Earlier this year, the Supreme Court decided on the much-anticipated case of South Dakota v. Wayfair, 585 U.S. ___, 138 S.Ct. 2080 (2018). At issue was the validity of a statute applying sales tax to internet retailers that had very limited economic nexus to the state (i.e., without property or employees in the state). By finding in favor of South Dakota, the Supreme Court upheld the legality of the statute and set important precedent in the state sales tax arena. The decision effectively overrules the previous standard requiring some physical presence in a state in order to establish economic nexus for tax purposes. For many online retailers that conduct sales remotely or through the internet, this decision could signal not only an increased tax burden, but could also increase the future potential for audit in Maryland.
Required Economic Nexus Prior to Wayfair: The Quill Standard
In order to understand the impact of Wayfair, it is necessary to review the state of the law prior to the decision. Prior to the decision, states were limited by the constitutional limitations explained in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). There, pursuant to a North Dakota statute, businesses were required to collect and pay use tax on sales shipped into the state. Quill Corporation, which was incorporated in Delaware, had no physical presence in North Dakota and had no employees in North Dakota. Instead, Quill Corporation sold office equipment and stationary within North Dakota through solicitations by catalog, flyers, advertisements, and phone calls. Deliveries were shipped directly to customers through common carrier.
The Supreme Court analyzed the statute’s validity under both the due process clause and the Dormant Commerce Clause. Even though the statute passed the minimum contacts test necessary to pass muster under the due process clause, the statute failed with respect to the Dormant Commerce Clause. In particular, the court relied on Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) and National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967) in finding that a business, such as Quill Corporation, whose sole contacts with a state are by mail or common carrier lack substantial nexus under the Dormant Commerce Clause. Accordingly, since the statute in Quill did not require sufficient economic nexus as applied, the Supreme Court ruled that Quill Corporation was not required to collect and remit use taxes on purchases by those from North Dakota. In other words, Quill dictated that states needed to show some physical presence with respect to a transaction or taxpayer in order to impose sales tax.
The Decision in Wayfair: Expansion of Economic Nexus Test
All of this changed as a result of Wayfair. With the evolving methods of doing business in the information age, many states passed legislation aimed at upending Quill. Additional legislation was passed as a result of a concurring opinion authored by Justice Kennedy in Direct Marketing Ass’n v. Brohl, 575 U.S. __, 135 S.Ct. 1124 (2015). Though that opinion did not change the decision of Quill, Justice Kennedy noted that “it is unwise to delay any longer a reconsideration of the Court’s holding in Quill” and that e-commerce sales now exceeded $3.16 trillion annually. These comments were seen by many as an announcement that Quill could, or would, be overturned if decided again. As a result of that concurring opinion, South Dakota passed legislation requiring that those with sales in excess of $100,000 or with more than 200 different transactions to residents were required to collect taxes, regardless of physical presence. (Many other states passed similar legislation.) As might be expected, South Dakota argued that this was necessary as consumer compliance rates in remitting sales tax, where not collected directly from the vendor, were extremely low and that Quill effectively put out-of-state retailers at an unfair competitive advantage to intrastate or brick-and-mortar retailers.
Those vendors affected by the South Dakota legislation, including Wayfair, challenged its application. At both the state trial and appellate court levels, decisions were rendered in favor of Wayfair on the basis of the earlier Quill decision requiring physical presence. The case was eventually appealed to the United States Supreme Court for reconsideration of that decision. In Wayfair, the Supreme Court stated that the reasoning underlying Quill and National Bellas Hess was no longer sound and, therefore, overruled the effect of those decisions.
In doing so, the Supreme Court dictated that a tax statute must not discriminate against interstate commerce; however, statutes will be sustained as constitutional so long as they (1) apply to an activity with substantial nexus to the taxing state, (2) are fairly apportioned, (3) do not discriminate against interstate commerce, and (4) are fairly related to the services the state provides. Disposing of the Quill physical presence requirement, the Supreme Court stated that it did not “align analytically” with modern e-commerce and effectively created an arbitrary tax shelter for internet retailers. The Supreme Court dictated that “while nexus rules are clearly necessary,” they “should focus on rules that are appropriate for the twenty-first century, not the nineteenth.” Further, in Wayfair, the Supreme Court did not establish a bright-line test for nexus under the Dormant Commerce Clause. The Supreme Court merely stated that a taxpayer must “avail itself of the substantial privilege of carrying on business” in that jurisdiction to establish nexus. While the “economic and virtual” contacts of sellers of more than $100,000 in goods or services and over 200 transactions in a state clearly satisfy nexus requirements, as included in the South Dakota statute ruled upon, it is unclear if lesser thresholds could be established by states to satisfy the nexus requirement.
