Kill Quill: Volume 2


By Michael Rebagliati

2017 ended with a legislative bang as Congressional Republicans (rapidly) passed the most sweeping overhaul of the tax code in a generation. For many tax lawyers, 2018 has begun with a whimper as they scramble to understand what this means for their clients.

And yet, another major change to U.S. tax law still looms on the policy horizon. But this time, the change is coming not from Congress, but from the Supreme Court. On January 12th, the Supreme Court granted certiorari in the case of South Dakota v. Wayfair, Inc.

Wayfair is a case about state sales taxes and the internet. Fundamentally, the petitioner (South Dakota) wants to make sure that South Dakotans pay their sales taxes when they buy things online. To help accomplish this, the state would like out-of-state companies that sell things online to play by the same rules as in-state companies that sell things in person—i.e., collect sales tax on these online transactions and remit that money to the state. Of course, as many commentators have noted, consumers should technically already be paying taxes on these online purchases by reporting them to their state governments and paying a use tax. However, perhaps as you would expect, these self-reporting numbers have always been laughably low.

But, to understand why states are stuck with an untenable self-reporting sales tax system, we need to look at a previous case, Quill v. North Dakota. Quill is essentially a “prequel” to Wayfair, and it is set in North Dakota in the early 1990’s, in a world without online shopping. In Quill, the Court reaffirmed an even older case and held that it was unconstitutional for a state to require catalog retailers to collect sales taxes on sales made to state residents unless the retailer is “physically present” in the state.

Essentially, the Court decided that it would be too burdensome to ask catalog retailers to track the sales tax law of every state in order to collect and remit sales tax. This burden on companies that sell products in multiple states would violate the Commerce Clause (or more precisely, the Dormant Commerce Clause). So, catalog retailers did not need to worry about collecting sales tax unless they were physically present (e.g. with a sales outlet or sales representatives) in the state of sale.

The “physical presence” rule for nexus has not stood the test of time. In fact, it barely withstood the scrutiny of its own authors; in issuing its opinion, the Quill Court noted that physical presence rules had already become obsolete in most other areas of the tax law. However, the Court took comfort in the possibility that, even if its ruling was inconsistent with other Commerce Clause jurisprudence, Congress could fix the problem and pass a new law that would allow states to force out-of-state retailers to collect sales taxes.

However, Congress did not act, and in the meantime, the Internet showed up. And, as anyone who has ever sat in the back of a law school classroom knows, the Internet has vastly changed how people shop. So, the old law now applies to new technology: internet retailers do not need to collect sales tax from customers unless the internet retailer has some kind of physical presence in the state from which it collects revenue. As more people shift to buying products online instead of in brick-and-mortar stores, this anomaly has put increasing pressure on state treasuries, especially in states like South Dakota and Washington that have no income tax and thus rely on sales taxes for a large portion of their revenue. This growing state-revenue crisis has been alarming to many, to the point that it spawned the “Kill Quill” movement—a coalition of states and other stakeholders dedicated to overturning Quill’s physical presence rule.

But it’s not only the Kill Quill movement that is concerned about this issue. In 2015, Justice Anthony Kennedy (who voted for the result in Quill) used his concurrence in a different tax case to explicitly invite a case like Wayfair, stating that “[t]he legal system should find an appropriate case for this court to re-examine Quill.”

Remarkably, as the Petitioners in Wayfair explain, almost the entire machinery of the South Dakota state government came together to answer the call. The State then crafted Senate Bill 106, a law specifically designed for Supreme Court litigation. The bill required out-of-state sellers to collect and remit sales tax based on their economic (not physical) connection to the State—a threshold of $100,000 in sales or 200 separate transactions would trigger the collection requirement. The South Dakota Legislature even took several pro-active steps to protect out-of-state sellers during the expected litigation by including provisions that would insulate them from any interim tax obligations and by including express protections against any retroactive tax collections.

The Legislature also sought to provide an efficient vehicle for Supreme Court review by providing a cause of action for the State to sue out-of-state retailers who failed to comply, expediting the normal hearing and appeal process, and providing for an automatic injunction that would stay the law’s enforcement. The Legislature also went to extra lengths to include detailed factual findings in the bill regarding the state revenue shortfalls that would go on to help the State’s future lawyers make an argument that Quill should be overturned because of changed economic and technological circumstances. In contesting the petition for certiorari, the Respondents raised many justiciability arguments with respect to this tailor-made legislation; however, the Court appears to have rejected these arguments and has accepted the bill as a valid basis for litigation.

It remains to be seen whether South Dakota will prevail on the merits, which will likely revolve around how much (or how little) of a burden it is for internet retailers to track the various state sales tax laws. The Respondents will likely try to complicate this picture, arguing that sales tax laws vary wildly and that the brunt of the burden will fall on small and medium-sized internet retailers. The Petitioners will likely counter by pointing out that various software solutions make it is easier for modern e-retailers to track myriad sales tax laws than it was for past catalog retailers. Petitioners will also likely frame this as a “fair play” argument by highlighting the plight of local, brick-and-mortar businesses that are at a disadvantage because they must collect sales tax.

Although some (pro-sales tax) commentators fear that the pro-business bent of the Roberts Court will lead to a result that still bars these taxes, it seems likely that South Dakota will prevail. For one thing, Justice Kennedy (the usual swing vote) specifically asked for this case. Additionally, conservative Justices Thomas and Gorsuch have both been critical of the Quill rule in the past. The position of these judges is certainly not lost on South Dakota. Indeed, the State’s petition for certiorari often reads like a tribute to Kennedy/Thomas/Gorsuch jurisprudence, frequently quoting from these Justices’ prior opinions.

Whatever the result, the South Dakota state government, its lawyers, and their allies in the Kill Quill movement have put on an impressive clinic in impact litigation strategy.

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