The times they are a-changin': States challenge long-standing sales tax nexus standards

At the beginning of this year, the Iowa Department of Revenue (“Department”) announced that Amazon customers located in Iowa will likely begin to pay an additional six percent (or seven percent in local option sales tax areas) sales tax on their purchases from Amazon. This is not technically a tax increase on customers due to the complementary use tax that customers were previously required to pay (see Back to Basics: Iowa Use Tax), but I have received many questions about what triggers a company’s sales tax collection requirement. The short answer is that a company is only required to collect sales tax if it has “nexus” in a state. Of course, it is more complicated than that.   

Historically, nexus for sales tax purposes (there are different nexus standards for state income tax), required physical presence, such as a “sales force, plant, or office.” Quill Corp. v. North Dakota, 504 US 298 (1992).  Thus, because many online retailers do not have physical presence in all 50 states, many online retailers are not required to collect sales tax in a significant number of states. The United States Supreme Court in Quill stated that “it is not unlikely that the mail order industry's dramatic growth over the last quarter century is due in part to the bright line [physical presence] exemption from state taxation.” Indeed, we have seen explosive growth in online shopping since Quill was decided in 1992. As a result of the online industry’s growth, Justice Kennedy recently hinted that it might be time to review the sales tax nexus standards.    

In Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2015), where the Supreme Court considered a technical issue regarding the Tax Injunction Act, Justice Kennedy’s concurring opinion suggested that it was time to “reconsider. . . the Court’s holding in Quill.” Id. at 1135 (Kennedy, J., concurring). Justice Kennedy noted the “far reaching systemic and structural changes in the economy” since Quill and that

there is a powerful case to be made that a remote seller doing extensive business within a State has a sufficiently ‘substantial nexus’ to justify some minor tax collection duty, even if that business is done through mail or the Internet.

Id. at 1134.  Finally, Justice Kennedy called on the Supreme Court to “find an appropriate case . . . to reexamine” the sales tax nexus standards. Id. at 1135.  Not coincidently, subsequent to Justice Kennedy’s concurring opinion in Direct Marketing Association, a few states have enacted or proposed legislation or administrative rules that fly directly in the face of Quill.

Since October 2015, Alabama, South Dakota, and Tennessee have enacted administrative rules or statutes setting economic nexus standards for out-of-state retailers making sales in the state. 

Alabama: Effective January 1, 2016, an entity is deemed to have sales tax nexus and collection requirement, even though it lacks physical presence, if it has over $250,000 in sales into the state and conducts one or more listed activities, some of which do not require physical presence.

South Dakota: Effective May 1, 2016, all entities with annual sales into the South Dakota greater than $100,000 or more than 200 separate transactions in the state are deemed to have sales tax nexus and collection requirement. Three out-of-state sellers challenged this law; on March 6, 2017, the Hughes County Circuit Court struck down the law, finding that the nexus standards of Quill are controlling. The state is expected to appeal the decision to the South Dakota Supreme Court. 

Tennessee: Effective January 1, 2017, out-of-state dealers with no physical presence in Tennessee who engage in regular and systematic solicitation, by any means, of consumers in Tennessee and who make sales exceeding $500,000 to Tennessee consumers during the previous 12-month period are deemed to have nexus and a collection requirement.

Wyoming, Nebraska, and Mississippi have all introduced legislation, which could become effective in 2017, adopting economic nexus standards.     

As of the date of this blog, Alabama and South Dakota’s statutes and rules have been challenged as violating, among other things, the physical presence standard espoused by the Supreme Court in Quill. Both cases are in very early stages, but are expected to be appealed to the Supreme Court. Updates will be provided on this blog as they become available. It is expected that Tennessee’s administrative rules will be challenged as well.

Iowa-based retailers selling into Alabama, South Dakota, and Tennessee should be aware of the issues raised by these changes. Additionally, although Iowa has not proposed or enacted laws challenging Quill, a decision by the United States Supreme Court could drastically change sales tax nexus standards. Such a decision could result in sales tax collection responsibility in states in which the retailer has never stepped foot.

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.

- Cody Edwards