U.S. Supreme Court Says States Can Require Retailers Without Physical Presence to Collect Sales Tax

June 24, 2018 | Kristine A. Tidgren

The United States Supreme Court issued its opinion in South Dakota v. Wayfair on June 21, 2018. Read the Iowa Department of Revenue response to the Wayfair ruling here. Iowa will begin requiring larger online retailer to collect sales tax in 2019.

It is a question that has come before the United States Supreme Court on two prior occasions: When can a state require an out-of-state seller to collect and remit sales tax? The Court has twice found that the collection obligation turned on whether the seller had a “physical presence” in the state. But, this time, the answer was different. Recognizing that the Court’s prior decisions got it wrong, the Court in South Dakota v. Wayfair, Inc., No. 17-494 (U.S. Sup. Ct. June 21, 2018), overruled five decades of precedent to open the door for states to require out-of-state sellers to collect and remit sales tax, even when they do not have a physical presence in the state. This opinion is a game changer.

The South Dakota Law

It began in South Dakota, a remote state alleging that it loses $48 to $58 million annually in revenue because out-of-state sellers without a physical presence in the state fail to collect and remit sales tax. Although consumers are required to pay use tax when sales tax is not collected, they generally don’t. And without a state income tax, sales and use tax accounts for more than 60 percent of South Dakota’s general fund. In light of this climate, the South Dakota legislature in 2016 set out to challenge past Court precedent, passing S. 106, “An Act to provide for the collection of sales tax from certain remote sellers, to establish certain Legislative findings, and to declare an emergency.” The Act requires out-of-state sellers to collect and remit sales tax “as if they have a physical presence in the state.” The Act only applies, however, to sellers that deliver more than $100,000 of goods or services into the state or engage in 200 or more separate transactions for the delivery of goods or services into the state. The Act specifically states that it will not apply retroactively and that its enforcement will be stayed until its constitutionality is established. In passing the Act, the South Dakota Legislature declared an emergency, stating that the Act was necessary for the support of its government and essential services.

The South Dakota Challenge

Seeking a judicial ruling on the constitutionality of the new Act, South Dakota filed suit in state court against three large online retailers with no physical presence in the state—Wayfair, Inc., Overstock, Inc., and Newegg, Inc. None of these retailers collected sales tax from South Dakota consumers purchasing their products.  The State asked the court to declare the Act valid and require the retailers to collect and remit the sales tax. The South Dakota Supreme Court ruled that the Act was unconstitutional under U.S. Supreme Court precedent, but asked the Court to reconsider its prior decisions. On January 12, 2018, the U.S. Supreme Court granted certiorari.

Past Supreme Court Precedent

The specific constitutional question before the Court was whether a state violates the Commerce Clause[i] when it requires sellers without a physical presence in the state to collect and remit sales tax. Two principles guide the answer to all so-called dormant commerce clause questions: (1) state regulations may not discriminate against interstate commerce and (2) states may not impose undue burdens on interstate commerce. In applying these principles, the Court held in Complete Auto[ii] that it will sustain a state tax as long as:

  1. It applies to an activity with a substantial nexus with the taxing state
  2. It is fairly apportioned
  3. It does not discriminate against interstate commerce, and
  4. It is fairly related to the services the state provides

Two prior Supreme Court decisions have looked at the question of a “substantial nexus” in the context of out-of-state sellers. In Bellas Hess,[iii] a case decided before Complete Auto, the Court ruled that the State of Illinois had no power to require a large mail order retailer with no physical presence in the State to collect and remit sales tax. The Bellas Hess Court found that such requirement violated both the Due Process Clause and the Commerce Clause. Twenty-five years later, the Court affirmed its Commerce Clause holding in Quill.[iv] North Dakota had sought to require an out-of-state mail order company with no outlets or sales representatives in the State to collect and pay a “use tax” on goods sold to North Dakota consumers. The Quill court overruled the Due Process holding of Bellas Hess, but reaffirmed the physical presence rule.

The majority in Quill found that the physical presence rule was required to prevent undue burdens on interstate commerce. The Quill court grounded its physical presence rule in the Complete Auto requirement that the tax have a “substantial nexus” with the activity being taxed. The Quill decision was controversial, even in 1992. Three justices went along with the holding only because they didn’t wish to overturn past Court precedent. The lone dissenting justice, Justice White, argued that there was no relationship between the physical-presence/nexus rule and the Commerce Clause considerations that allegedly justified it.

South Dakota v. Wayfair, Inc.

Twenty-six years later, in Wayfair, a 5-4 majority embraced Justice White’s 1992 position and overruled Quill and Bellas Hess. Justice Kennedy, writing for the majority, stated that the physical presence rule was unsound and incorrect.

The Flaws of Quill

Quill, the majority found, was flawed on its own terms. (1) Physical presence was not a necessary interpretation of the “substantial nexus” requirement, (2) Quill created, rather than resolving market distinctions, and (3) Quill imposed the arbitrary, formalistic distinction that the Court’s modern commerce clause precedents disavow.

The Court explained that physical presence was not a good proxy for compliance costs that could burden interstate commerce. Under this standard, a smaller retailer with a single salesperson in each state is required to collect sales tax in every jurisdiction in which goods are delivered. A business with 500 salespeople in a central location and a website accessible nationwide, however, has no such collection requirement on otherwise identical nationwide sales.  Potential burdens on interstate commerce could be more accurately addressed in other ways, the Court stated.

