» Supreme Court hears arguments in major case challenging Quill
Like kids queuing for the next iPhone or Star Wars episode, state and local tax experts from across the country last week camped out overnight to witness U.S. Supreme Court arguments in the internet sales tax case, South Dakota v. Wayfair. The online seller, along with Overstock.com and Newegg, challenged a new South Dakota law that requires remote taxpayers to collect the state’s sales tax if they sell more than $100,000 of goods per year into the state or, regardless of dollar amount, have more than 200 transactions with state residents. Mississippi recently adopted a regulation imposing a similar requirement but with a $250,000 sales threshold and no particular number of transactions. States across the country have adopted a wide range of similar laws and regulations, all containing different tests and thresholds.
Virtually all of these laws openly defy the Court’s 1992 Quill Corp. v. North Dakota decision that affirmed a nonresident taxpayer must have a physical presence in a state before a jurisdiction may require it to collect sales or use tax. Quill upheld an earlier 1967 ruling to the same effect, National Bellas Hess, Inc. v. Dept. of Revenue of Illinois. The Mississippi Supreme Court, by the way, recognized its own use tax physical presence requirement as early as 1948 in Reichman-Crosby Co. v. Stone. Although physical presence has been the law for at least half a century, these new statutes and rules are part of the state-led “Kill Quill” movement, a phrase coined by a recent Alabama Commissioner of Revenue, designed specifically to overturn that case.
The Court wrestled over whether it should abandon or uphold its longstanding physical presence requirement and, if oral arguments were any indication, this complex case could go either way. Regardless of the outcome, Tuesday’s proceedings raised a number of issues that may not have been addressed in our own local debate over internet sales taxes and the impact a Quill reversal might have on Mississippi’s small business economy.
Remember – all of these sales already are fully taxable. Essentially, South Dakota is seeking to overturn Quill in order to “deputize an out-of-state retailer as its collection agent for a use tax” that is already owed by taxpayers over whom the state already has plenary jurisdiction – its own residents. (This characterization is directly from the Court’s National Bellas Hess ruling.) Justice Sotomayor cut to the chase on this point by interrupting South Dakota’s attorney, barely two sentences into his presentation, to ask why the state did not just collect the tax from its residents. “I’m sorry. Isn’t the problem not Quill but the fact that you don’t have a mechanism to collect from consumers? . . . So find a way to collect from them.” Unfortunately, additional questions came so fast the attorney never had the opportunity to answer that threshold inquiry.
Quill repeal may be a double-edged sword. A common theme throughout much of the recent commentary is that overturning Quill is necessary to “level the playing field” between small, locally owned merchants and the larger online companies that often do not collect local sales tax. The existence and extent of those tax-related economic advantages is a fair topic for debate, and some justices expressed skepticism that sales taxes were the actual source of that broader economic disadvantage, but if Quill falls many of the local merchants clamoring for its repeal should expect that they may very well wind up playing a role in levelling the playing field in other states.
Wayfair’s attorney noted that 70 percent of all small businesses currently have a website, and that figure is expected to grow to 91 percent by the end of this year. In other words, most main street merchants have begun doing business online to one degree or another and increasingly are using the internet to compete in interstate and even global markets they previously could not access.
Don’t let some arbitrary $100,000 or $250,000 trigger lure anyone into thinking this is only a big business problem. South Dakota and the U.S. Deputy Solicitor General both stated that they believe a single transaction into a state would satisfy the constitutional requirements to subject a company to a state’s collection and filing requirements, a rather surprising position that resonated with several justices. If that low standard should prevail, seemingly nothing would prohibit the states from changing their laws to capture virtually all remote sellers, regardless of volume.
Justice Alito stated succinctly the reality of that possibility: “But do you have any doubt that states that are tottering on the edge of insolvency … have a strong incentive to grab everything they possibly can?” Mississippi businesses that have not enjoyed the pleasure of a California, Illinois, or New York tax audit simply don’t know what they are missing, especially given that sales and income tax exposure go hand in hand in many of these more aggressive states. Clearly, absent some clear constitutional standard the sword that repeals Quill may end up cutting both ways.
Uncertain costs and benefits. Justice Ginsburg noted that this entire dispute turns on the balance between administrative tax collection efficiency and increased compliance costs. “[T]he state has the burden of going after consumers, I mean, just in the real world, it’s much more efficient, much more likely, to yield funds if you go after the seller than if you go after the individual consumer.” No evidentiary trial was ever held in this case, and no factual record existed to quantify with any certainty the actual lost revenues or compliance costs involved.
