Texas stands to gain from increased sales tax revenues after the Supreme Court today reversed an earlier ruling that had barred states from taxing out-of-state online retailers, including third-party retailers on Amazon who have hitherto dodged state taxes.
Amazon shares dropped 1.3% on Wall Street after the Court announced its ruling Thursday morning, as did shares of online retailer Wayfair, which lost the lawsuit against the state of South Dakota in the 5-4 ruling South Dakota v. Wayfair.
Justice Anthony Kennedy, in the court’s majority opinion, ruled that a “physical presence” rule established by the Court in 1992 no longer applied. “Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court’s precedents. This Court should not prevent States from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the State,” he said.
The 1992 ruling in Quill Corp. v. North Dakota effectively had prevented states from collecting sales tax on retail purchases made over the Internet or by mail-order catalog, unless the retailer had a physical presence in the state. The ruling, Kennedy says now, was “flawed” and based on an “arbitrary, formalistic” definition of physical presence. “In 1992, less than 2 percent of Americans had Internet access,” he explained. “When it decided Quill, the Court could not have envisioned a world in which the world’s largest retailer would be a remote seller.”
George Kelemen, president of the Texas Retailers Association, hailed the decision in an interview with Honest Austin, saying that it will help Texas businesses significantly as well as bring tax revenues to the state. “Texas is a big sales tax state. Other than a few online companies who are voluntarily remitting sales tax receipts you’ve got a lot of folks that have been selling product at a minimum of 8.25% cheaper than you could get it in-state,” he said.
The Texas Comptroller’s Office has estimated that Texas loses $1.1 billion in uncollected sales tax every year from untaxed online shopping sales. That compares to total state revenues of $111bn in 2017, meaning that by taxing online sales that state could grow its revenues by 1% once online retailers start to pay tax. Texas Attorney-General Ken Paxton had filed an an amicus brief to the Supreme Court arguing that the 1992 Quill ruling “disrupts the States’ right to respond to economic realities and impose lawful taxes in the absence of contrary federal law.”
According to the U.S. Department of Commerce, more than 13 percent of all retail sales in the U.S. are online, at an estimated $450 billion.
In oral arguments in April, lawyers for online retailer Wayfair had argued that a ruling against their client would impose unrealistic compliance burdens on small online merchants. According to Tax Foundation, a D.C.-based thinktank, there are more than 10,000 sales tax jurisdictions in the United States and this “can make tax compliance overwhelming if you operate a business online… Each jurisdiction has a distinct aggregate sales tax rate based on a unique combination of factors, including sales taxes levied by taxing authorities at the state, county, city, and district levels.”
In oral arguments in April, Marty J. Jackley, South Dakota’s attorney general, argued that out-of-state retailers could use modern software to deal with the complexities of calculating and collecting taxes for thousands of state and local jurisdictions.
This arguments appears to have been accepted by Justice Kennedy in his opinion. He wrote, “Eventually, software that is available at a reasonable cost may make it easier for small businesses to cope with these problems. Indeed, as the physical presence rule no longer controls, those systems may well become available in a short period of time, either from private providers or from state taxing agencies themselves. And in all events, Congress may legislate to address these problems if it deems it necessary and fit to do so.”
Dino Marcaccio, a former Texas state auditor, writing before the Wayfair ruling, predicted that a win for South Dakota and the states “could be a potential nightmare scenario for online retainers, especially the smaller ones. Imagine each sales tax state forcing every online retailer to register and collect tax.”
However, Justice Kennedy said he considered that the South Dakota sales tax law “affords small merchants a reasonable degree of protection. The law at issue requires a merchant to collect the tax only if it does a considerable amount of business in the State.” Online retailers selling less than $100,000 in the state are exempt.
Asked whether today’s ruling could hurt small businesses because of the compliance burden, Kelemen, who represents Texas retailers that have both brick-and-mortar operations and online operations, said that the ruling creates a “level playing field.” “Whether you’re a little guy that has a store on the corner or a little guy who sells online,” everyone now needs to pay the same taxes. “This is the law catching up to how retail should work.”
Amazon, the largest online retailer, began paying sales taxes in Texas in mid-2012 after reaching an agreement with the state whereby Texas forgave it $269 million in claimed back sales taxes. However, a loophole based on the now-overturned physical presence requirement allowed an army of third-party retailers to use Amazon’s platform to continue shipping products to Texas customers while avoiding sales taxes.
“It definitely changes it for the third-party retailers. Now everyone will be captured under the requirements. Now it’s about competing,” Kelemen said of the Amazon sellers.
The losing respondents in the Supreme Court case decided today are Wayfair, Inc., a leading online retailer of homegoods, Overstock.com, a top online retailer, and Newegg, Inc., an online electronics dealer.
Kelemen says it is “too early to tell” whether the Texas legislature or comptroller’s office will need to make changes to existing laws or regulations in order to take advantage of the tax benefits to the state provided by the today’s ruling. He says his group will be studying the issue to determine whether to lobby for new legislation on the issue or not.
