Will Landmark SCOTUS Sales Tax Ruling "Level The Playing Field"
Or Create New Problems?
IN A NARROW 5-4 RULING issued on June 21, the U.S. Supreme Court struck down the law that had allowed mail order retailers to skirt collecting sales tax for nearly three decades. Writing for the majority, Justice Anthony Kennedy said that basing sales tax collection on having a physical presence in a state was "unsound and incorrect" and failed to account for a technological upheaval that "upended the retail landscape." At first glance, the Court ruling seems to answer the prayers of brick-and-mortar retailers who have long complained about the unfairness of competing with mail order retailers that did not have to collect sales tax. However, the uncharted waters of cross-border sales tax collection may introduce entirely new and unwelcome problems, so it's prudent to hold off on the celebration.
   First, a little background on the origins of the mail order sales tax loophole, and a few thoughts on what may lie ahead. In 1992, the State of North Dakota sued Quill, a Minneapolis-based seller of office products, demanding unpaid sales tax. The State argued that the thousands of catalogs Quill mailed into North Dakota constituted an "in-state presence," and thus the retailer was responsible for collecting and remitting sales tax. Quill's legal team dissented vigorously all the way to the Supreme Court. Justice John Paul Stevens ultimately ruled in favor of Quill. Citing the Constitution's Commerce Clause, he argued that to be liable for sales tax, a business had to have a physical presence in the state that included some combination of personnel and facilities. Catalogs apparently didn't count. In his ruling, though, Stevens left the door open for Congress to draft legislation that would either redefine what constituted a physical presence or enable some type of cross-border tax collection. Twenty-four years later, no meaningful legislation addressing the issue has been produced, although numerous states, including New Jersey, New York, and Connecticut, have established reciprocal sales tax collection agreements.
   In the absence of legislation, the issue was reopened earlier this year in South Dakota vs. Wayfair, a case very similar to the 1992 Quill case. South Dakota argued that the numerous independent merchants who sold housewares through the Wayfair digital marketplace owed an estimated $50 million in unpaid sales taxes. They reasoned that the Wayfair website, app, and cookies, which resided on computers and tablets throughout the Mount Rushmore State, constituted an "in-state" presence. Justice Kennedy and four of his colleagues apparently agreed, effectively ruling that all cross-border mail order transactions could be subject to sales tax.
   A Supreme Court decision is not to be confused with tax policy. Although Kennedy's ruling gives states the right to tax mail order transactions, how they decide to implement that right is the prerogative of the legislature. Given the vagaries of the lawmaking process, the potential for unintended consequences is significant. Kennedy wrote that the South Dakota statute limiting sales tax collection to retailers with in-state sales of more than $100,000 or 200 transactions annually was "fair and reasonable." Lawmakers in the 47 states that currently collect sales tax could possibly define "fair and reasonable" differently.
   The process of translating a Supreme Court ruling into law raises a host of questions. Will revenue-hungry states launch sweeping nationwide efforts to collect taxes from out-of-state merchants? Will they be emboldened to use extra-harsh methods, knowing that their distant targets would not have any recourse in the voting booth? How about the case of a music dealer with a brick-and-mortar store who generates 35% of his revenue on eBay and Reverb? What would his reaction be when ten states sent bills for unpaid sales taxes, along with additional fines and penalties? Will the administrative cost to calculate and remit appropriate sales tax to the 2,000-plus distinct jurisdictions force smaller retailers to abandon online sales, either on their own site or on digital marketplaces? Is there any accessible software that can help manage compliance?
   While waiting for answers to these and numerous other questions, we'd suggest that the Supreme Court ruling may not alter the competitive balance between brick-and-mortar and online sellers. For starters, avoiding sales tax is just one reason customers shop online; it's certainly not the only reason. Furthermore, with the exception of a handful of high-end piano retailers, every store in our annual Top 200 ranking is an online seller to one extent or another. They either sell through their own sites or on various online marketplaces. Consequently, with the newly "leveled playing field," they may face serious and costly tax compliance issues. Ironically, the court's decision will have no impact on "mega-retailers." Amazon, Wal-Mart, Target, and numerous others are already collecting and remitting sales tax nationwide. The burden will fall disproportionately on small businesses, which include the vast majority of music retailers.
   Retail is retail whether it's done over the counter or on a website. Since basic fairness dictates according similar legal treatment to similar activities, it follows that if brick-and-mortar retailers are responsible for collecting sales tax, so should their online competitors. Unassailable logically, but how it plays out once state taxing agencies get involved is anyone's guess. Will brick-and-mortar retailers regain a competitive edge with the playing field "leveled?" Or, will they face unforeseen liabilities and extra administrative cost complying with out-of-state agencies? Let's hope for the former, but prepare for the latter.
Brian T. Majeski