Many of the states based their figures on a study performed by two University of Tennessee professors. A GAO study, however, concluded the Vols’ revenue estimates may have been overstated by multiples of three or four, and many of the justices expressed reservations about overturning precedent without clearly understanding the true amounts at stake.
Similarly, the Court questioned the “wildly disparate estimates” of the compliance costs to taxpayers if Quill were to be overturned, and whether technology can adequately allay these and other related compliance issues. Justice Breyer recognized that there are more than 10,000 state and local jurisdictions imposing sales taxes, and that there is widespread lack of uniformity among those jurisdictions as to rates, tax bases, exemptions, and administrative requirements. Wayfair’s attorney put this figure closer to 12,000 and noted that uniformity has been an elusive goal as most of the larger states (New York, Illinois, Texas, Florida, California, etc.) refused to join the Streamlined Sales and Use Tax Agreement, a multistate compact aimed at promoting multistate sales tax uniformity.
A technological “silver bullet?” South Dakota suggested all this could be managed by modern software and technology, and that available programs start at “$12 per month for 30 transactions.” The justices at times appeared skeptical, especially considering that’s actual sales transactions, not tax returns, so the compliance fees could add up quickly especially for low-value high-volume businesses. Breyer also expressed concern over the accuracy of these programs, highlighting that taxpayers facing these disparate rules might “get it wrong, and either the state assesses a $500 penalty for every mistake, which is billions or, you know, a lot, and — or the class action lawyers sue you for having paid too much.” In a small business context, those penalties and lawsuits can be crippling.
Wayfair’s attorney countered that software was “no silver bullet” because it is prohibitively expensive (perhaps $250,000 just for initial installation), prone to inaccuracies, does not address broader record keeping concerns, and does nothing to alleviate the exponentially greater audit costs and burdens that would result from those new collection and filing obligations. In the end, however, it was clear there was widespread disagreement over actual compliance costs as well as the limits of current technology.
Monopolistic concerns. Also absent from most of the local discussion about internet sales taxes is possible negative impact a Quill repeal could have on Mississippi’s local merchants. Wayfair’s attorney contended that the larger battle is not between small in-state retailers and out-of-state direct marketers but with the large companies, the “omni merchants” who, in his view, are multi-channel merchants increasingly dominating the internet. Repealing Quill, he argued, will increase the “cost of admission” to online commerce with the inevitable effect that “those small and medium-sized companies are going to be deterred and there will be even greater concentration by the largest retailers.”
Justice Breyer shared that concern and used the term “oligopoly” when questioning the Deputy Solicitor General on whether compliance costs might serve as a barrier to small businesses entering the online market. Justice Kagan similarly noted “the irony in saying the problem with Quill is that it benefitted all these [large] companies, so now we’re going to overturn Quill so that we can benefit the exact same companies.” How this issue might play out for Mississippi’s “main street” businesses is a valid issue that needs to be explored more fully.
Would a Quill repeal also ensnare professional services? Another important issue not addressed in our local debate is the impact a Quill repeal could have on local service providers with clients outside Mississippi. The online market for remote professional services has not developed as fast as that for selling goods, but it is an area experiencing rapid growth. Even though Mississippi does not ordinarily tax engineering, architecture, legal, accounting and other similar services, many states do.
Following a Quill repeal, it is entirely possible many Mississippi-based service providers could be required to collect sales tax in their customers’ states. Even if no employee of the firm ever entered those states and all the services were provided remotely, those services might become taxable based solely on the client’s location. Many states already apply these “economic nexus” and “market sourcing” concepts in the income tax context, and sales tax could soon follow if Quill falls. The Court did not address this issue on Tuesday, but it was discussed in briefs filed in the case and is something Mississippians must consider going forward.
So what’s next? It is always risky to predict how the Supreme Court will rule on such an important case based on oral arguments, but there seems to be widespread recognition among national practitioners that several justices could be inclined to leave Quill intact and once again direct the states toward Congress to resolve these issues that many of them, ultimately, view as legislative in nature. Several justices also were concerned with issues of retroactivity following a repeal and that overturning Quill would likely spawn vast uncertainty and extensive litigation – with many of Mississippi’s small businesses caught right in the middle.
No matter how the Court rules in Wayfair, the consequences and public debate over this case will play out for years to come.
» JOHN FLETCHER is a tax partner at Jones Walker LLP in Jackson, whose practice focuses primarily on state and local tax issues in Mississippi, Louisiana and other states. Having worked as a state tax attorney at General Electric Company and two national accounting firms, he is a former adjunct tax professor at the State University of New York at Albany and is a frequent speaker and instructor on a wide range of state and local tax issues of national interest.
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