A U.S. Supreme Court ruling expected this summer could either clarify or bring further uncertainty to the debate over when states can force online retailers to collect sales taxes.
The case involving the state of South Dakota and Boston, Mass.-based online retailer Wayfair Inc. (NYSE: W) — which sells home furnishings, household decor and housewares — has potential ramifications across the board for retailers. At issue is a South Dakota law that requires online sellers to collect use taxes when purchases by their customers in the state exceed 200 transactions or $100,000 a year.
Justices will decide whether the South Dakota law squares with a 1992 Supreme Court decision that said states can only force so-called remote sellers with a “physical presence” in the state — such as employees or a store or warehouse — to collect sales or use taxes on transactions.
The precedent-setting ruling 26 years ago came down before the dawn of the internet age and the creation of e-commerce and online retailers like Amazon and Wayfair. The decision addressed catalog sales handled by telephone or mail order.
Proponents angling for the court to uphold the South Dakota law have long argued that the issue comes down to fairness in the battle between brick-and-mortar retailers that must collect sales taxes, and online sellers that sometimes don’t.
“E-commerce is no longer a new, fledgling industry and we have to play by the same rules,” said Amy Drumm, vice president of government affairs for the Michigan Retailers Association.
The association and others argue that the billions that online sellers do not collect in sales and use taxes annually across the U.S. put brick-and-mortar stores at a competitive disadvantage.
“We don’t want to be unreasonable, but at the end of the day if you’re making a sale, whether it’s online, in-person, through the mail or over the phone, you should be paying the same taxes. That’s just a matter of fairness,” Drumm said. “It’s a huge issue for our members, particularly smaller stores that don’t have the staff to try and run a complex website and have a robust online presence. That’s expensive to do and they’re trying to compete and trying to keep up with the changing marketplace and offer the best customer service that they can. But for a lot of folks, it comes down to price. If you can get it 6 percent cheaper somewhere else, why wouldn’t you do it?”
PATCHWORK OF LAWS
On the other side of the issue are arguments that allowing states to force remote sellers to collect sales taxes where they lack a physical presence amounts to taxation with representation, and that the issue is one for Congress to address, not states.
Forty-five states and the District of Columbia have some form of laws that set varying requirements on when online sellers must collect sales taxes.
Michigan’s law took effect in October 2015 and requires out-of-state sellers to collect taxes if they sell directly to a consumer and if they use a referral, or click-through, to connect with a consumer. Remote sellers must collect sales tax if gross receipts from click-through sales exceed $10,000 in the prior 12 months, and if direct sales exceed $50,000.
Even with the law, the Michigan Department of Treasury in 2014 estimated that $300 million in sales taxes for online retail transactions would still go uncollected annually as of 2017. Another $168 million would go uncollected on mail order sales as of the state’s 2017 fiscal year, according to the Treasury Department analysis that assumed mail order retailers collected taxes on a little more than one-third of sales to Michigan residents.
The law would result in the state generating $60 million in tax revenue in the 2016 fiscal year and $62 million in the 2017 fiscal year, the Treasury Department estimated.
“The Michigan law only captures a small fragment of the business that’s going on,” Drumm said.
Nationally, the federal Government Accountability Office in December estimated that state and local governments could have generated $8 billion to $13 billion in 2017 if states had the authority to require remote sellers to collect sales taxes.
That amount of money has been driving states to push the issue, said attorney Michael Antovski, a partner at Detroit-based Bodman PLC.
“At the end of the day, it’s really the states that are looking to benefit and capture more revenue,” Antovski said.
What the Supreme Court decides in the case has implications for more than retailers.
Commercial realtors who represent tenants and owners of shopping malls and retail centers are watching the case as well.
Brick-and-mortar retailers are adversely affected when competing against online sellers that have a different threshold for when they have to collect sales tax on purchases, said Jeff Hainer, senior research analyst in West Michigan for Colliers International.
That in turns affects a retail store’s bottom line and its operator’s ability to afford rent, especially in a market like Grand Rapids that has a low vacancy rate and high lease costs.
“We want physical brick-and-mortar retailers to be as healthy as possible,” Hainer said. “If we can just level the playing field, we feel there’s a large benefit to brick and mortar because we see the demand and a huge desire to go to a store, but when you start having a discrepancy in pricing just because of the channel, it’s hard to compete.”
A MATTER OF SCOPE
In deciding the case involving South Dakota and Wayfair, justices could uphold the 1992 precedent that remote sellers must have a physical presence before a state can require them to collect sales taxes. Or the court could rule that the requirement no longer applies in the e-commerce era and that an “economic presence” is enough, said tax attorney Wayne Roberts of Varnum LLP in Grand Rapids.
In the latter instance, if the Supreme Court were to strike down the physical presence requirement, justices also could decide that the threshold in South Dakota law is not enough of an economic presence in the state to require online retailers to collect sales taxes, Roberts said.
Roberts doubts that justices would ever establish a new threshold, noting that he expects the court will only rule on what the South Dakota law requires.
“The United States Supreme Court is not in the business of writing rules, usually,” he said. “The statute in front of them has a threshold, and they may rule on that threshold only.”
If justices were to rule that an “economic presence” is enough for a state to compel a remote seller to collect sales taxes, it would recognize the revolution that the internet triggered beginning in the mid 1990s.
When establishing the 1992 precedent, the court could not envision the emergence of e-commerce in the years ahead, nor what the industry would become, Bodman’s Antovski said.
“The paradigm of sales has changed from 1992,” he said. “Who would have envisioned in 1992 that we would buy literally everything, even kitchen sinks, online?”
QUESTION FOR CONGRESS
Forrester Research Inc. last August predicted that online sales in the U.S. for 2017 would top $459 billion and account for 17 percent of total retail sales by 2022.
For example, defendant Wayfair in February reported 2017 sales of $4.6 billion, a 42.5-percent increase from 2016.
A reversal of the 1992 ruling could create uncertainty unless Congress steps in and enacts federal legislation that resolves the matter. Past efforts to enact such legislation repeatedly failed to gain the support needed to pass.
Lacking congressional action, myriad state rules now dictate when remote sellers must collect sales or use taxes. Setting aside the 1992 ruling could muddy the issue further without subsequent action by Congress.
“If they just say ‘physical presence’ is no longer the test, then I think we’re open to whatever the states come up with as the threshold, and each one will have to be tested,” Roberts said. “If this ‘physical presence’ and the court requirement is eliminated … how many different rules will there be and how many different cases will need to be litigated?”