Supreme Court Delivers Heavy Blow To Online Retailers But Amazon Remains Ahead Of The Curve

Some at Amazon must be chuckling at a recent Supreme Court decision that dealt a major blow to most online retailers.  The Court’s decision vindicates a gutsy move by Amazon to voluntarily seek to pay millions in sales taxes annually.

The decision, South Dakota v. Wayfair, overturned a prior legal precedent that prohibited states from mandating out-of-state online retailers collect and remit sales tax for purchases made by the states’ residents.  Now, the Wayfair decision provides a mechanism for states to mandate online retailers collect sales tax even if the online retailer lacks a physical presence within the state.

Amazon’s History Fighting Sales Tax

Several years ago, the online retailing giant Amazon was fighting a similar battle.  Amazon fiercely resisted collecting sales tax on transactions where Amazon lacked a physical presence in the particular state.  After losing  battles legislatively where Amazon would be forced to collect and remit sales tax if it maintained an in-state associate network, Amazon gutted its associate network. At first, it appeared to be a nuclear option.  Instead of collecting sales tax on sales, Amazon lopped off a significant chunk of its (re)seller’s network.

Shortly thereafter, Amazon appeared to reflect on current events, seeing the “writing on the wall” that continuing to fight against sales tax collection would eventually prove to be a futile (as the current Wayfair decision highlights). Instead of fighting the seemingly inevitable, Amazon changed its strategy.  It acceded to states’ tax authority and made massive “boots on the ground” investments, among other things, building distribution centers in states where just months before it had refused to collect sales tax. Amazon now collects sales tax on a significant portion of its overall sales (but not all sales from third-parties made within Amazon), which it remits to individual states. At the same time, Amazon has built an infrastructure that provides it a competitive advantage in many markets to deliver goods within a short period of time (e.g., Prime Now’s two hour delivery).

Consumers Should Brace For Paying Sales Tax On Internet Transactions

The recent Wayfair Supreme Court decision appears to highlight how Amazon is a step ahead of its online retailers. Many other online retailers, including Wayfair, have appeared willing to stick with the traditional e-commerce website model with operating as few warehouse/fulfillment-based physical sites as possible to limit the potential of having to collect sales tax.  Now the Wayfair decision paves the way for significant changes in the ways online retailers will compete for business.

While Wayfair previously trumpeted that no tax was payable for its transactions (a techniques the Wayfair decision noted was akin “to assist[ing] in tax evasion” because consumers rarely paid the mandated use tax on internet purchases), Wayfair transactions now appear they will be taxable at least in the state of South Dakota.  The law at issue mandated the collection of sales tax where an online retailer had over $100,000 in annual sales or 200 transactions annually. The Supreme Court determined such a law was legitimate if: (1) there is a substantial nexus between the taxed activity and the state (e.g., where a retailer avails itself to the privilege of carrying on business within the state), (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the state provides.

Supreme Court Decision Will Hurt E-Commerce Business And Start-ups

The Wayfair decision represents a marked shift in past precedent that could have a large impact on modern commerce.  Local “bricks and mortar” businesses will certainly applaud the decision as long overdue, and help them compete better on price with their internet rivals.  Online retailers no longer will have an automatic competitive price advantage related to not charging sales tax (which in some states exceeds 7%).

Online retailers will also be increasingly forced to abide by the patchwork of individual states’ laws related to the charging and remittance of sales tax.  States now have a strong judicial backing to enact laws that mandate out-of-state e-commerce businesses charge and remit sales tax. The Supreme Court seemed unsympathetic to the logistical challenges for e-commerce businesses.  Instead, the Court identified the decision as presenting an opportunity for software developers to produce software solutions for online retailers who will now be forced to comply with an array of individual states’ tax laws.

One of the Wayfair decisions most troubling consequences is that it may stifle small start-up e-commerce businesses.  While states like South Dakota provided leeway for out-of-state online retailers with less than $100,000 in annual sales or 200 transactions per year to not collect sales tax, other states’ laws will be less forgiving.  For example, Minnesota’s current law only provides an exception where total annual sales are under $10,000.  State taxing authorities, including in Minnesota, are in the process of offering additional guidance of how the Wayfair decision will impact state tax laws.

Bottom Line

E-commerce businesses, in particular, are now faced with greater hurdles and costs involved with tax compliance. Simply conducting business in another state through the sale of goods from the Internet may be enough to trigger tax consequences.  E-commerce businesses should pay close attention to the guidance and seek professional legal and accounting assistance to comply with the applicable laws.

Jon L. Farnsworth is an attorney at Felhaber Larson.  He regularly works with technology and e-commerce companies.