A recent court decision is a win for commercial real estate, brick-and-mortar businesses, and state and local governments alike, bringing similar taxes to online and brick-and-mortar transactions.
In June, the U.S. Supreme Court issued a long-awaited decision in the case South Dakota v. Wayfair Inc., holding that states have the authority to tax online purchases even if the retailer does not have a physical presence in the state. The South Dakota law allowed state sales tax to apply to online transactions from retailers with more than 200 annual transactions or $100,000 in sales per year in the state. The opinion by Justice Kennedy, and joined by justices Thomas, Ginsburg, Alito, and Gorsuch, overturned a 1992 decision, Quill Corp. v. North Dakota, requiring retailers to have a physical presence to mandate the collection of state sales taxes on purchases.
When Quill was decided, the Supreme Court was not even addressing online sales -- these were still a figment of most Americans' imaginations. In 1992, less than 2 percent of Americans had internet access and very few could imagine how quickly our economy would transform to include digital purchases. With the revolution in e-commerce, the challenge by Wayfair, Overstock.com, and Newegg to the South Dakota law provided a timely opportunity for the court to revisit the physical presence requirement that has had its share of critics over the past 26 years.
Physical Presence Requirement Overturned
Quill decided that merchants lacking a physical presence in a state were exempt from having to pay a sales tax in that state. The Quill court, in addressing purchases through mail-order businesses, did not think that mailing goods across state lines was significant enough a nexus, under the Commerce Clause, to allow taxation without a physical location.
Times have changed. In the Wayfair opinion, Justice Kennedy used the example of two different online furniture businesses. The first business might have a small warehouse in South Dakota stocking a very limited selection of inventory. A second business could have a huge warehouse, just over the state border in Nebraska, and an elegant virtual showroom with a sophisticated and robust online presence. Before South Dakota's legislation that prompted South Dakota v. Wayfair, a South Dakotan would pay sales tax on the first purchase, but not the second. The court found this distinction unfair and not reflecting the realities of today's digital economy.
Leveling the Playing Field
Exempting e-commerce purchases gives online retailers a competitive advantage over their brick-and-mortar counterparts. As Justice Kennedy noted in the Wayfair opinion, the physical presence rule “produces an incentive to avoid physical presence in multiple States. Distortions caused by the desire of businesses to avoid tax collection mean that the market may currently lack storefronts, distribution points, and employment centers that otherwise would be efficient or desirable.” This distinction created an online sales tax loophole especially unfair to local brick-and-mortar businesses that already might be struggling to compete with their digital counterparts.
“Like the retention of 1031 exchanges in tax reform, this decision is another win for commercial real estate and demonstrates the significant impact CCIM members can have on public policy that affects both our livelihood and our communities,” says Drew Showfety, CCIM, chair of the CCIM Government Affairs Committee. Over the past several years, CCIM Institute and the National Association of Realtors have been advocating for online taxation parity in collaboration with a coalition of like-minded association and industry partners.
Opposing Concerns
Opponents of the decision argue that taxing online sales places an undue burden on small internet retailers, who will struggle to administer tax collection in various jurisdictions. Critics have emphasized the logistical complexities of such tax collection and the difficulties this will pose for small internet entrepreneurs. The Supreme Court's dissenting opinion expressed that Congress should have legislated an appropriate online sales taxation standard, not the judicial branch. Several e-fairness bills have been introduced in Congress over the past several years, but none were enacted. Since the South Dakota v. Wayfair decision was released, opponents of the decision have introduced legislation in Congress to reinstate the physical presence standard on e-commerce purchases.
South Dakota Law as Model
The South Dakota law addresses the undue burden concern by exempting small businesses with fewer than 200 annual transactions or less than $100,000 in sales per year within South Dakota. Justice Kennedy acknowledged that the multitude of taxing jurisdictions could create a difficulty for extremely small businesses that lack the accounting and operational capacity to manage such challenges. While software can facilitate collecting sales tax in multiple taxing jurisdictions, the court agreed that the South Dakota law adequately addresses this potential logistical burden for small online retailers. Other states are expected to follow suit, with similar restrictions on the taxation of small online merchants. Currently, about 20 states have passed legislation requiring only an economic nexus, not a physical presence, for state sales tax application.
Win for State and Local Governments
Not taxing internet sales as they increasingly have replaced brick-and-mortar retail has resulted in a significant decline in sales tax revenue for state and local governments. In a 2016 study, the National Conference of State Legislators, in conjunction with the International Council of Shopping Centers, estimated that states lose nearly $26 billion annually in sales tax revenue from remote purchases. The court cited a study estimating closer to $33 billion in annual lost revenue.
The ramifications of this lost revenue can be felt in several different ways. States must make up for this lost revenue in higher taxes elsewhere or through the cutting of public services and amenities. The ability to require the collection of sales tax on online purchases will help fill these gaps, but the changes will not happen overnight. Some states have passed legislation similar to that of South Dakota's or have such legislation pending in their legislatures, but other states will take a little longer to get such legislation enacted.
Commercial Real Estate Impact
Some online retailers who might have considered opening a brick-and-mortar location could have decided against such a location due to Quill's physical presence standard. Now that the Supreme Court has eliminated this requirement, businesses might be more inclined to open a physical retail location to complement their online presence. Decisions to close or not open a brick-and-mortar retail location had a profound and complex impact on communities. Not only did communities lose out on tax revenue, but physical retail locations often are community institutions that anchor a community's identity and sense of place.
“We see two major impacts of the ruling to retail in our communities,” says Jennifer Platt, vice president of Federal Operations for the International Council of Shopping Centers in New York. “First, is the psychological impact on consumers no longer being led to believe that shopping online is tax-free. Second, is the functional impact on online retailers who have not wanted to create a physical nexus by building out a brick-and-mortar presence. That dynamic has been wiped away with the Wayfair decision,” Platt says.
These economically equivalent transactions now will bring similar tax consequences and support a level playing field for local in-store retailers and remote merchants alike.