The Court then asserted that Quill placed many local businesses at a competitive disadvantage relative to remote sellers. “In effect,” the court stated, “Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a state’s consumers, something that has become easier and more prevalent as technology has advanced.” “Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court’s precedents.”  

The Court finally explained that Quill has treated economically identical factors differently and for arbitrary reasons. It makes no sense, the Court explained, for two online furniture businesses to be treated differently because one maintains a small warehouse in South Dakota and the other maintains an identical warehouse across the river in Nebraska.  “The basic principles of the Court’s Commerce Clause jurisprudence are grounded in functional, marketplace dynamics and States can and should consider those realities in enacting and enforcing their tax laws.”

Physical Presence Rule Artificial

The Court declared that the physical presence rule was artificial in its entirety. The continuous and pervasive virtual presence of retailers today is simply irrelevant under Quill. The Court said that it should not maintain a rule that ignores these substantial virtual connections to the State. Finally, the Court acknowledged that Quill was an extraordinary imposition by the Judiciary on States’ authority to collect taxes and perform critical public functions.

The respondents argued that the Court should retain the rule because it has permitted start-ups and small businesses to use the internet without the complexity and burden of nationwide sales tax collection. The Court stated that Congress may legislate to address these problems if it deems necessary. But the South Dakota law at issue, the Court explained, requires tax collection only if the merchant does a considerable amount of business in the State. The Court then stated that “other aspects” of the Court’s Commerce Clause doctrine can protect against undue burden on interstate commerce, taking into consideration the small businesses, startups, and others who engage in commerce across state lines. Likewise, respondents argued that complex state tax systems could have the effect of discriminating against interstate commerce. The court noted that small businesses with only de minimis contacts could seek relief from collection systems thought to be a burden under other theories. But these issues were not before the Court in this case and the Court ruled that their potential to arise could not “justify retaining an artificial rule that deprives States of vast revenues from major businesses.”

Legal Framework Moving Forward

After directly overruling Quill and Bellas Hess, the Court stated that Complete Auto continues to provide the proper legal framework for Commerce Clause analysis of state taxation. The operative question, the Court explained, is whether the tax applies to an activity with a substantial nexus with the taxing state. Such a nexus is established when the taxpayer avails itself of the substantial privilege of carrying on business in that jurisdiction. This substantial nexus requirement of Complete Auto was met in the instant case because the South Dakota statute limited the sellers to which the tax requirements apply.

The Court noted that the South Dakota law also includes features appearing to prevent discrimination against or undue burdens upon interstate commerce: (1) a safe harbor to those who transact only limited business in South Dakota (2) no obligation to remit the sales tax can be applied retroactively, and (3) South Dakota is one of more than 20 states that has adopted the streamlined sales and use tax agreement, standardizing taxes to reduce administrative and compliance costs.

The court vacated the South Dakota Supreme Court’s order and remanded for further proceedings, noting that other claims regarding the application of the Commerce Clause in the absence of Quill and Bellas Hess could be first addressed on remand.


Justice Roberts—joined by three other justices—dissented. Although the dissent agreed that past precedent was wrongly decided, they urged that Congress, not the Court, should fix the problem. E-commerce has grown into a significant and vibrant part of the national economy against the backdrop of the established rules. As such, a change to those rules has the potential to disrupt a critical segment of the economy. Congress, not the Court, should make such a change, the dissent argued. The dissent also asserted that the harm of Quill has been receding in recent years as many large online companies, such as Amazon, are voluntarily collecting and remitting sales tax. The dissent focused on the potential harm to small businesses of the elimination of Quill, noting that there are over 10,000 jurisdictions leveling sales tax, each with different rates and rules. The dissent gave several examples, including Illinois categorizing a Twix candy bar as food and a Snickers candy bar as candy, each with different tax consequences. Justice Roberts wrote that an erroneous decision from the Court may have been an unintended factor contributing to the growth of e-commerce. Consequently, he stated, “I would let Congress decide whether to depart from the physical-presence rule that has governed this area for half a century.”

What Does the Wayfair Decision Mean for Retailers?

In the wake of Wayfair, states are free to draft laws requiring retailers without a physical presence in the state to collect and remit sales tax. This does not mean, however, that these laws are not limited by Commerce Clause considerations. The Court opinion, while not specifically ruling on all aspects of the Act, seems to suggest that South Dakota got it right. A law providing a safe harbor for smaller retailers with limited sales in the state, a protection against retroactive enforcement, and a streamlined administrative and collection process will likely pass constitutional muster. Some states will likely begin seeking to enforce sales tax laws already on the books against out-of-state retailers, particularly if the law contains a safe harbor for sellers with de minimis sales.

The larger question is whether Congress will step in to facilitate a nationwide framework for sales tax collection and remittance. As the majority noted in its opinion, software will likely become more accessible to smaller retailers, reducing the burden and cost of complying with sales tax remittance in thousands of state and local jurisdictions. And more states may agree to work together, as with the streamlined sales and use tax agreement to which South Dakota has subscribed. Even so, it appears we may be poised for a nationwide solution, ensuring that the concerns detailed by the dissenters, particularly with respect to smaller businesses, are not borne out.

In the meantime, online and mail order retailers that have not been collecting sales tax must watch the administrative and legislative activity of the states in which they do business closely. Lots of change is no doubt in store, and that change will come quickly.


[i] U.S. Const. Art. I, § 8, cl. 3

[ii] Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).

[iii] National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967)

[iv] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).