If you run a business large or small, it’s hard to ignore today’s headlines: Supreme Court rules states can force online retailers to collect sales tax (CNN), Supreme Court rules states can collect sales tax for online purchases nationwide (Fox News), Supreme Court rules states can require shoppers to pay online sales tax (MSNBC). In a news cycle saturated by politics, these headlines broke through because of their potential to impact our economy more than any act of Congress over the last twenty years. States will now be able to force online retailers and other sellers to collect an Internet sales tax from customers in those states.

A brief history of e-commerce and the Internet sales tax

When Amazon and a few of its peers broke onto the scene in the mid-1990s, nobody believed that online sellers and marketplaces presented a significant challenge to the dominance of brick-and-mortar retailers. The Internet at that time had only 16 million users (roughly 0.5% of the world’s population), and using the Internet usually involved clunky dial-up modems and having to cut your web browsing short so a family member could use the phone.

Fast forward to 2017, and online retail sales in the United States comprised 13% of the overall retail spending. Consumers in the United States alone spent more than $450 billion in online retail purchases, with a few dominant players in the marketplace enjoying most of those sales. How did e-commerce grow to become such a large segment of the economy, displacing brick-and-mortar giants and disrupting whole industries along the way? The answer is simple: online retailers could offer the same products for less cost.

Some of those cost savings were from built-in efficiencies of e-commerce. For instance, an online retailer doesn’t need to pay rent on its brick-and-mortar stores or an extensive network of retail employees. Cutting out the large physical footprint of other retailers let Internet retailers pass some of that savings onto their customers. One of the biggest cost savings enjoyed by e-commerce customers, however, has nothing to do with business models or efficiency — for nearly twenty years, customers of online retailers never had to pay an Internet sales tax. This is partly because, when e-commerce was first taking off, the states had little understanding of e-commerce and even less understanding of how to tax it. However, once the states better understood e-commerce, they found themselves bound by decades-old legal precedent and couldn’t tax Internet sales in most instances.

The states have, up until recently, been bound by the legal precedent of decades-old cases such as Quill Corp. v. North Dakota and National Bellas Hess, Inc. v. Department of Revenue of Illinois, cases which tied the states’ hands and required that a business have some physical presence in the state before the state could tax it. That physical presence requirement satisfies an even older legal principle that, before a state can tax economic activity, that activity must have a substantial nexus with that state. Ultimately, this all meant that an efficient e-commerce company operating out of one state — let’s use Washington in this example — could keep all of its offices and warehouses in Washington, sell to customers in all fifty states, but only be required to pay sales tax on sales to Washington customers. If you lived in Nebraska and had to choose between paying sales tax in a brick-and-mortar store or buying the same product without paying sales tax, which would you choose? For many people, the answer was simple — and, thus, online sales boomed for decades in what its critics considered a legally subsidized marketplace.

The Supreme Court decision

The financial crisis of 2008 and its aftermath took a heavy toll on state tax revenues. States, seeing an opportunity in e-commerce to boost their tax collections, began testing the boundaries of Quill and Bellas Hass, coming up with new arguments for why Internet retailers should still be subject to a state’s taxing jurisdiction even if they’re not physically located there. Sensing a sea change on the horizon, some online retailers (such as Amazon.com) voluntarily began collecting sales tax on its customers in all fifty states. Today, in its opinion in the matter of South Dakota v. Wayfair, Inc., the Supreme Court overruled Quill and Bellas Hess, eliminated the physical presence requirement, and paved the way for the remaining states to also begin collecting sales taxes on online retailers.

Despite the headlines, the Supreme Court’s opinion does not explicitly say that the states can tax all online sales. It does eliminate the requirement that a seller be physically present in the state before the states may do so, but it does not eliminate the older and broader requirement that there be some substantial nexus connecting the activity being taxed to the state that wants to tax it. In the case of South Dakota, the Supreme Court upheld an Act that only imposed an Internet sales tax on online sellers with at least $100,000 in sales or at least 200 separate transactions within the state on an annual basis, finding that such restrictions limited applicability of the tax to economic activity with a substantial nexus to the state.

Where the Internet sales tax leaves us

As of right now, the only real change that takes effect today is that South Dakota may collect sales tax under the laws it already passed. It seems inevitable that the other states will follow South Dakota’s lead. It isn’t a matter of ‘if’ so much as ‘when’ the other states will impose their own sales taxes on online transactions. Some will pass laws like South Dakota’s, while others will insist that their current sales tax laws already apply to online sales to customers within their borders. Prudence dictates that businesses start planning now for the day when they will need to have a comprehensive system in place to register with and pay taxes to all fifty states. Here at Law 4 Small Business, we help our mixed retail and e-commerce clients develop systems and structures that help them to understand and comply with the ever-changing state and local tax landscape. Give us a call and let us see what we can do for you.

We are keeping are eyes out for e-commerce companies that can help online companies keep abreast of the internet sales tax changes on a state and local basis. One such company is TaxJar, offering a full solution that integrates with a number of popular shopping carts and e-commerce platforms. If you know of other respected providers, please let us know in a comment to this blog article.

Law 4 Small Business, P.C. (L4SB). A little law now can save a lot later. A Slingshot company.

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