How Maryland Responded to the Wayfair Decision
While Wayfair effectively clarifies (and broadens) states’ abilities to tax out-of-state retailers and e-commerce, the effect of the decision requires a state-by-state review. As mentioned supra, Wayfair only decided that the statute in South Dakota passed constitutional muster. It is not clear if statutes attempting to expand nexus to more “remote” taxpayers will be treated similarly. Further, in order to have any impact, a state must still have statutory authority to levy taxes on those individuals or businesses. Many states have issued temporary guidance to provide clarification on the application of Wayfair and to increase the application of sales tax to out-of-state vendors. Maryland is one of those states.
In this regard, earlier this year, the Maryland General Assembly approved emergency regulations issued by the Comptroller of Maryland to implement Wayfair. These regulations took effect on October 1, 2018. Adopted at COMAR 03.06.01.33, those regulations provide generally as follows:
- Beginning on October 1, 2018, out-of-state vendors should track gross revenues and sales delivered into Maryland to determine if, on a calendar year basis, (a) gross revenues from the sale of tangible personal property or taxable services delivered to Maryland exceeds $100,000 or (b) sales of tangible personal property or taxable services delivered to Maryland took place in 200 or more separate transactions.
- If either the revenue or transaction threshold is met for the period from October 1, 2018 through December 31, 2018, economic nexus will be established and the vendor will be required to register to remit sales tax in Maryland and will be required to remit tax as soon as either threshold is met. (For future years, the period analyzed for economic nexus purposes will be the most recently concluded calendar year.)
- If economic nexus under these standards is established, sales tax must be remitted on a schedule determined by the Comptroller. In many cases, this will be monthly.
- If economic nexus under these standards is established before the end of a given month or year, registration with the Comptroller is required by the first day of the month after the threshold was met.
- The vendor is required to comply with these reporting and payment obligations until it can be shown that the vendor did not have economic nexus for the prior year (i.e., they did not satisfy either threshold requirement for the entire prior calendar year). Even if that occurs, the vendor will be required to re-register if the vendor later has economic nexus under these threshold tests.
In addition to the emergency regulations, the Comptroller has issued notices describing the application of these rules with explanatory examples. These examples show when registration and payment obligations can occur if a vendor is fluctuating above and below the thresholds on a frequent basis.
Impact of Wayfair on Those Conducting Business in Maryland
Given that the emergency regulations promulgated by the Comptroller of Maryland are based on the statute from South Dakota, which was deemed constitutionally valid in Wayfair, it is likely that they would withstand similar scrutiny if challenged. If additional state tax authorities litigate the issue, it is possible that the threshold to establish economic nexus could be reduced further. At this point and as provided by the emergency regulations, there is a “safe harbor” – set forth in the emergency regulations discuss supra – allowing certain retailers to avoid payment and reporting obligations. These regulations will only be enforced prospectively beginning on October 1, 2018.
Still, given the perceived tax gap caused by the constitutional standard prior to Wayfair, it is somewhat likely that the Comptroller will heavily target enforcement in this area – in the near-term, at the very least. It is still unclear whether businesses may be able to skirt the application of these rules through the use of affiliate or subsidiary businesses or by create determination of “a separate transaction.” It is also unclear whether the Comptroller will offer some sort of grace period or amnesty to promote compliance given the change this may have on unwitting retailers. Finally, it has yet to be seen whether the Comptroller will target smaller retailers, who use platforms such as Wayfair and Amazon to make sales in Maryland, but may not from their own sales trigger the dollar or transaction threshold.
At a minimum, affected (or potentially affected) vendors should understand that the scope of enforcement is less than certain and that the Comptroller can theoretically assess and collect tax from those owning or controlling entities involved in retail sales (e.g., officer liability) and can also seek substantial interest and penalties. Those engaging any level of e-commerce in Maryland should consider these potential effects and issues, which may not be obvious from the decision in Wayfair or Maryland’s emergency regulations. If these vendors to not pay heed, they could be forced to pay a substantial sales tax bill instead.