A recent Supreme Court decision in the South Dakota v. Wayfair, Inc. is a possible win for main street brick-and-motor retail, commercial real estate and state and local governments. In June the Court issued a decision in the case deciding that states have the authority to tax online purchase even if the retailer does not have a presence in the state. The South Dakota law allows state sales tax to apply to online transactions from retailers with more than 200 annual transactions or $100,000 in sales per year in the state.
The majority opinion, authored by Justice Kennedy, and joined by justices Alito, Ginsburg, Gorsuch, and Thomas, overturned a 1992 decision in Quill corp. v. North Dakota, requiring retailers to have a physical presence in a state to mandate the collection of state sales taxes on purchases. When Quill was decided, the Supreme Court was not even addressing online sales, as these were still not even in the mind of most Americans’. In 1992, less than 2 percent of Americans had internet access and very few could project how quickly our lives would be changed with digital purchases. The revolution in e-commerce, the challenge by Wayfair, Overstock, and Newegg to the South Dakota law provided a timely opportunity for the court to revisit the physical presence requirements.
In 1992, Quill exempted merchants from paying sales tax in a state when they did not have a physical location. The case, addressing mail-order purchases, did not think that sending goods across state lines was significant enough to create a nexus under the Commerce Clause, to allow taxation without a physical location.
Now in the Wayfair opinion, Kennedy used the example of two different online furniture businesses. The first one may have a small warehouse in South Dakota with a limited selection of inventory. A second business, may have a huge warehouse, just over the state line in Nebraska, with a fancy virtual showroom and first-rate online presence. Before this decision, a South Dakota resident would pay sales tax on the first purchase but not the second. The court found this distinction unfair and not in line with the realities of today’s on-line economy.
Justice Kennedy noted the physical presence rule “produces an incentive to avoid physical presence in multiple States. Distortions caused by the desire of businesses to avoid tax collection mean that the market may currently lack storefronts, distribution points, and employment centers that otherwise would be efficient or desirable.” The distinction created an unfair advantage for online purchases compared to the local storefront which may be already struggling to compete with their digital counterparts.
Opponents of the decision contend that taxing online sales places an undue burden on small internet retailers, who may struggle to administer tax collection in various locations with different tax state and local tax rates. The Court’s dissenting opinion argues that Congress should have legislated an appropriate online sales taxation standard and not the judicial branch. Several bills have been introduced in Congress to address this issue, but none have been enacted.
The South Dakota law addresses the undue burden concern by exempting small businesses with few sales and transactions from the law. While software can facilitate gathering sales taxes in multiple jurisdictions, the court agreed the South Dakota law as adequately addressing this logistical burden for small online retailers. Other states are expected to follow suit, and 20 states have passed legislation requiring only an economic nexus and not a physical presence, to collect sales taxes.
It is easy to see the favorable possibility of more local sales with this new ruling that attempts to level the playing field between main street and online retailers. But there is also a big windfall for state and local governments. A 2016 study from the National Conference of State Legislators in conjunction with the International Council of Shopping Centers, estimates that states lose nearly $26 billion annually in sales tax revenue from remote purchases. The Court cited a different study estimating closer to $33 billion in lost revenue. The loss of this revenue could be felt with higher taxes in other areas or a reduced funding for other services provided by governments.
Another area that is expected to benefit from this ruling is commercial real estate. Now that the Supreme Court has eliminated the physical presence standard, businesses might be more inclined to open a physical retail location to add to their internet presence. A decision to close or not to open a physical location in a town may have a large impact on the community. Not only does the town lose tax revenue, but the lack of local sales may drive retailers out and have empty storefronts, driving down real estate values.
Jennifer Platt, vice president of Federal Operations for the International Council of Shopping Centers in New York lists two impacts of the ruling to retail. “First, is the psychological impact on consumers no longer being led to believe that shopping online is tax-free. Second, is the functional impact on online retailers who have not wanted to create a physical nexus by building out a brick-and-motor presence. That dynamic has been wiped away with the Wayfair decision.”
This ruling should provide benefits to local retailers, local and state jurisdictions, and retail commercial real estate. Hopefully, some of these favorable factors may keep more local retailers open, instead of seeing more businesses dark and boarded up.