to grow to nearly 9% of all sales. In addition, the movement of data, downloading of apps and cookies, and state efforts to redefine “physical presence” had cast some doubt on the workability of the existing rule. The Court also dismissed claims that online retailers had come to rely on exemptions from state tax obligations, finding that businesses could not hang a reliance interest on a practice of tax avoidance.

Justice Kennedy did express some concerns on behalf of small businesses or those with de minimis sales in a state, for whom being subjected to a state’s sales tax could be prohibitively complicated. However, because the statute at issue only applied to businesses with at least $100,000 in business in South Dakota, and because South Dakota had other protections for small businesses, the Court’s opinion was not overly worried about harm to small businesses.

Justice Thomas, interestingly, wrote a short concurrence noting his regret that he had earlier joined an opinion in favor of the “physical presence” rule. (Though the most recent addition to the Court, Justice Gorsuch also concurred, he offered little additional reasoning on the controversy before the Court.)

Although four Justices dissented, they did not disagree that the “physical presence” rule made little sense. Rather, in a dissent written by Chief Justice Roberts, they questioned whether it was the Court’s place to overturn decades of longstanding precedent on its own when Congress had not seen a need to upset the existing rule.

States will move quickly to take advantage of this ruling; therefore, online retailers should keep a close watch on state sales tax laws to ensure that they are in compliance with new requirements as they are passed.