How Sales Tax Ended Up in the Supreme Court

Jan 18, 2018

Online Commerce Adds Twist to 1992 Ruling

SMITH BRAIN TRUST – The Supreme Court is poised to take up an issue that states have wrestled with since before the earliest days of online retail sales. It’s the issue of whether states may collect sales tax from out-of-state retailers who sell to their in-state residents.

The issue goes back decades.

In 1992, the Supreme Court established a physical presence test for tax sales in the Quill Corp. v. North Dakota case. It was before e-commerce, at a time when the comparatively smaller catalog business was more often the way shoppers ordered goods to their home.

“The world of retail sales was one thing in 1992,” says Samuel Handwerger, lecturer of Accounting and Information Assurance at the University of Maryland’s Robert H. Smith School of Business. “It certainly is different in 2018.” 

In 2018, e-commerce is big and growing. But states still are struggling to find ways to collect tax revenue from out-of-state retailers who are selling goods to their residents. 

Back in 1992, Handwerger recalls, most customers bought things by driving to a brick-and-mortar store, waiting in line for a cashier, paying for their goods and the associated sales tax and then driving home with the desired product. 

“Back in 1992, the closest thing you had to internet selling were mail-order catalogs,” he says. “Customers could comb through the pages of a catalog and by mail or telephone send in their order and wait for delivery by common carrier several weeks later.”

One of the lures to catalog orders, he says, was the ability to avoid paying state sales tax when the retailer was out of state, often a savings of 5 percent or more.

“If the consumer was willing to wait for delivery they had a perceived price advantage,” Handwerger says. “We say ‘perceived’ because really the consumer in this scenario was supposed to voluntarily declare the out-of-state purchase to their resident state and pay the use tax on that item – a mathematical equivalent to the state sales tax.”

A lot of people didn’t. “Do you know anyone who has ever done that?” Handwerger asks.

For states, these catalog sales represented lost sales tax (or, more accurately,  lost “use” tax).

North Dakota, among other states, wasn’t happy about the lost tax revenue, Handwerger explains, but realized that residents would be unwilling to suddenly become use tax compliant. So state authorities tried to require an out-of-state catalog company to collect the sales tax on sales made to North Dakota residents. “The catalog company, Quill, challenged this – all the way to the Supreme Court,” he says.

The Supreme Court ruled in favor of Quill, saying that “a physical presence” was required before a state could require the retailer to collect the tax. “This became the standard law of the land and everybody lived happily ever-after, until the internet sales started escalating,” he says.

The scale of internet sales compared to catalog companies has altered the dynamics of the conversation, Handwerger says. “Now the amount of lost sales tax collections by states has become worthy of taking some aggressive legislative positions,” he says.

Several states have taken action to try to collect sales tax from out-of-state vendors, and some of those actions have been legally challenged by the e-commerce retailers. The results: Mixed.

“The judicial verdicts show some wins and some losses such that now we have a hodgepodge of state laws and no clear definition of whether states can require vendors to collect sales tax on internet sales,” Handwerger says. 

Among the mishmash of court decisions, states and e-commerce companies have asked the Supreme Court multiple times to reconsider the Quill decision, putting it in the context of modern, online retailing. The Supreme Court has refused each such request, Handwerger says, “quietly sending the message that it is up to Congress to act.” 

“And did Congress get the message? Well, yes and no,” Handwerger says. “Yes, in the sense that in just about every year for the past 10 years, a bill or two has been introduced to address inter-state sales and make some sense out of the jungle. But, no, in the sense that these bills have been largely dead on arrival.” 

Now, the Supreme Court is set to consider a sales tax issue from another Dakota. This time, South Dakota. 

In 2016, South Dakota passed a law requiring sales tax collection from internet vendors having sales transactions in the state exceeding $100,000 or 200 transactions on an annual basis. Other states followed suit last year, enacting similar legislation.

The state’s Supreme Court ruled against the state in South Dakota v. Wayfair Inc., calling the new law unconstitutional. The ruling prompted a request to the U.S. Supreme Court to consider the case. “The expectation was that the Supreme Court would turn it down as they have been so accustomed to doing, but to the surprise of many, they have agreed to hear the case,” Handwerger says.

“Perhaps happier than most with this news is our Congress,” he adds, “since they may get left off the hook on this one.”



About the Expert(s)

Sam Handwerger, CPA, is a full-time Lecturer in the department, and is a University of Maryland undergraduate accounting alumnus. He also holds a Master of Science in Taxation degree from the University of Baltimore. Handwerger was a Senior Tax Researcher with EY in New York City and later led the Tax Planning and Preparation Departments of the CPA firm Handwerger, Cardegna, Funkhouser & Lurman. In 1996, he was awarded the Governor's Volunteer of the year award in the State of Maryland for financial and management advisement to non-profit organizations. Before joining the Smith School on a full-time basis, Handwerger held adjunct positions at the Johns Hopkins University School of Business and the University of Baltimore Law School.

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