Local Tax Challenges After the Wayfair Case
February 22, 2022
By Nikki Dobay, partner with Eversheds Sutherland, and formerly senior tax council for the Council on State Taxation (COST)
As more retailers embraced the internet to sell their wares, states grew concerned about forgone sales tax revenues. A well-known 2018 court case, South Dakota v. Wayfair Inc., helped to alleviate some of these concerns, but nothing is ever simple. And as time has passed, it has become clear that multistate taxpayers have to contend with enormous compliance issues.
By way of background: Prior to the Supreme Court’s decision in Wayfair, the actual physical presence of a business was required for a state to levy transactional taxes. In tax circles, this is referred to as establishing nexus. Wayfair overruled the physical presence requirement at the state level, though it did not establish a new bright-line test to clarify when tax collections were permissible.
Specifically, the Court ruled that thresholds for taxation of transactions with out-of-state firms, for taxpayers in South Dakota (a $100,000 purchase or 200 separate transactions) did not violate the substantial nexus standard. This overruled its long-standing physical presence test under the Commerce Clause.
While the Court recognized that unrestricted virtual presence may create an undue burden on taxpayers, it found that the thresholds contained in South Dakota’s law, along with other features of South Dakota’s sales tax regime were sufficient to prevent discrimination and undue burdens from being imposed on non-physically present corporate taxpayers. Among those features specifically noted by the Court was South Dakota being one of more than twenty states that had adopted the Streamlined Sales and Use Tax Agreement (SSUTA), which standardizes tax administration and compliance by requiring state-level administration and providing uniform definitions of products and services as well as simplified rate structures.
Because the Court did not ultimately determine the constitutionality of South Dakota’s law, it did not provide a generally applicable nexus standard to replace the physical presence standard. Nonetheless, the Court did recognize that there are limits on the ability of states to impose sales tax collection obligations on out-of-state retailers, and that “[o]ther aspects of the Court’s doctrine can better and more accurately address any potential burdens on interstate commerce.”
Here the Court looked to the “balancing framework,” which was provided in a prior case that established that a law only incidentally affecting interstate commerce will satisfy the Commerce Clause unless the burden is “clearly excessive” when compared with the benefits the law provides. As a result, if there is a legitimate local purpose, the question of whether the law places an undue burden on interstate commerce becomes one of degree.
Thus, following Wayfair, questions remain regarding its application in states that have neither adopted the SSUTA nor have provided other simplification solutions for tax compliance and administration at the local level.
While it is not unreasonable for a multistate taxpayer to be on notice of state-level taxes, the sheer number of local jurisdictions that impose taxes makes it much more challenging for these taxpayers to effectively track—especially without a physical presence in the locality.
This is particularly true as more local jurisdictions have adopted non-traditional, new taxes or have imposed new collection requirements at the local level (i.e., targeted gross receipts taxes or requiring collection by a marketplace for local occupancy or lodging taxes).
Considering the significant time and cost required to comply at the local level due to the vast number of local jurisdictions (approximately 11,000 currently), and the fact that a transaction may be subject to multiple local taxing jurisdictions simultaneously, the burdens are substantial, and states that authorize local-level tax administration should be mindful of the potential constitutional issues created by requiring local-level tax remittance. A court may find these burdens excessive and sufficient to support a constitutional challenge. At least one such challenge has already been initiated in Louisiana, and it would not be surprising if others followed.
Ultimately, locally administered taxes may be the next frontier in substantial nexus litigation and the countless permutations of locally administered taxes means we may not have a final answer for quite some time. Ideally. states would mandate state-level administration of all local taxes to address the burdens created by local-level administration.
Alternatively, states could call for the creation of and requirement that local jurisdictions use a cooperative portal through which taxpayers may remit taxes. Examples of such a portal would be Colorado’s Sales and Use Tax System (SUTS) or the Alaska Remote Sellers Sales Tax Commission (ARSSTC). State laws requiring local taxes to be remitted to a centralized cooperative portal would significantly reduce the attendant compliance burdens, which in turn is likely to reduce to the probability of a successful constitutional challenge.
The contents of this blog post reflect those of the author, and not necessarily those of the GFRC.