"Virtual Presence" Nexus: Wayfair Overturns Historic Quill Physical Presence Nexus Rule

The much-anticipated United States Supreme Court Wayfair opinion has been issued. In a 5-4 decision, the Court overturned its historic physical presence nexus standard, to be replaced by an inquiry into whether the taxpayer has availed itself of the privilege of carrying on business in the state. The thresholds in the South Dakota tax system were found to meet this test, and the state's tax simplification as part of the Streamlined Sales and Use Tax Agreement (SSUTA) meant that there would not be an undue or discriminatory burden on out-of-state businesses. The case was reversed and remanded for further proceedings, which leave open the option of further challenges but likely will put the South Dakota economic nexus law into effect.

States that follow South Dakota's framework of (1) reasonable virtual nexus thresholds, (2) overall simplification as part of SSUTA or otherwise, and (3) no retroactivity should be on solid ground. The Wayfair opinion leaves open the possibility that more aggressive state approaches not meeting one or more of these elements may not be similarly upheld.

Physical Presence Rule Overturned as Artifact of Ancient Jurisprudence

Recall that South Dakota's "economic nexus"--or should we now say "virtual nexus" given this opinion--law creates seller sales tax collection obligations for taxpayers with sales into South Dakota in excess of $100,000 or 200 discrete transactions annually. Pursuant to its provisions, the law has been enjoined pending fast-track adjudication to determine its constitutionality, since it is a facial attack on the physical presence rule of the Court's 1992 Quill Corp. v. North Dakota decision.

The crux of the Wayfair opinion is that Quill was expressly recognized as inconsistent with modern Complete Auto Commerce Clause tax jurisprudence but was wrongly upheld under stare decisis principles. The Court in Wayfair holds that physical presence is not required for Commerce Clause nexus, and the opinion notes that physical presence is not a good proxy for the administrative burden of seller tax collection. The physical presence rule is described as "judicially created tax shelter." Physical presence test reliance arguments are misplaced since lawfully due state sales and use taxes are being avoided under the rule.

The Court instructs that the Commerce Clause nexus analysis should be similar--but not necessarily identical--to a contacts analysis for the Due Process clause. "Due Process and Commerce Clause standards may not be identical or coterminous, but there are significant parallels." It will remain to be seen how this standard is fleshed out in practice.

The majority opinion also leaves open that "[c]omplex state tax systems could have the effect of discriminating against interstate commerce." There may be issues with undue burdens or outright discrimination. So conceivably the same nexus thresholds that on balance justify a South Dakota's sales and use tax collection obligation might not apply in a more complex state like Louisiana or Colorado.

The 5-4 opinion comes with concurrences from Justice Thomas and Justice Gorsuch. These call into question the dormant Commerce Clause more generally and should not practically affect the application and implementation of the majority opinion authored by Justice Kennedy. The dissent, authored by Chief Justice Roberts, would have upheld the physical presence rule based on stare decisis and concerns over the administrative burden on taxpayers.

What Does This Mean for States and Taxpayers

The Wayfair opinion gives states a roadmap for how to approach virtual presence nexus. A state that has adopted SSUTA, follows South Dakota's thresholds, and looks for prospective-only collection should be on solid ground. A state that takes a more aggressive approach or which refuses to simplify compliance for out-of-state taxpayers may not fare as well. Conceivably, the complexity and burdens of a state tax system can now be litigated in court as part of a constitutional argument, although the taxpayers best poised to make such arguments would be unlikely to have the resources to put on such a case.

The Wayfair holding is not expressly prospective-only but the opinion twice references the absence of retroactivity in South Dakota's law. So conceivably another state could seek retroactive liability based on virtual presence, however query whether this would create undue burdens on taxpayers under Wayfair's analysis.

Going in the other direction, Wayfair also opens up the potential for arguments that minor physical presence is not enough to establish nexus. Hopefully we will see states walk away from more tendentious physical presence nexus approaches and rely more heavily on the Wayfair virtual presence analysis.

Wayfair has overruled Quill but it has not provided a clear alternative, instead providing essentially what seems to be a balancing test of contacts and burdens. This not only applies to sales and use taxes; it should apply to all state and local taxes. This will be a fertile field of controversy in the years to come.

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