Substantial Nexus Post-Wayfair: How did we get here and where do we go?

wayfair, tax, nexus, ecommerce

On June 21, 2018, the United States Supreme Court overruled the “physical presence” bright-line rule for substantial nexus in its landmark decision South Dakota v. Wayfair. Its decision overruled 50 year-old precedent. The Court dug into the constitutional limitations on the states’ authority to impose sales tax collection on out-of-state retailers, as well as the practical ramifications of its ruling that businesses need not have a physical presence to be subject to tax collection and remittance requirements.



The physical presence requirement has its roots in the Commerce Clause, which grants Congress the affirmative power to regulate interstate commerce and also limits a State’s ability to regulate commerce. The negative limitation on states, known as the Dormant Commerce Clause, comprises two restrictions: 1) states may not discriminate against interstate commerce; and 2) states may not inflict undue burdens on interstate commerce.

In Complete Auto Transit, Inc. v. Brady, the Court laid out a four-prong test for analyzing the validity of a State’s taxation on interstate commerce. This test provides that state taxation is permissible under the Commerce Clause so long as it 1) applies to an activity with a substantial nexus to the taxing state, 2) is fairly apportioned, 3) does not discriminate against interstate commerce, and 4) is fairly related to the services the State provides. As to the substantial nexus prong, the Court had twice held that a company whose only connection to a state was through a common carrier lacked sufficient nexus for the state to impose a sales tax collection obligation. National Bellas Hess v. Dep’t of Rev., 386 U.S. 753 (1967) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Due to the heavy burden associated with sales tax collection, the Court found an in-state physical presence was necessary to prevent undue burdens on interstate commerce.

The physical presence requirement has shaped the way that retailers do business, especially since the dramatic rise in e-commerce and advanced technology. In response to Quill, several states entered into the Streamlined Sales and Use Tax Agreement (SSUTA) to make sales and use tax simpler and more uniform, reducing administrative compliance costs and removing the “undue burden,” of subjecting business with no physical presence to state tax. Yet, the SSUTA had not accomplished its objective, until Wayfair.

Especially in the last eight years, states sought to expand the scope of what constitutes substantial nexus and enacted statutes that tested the limits of the physical presence requirement. States experimented with click-through nexus, affiliate nexus, notice and reporting requirements, and “virtual presence” as a way to require retailers with pervasive online sales to collect and remit tax, even in the absence of an in-state brick-and-mortar presence. These laws were no substitute for the elimination of Quill’s physical presence requirement, but their consistent validity emboldened states to further challenge Quill’s ruling.

This leads us to South Dakota’s 2016 emergency enactment of an “economic nexus” statute which required remote sellers who either made at least $100,000 of sales or engaged in 200 separate transactions for goods or services delivered to South Dakota to collect sales tax. The statute, specifically designed to challenge Quill’s physical presence standard, included a fast-track appeals process and prohibited enforcement until a final determination that its economic nexus standard was constitutional. South Dakota filed for declaratory judgment against three major online retailers, Wayfair, Overstock and Newegg, with no physical presence in the state, and petitioned to the U.S. Supreme Court who granted certiorari.



The Court began with the history and evolution of the Dormant Commerce Clause and physical presence standard. With this background, the Court found “the physical presence rule of Quill is unsound and incorrect” because the requirement: 1) was not a necessary interpretation of Complete Auto’s substantial nexus requirement; 2) effectively created a tax shelter for sellers who limited their physical presence and impeded States’ ability to collect rightfully owed taxes; and 3) imposed an arbitrary distinction giving an unfair advantage to remote sellers with pervasive internet sales, while penalizing other sellers with even a minimal physical presences.

The physical presence requirement allowed remote sellers with a central physical location and expansive internet presence to avoid regulatory burdens and profit from their license not to collect tax. The rule provided such retailers with a competitive pricing advantage over local brick-and-mortar stores selling identical products. The Court denounced this distinction, stating that Quill’s holding served 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.” Moreover, technological advancements neutralize concerns as the costs of compliance have a tenuous connection to whether the retailer has a physical presence.

The Court found the physical presence requirement unworkable in our modern and digitized economy. Consumers are closer than ever to most major retailers regardless of the retailers’ closest physical storefront. As e-commerce exploded, and consumer compliance for remitting use tax is notoriously law, Quill impeded states’ revenue collection and limited their ability to perform other “critical public functions.” Although there are concerns about the burden of compliance for start-ups and small businesses who take advantage of Quill to grow their businesses, the South Dakota law provided acceptable safeguards to protect those smaller businesses ($100,000 or 200 sales into the state). In finding that South Dakota did not unduly burden interstate commerce, the Court emphasized three critical aspects of its economic nexus law: (1) safeharbor for small businesses; (2) no retroactive application; and (3) South Dakota is a party to the Streamlined Sales Tax Agreement and provides software excusing vendors’ collection errors resulting from such software.

The Court remanded the case to the South Dakota Supreme Court to analyze whether the law passes constitutional muster under the other three-prongs to comply with the Commerce Clause under Complete Auto Transit. It is important to note that the Court did not define a new test for state taxation to comply with the Commerce Clause; it only determined that a physical presence is not necessary to establish substantial nexus for sales tax collection. Nonetheless, there is still significant uncertainty as to exactly what level of economic or virtual presence is constitutional, as compliance with the Commerce Clause is determined on a case-by-case basis. Specifically, it is unclear whether SSUTA membership and a lack of retroactive application are necessary components of a constitutional state taxing scheme. Certainly it would be helpful for Congress to provide clear guidance on these issues, as well as make clear when states can begin enforcing economic nexus standards.


What Now? Multi-State Taxation Post-Wayfair

The sales tax arena is sure to change rapidly. Businesses must start preparing to collect and remit sales tax in every state that has enacted a law similar to South Dakota and is an SSUTA member, if their sales volume exceeds $100,000 or 200 separate transactions delivered into the state. Additionally, businesses should analyze their sales volume in non-SSUTA states, many of which have already enacted economic nexus laws. And more states will certainly follow South Dakota’s blueprint and enact economic nexus standards identical to that which the Supreme Court upheld in Wayfair.

States will surely be emboldened by their victory in Wayfair and use this opportunity to increase tax revenue. Although there are no guarantees, states should act fairly by not enforcing sales tax collection until businesses have had a reasonable opportunity to update their systems and processes to collect tax. Hopefully, state tax administrators will release statements providing a future date when enforcement will commence or U.S. Congress will limit the states in such a manner. Unfortunately, at least two states have released statements that they will not treat remote sellers fairly. Vermont released a statement that its economic nexus law is effective July 1, 2018 and Massachusetts indicated its nexus law, based upon in-state software (apps, cookies, or use of content distribution networks), was effective in October 2017 and not impacted by Wayfair.

The bottom line is that remote sellers need to prepare to be subject to taxation in more jurisdictions in the post-Wayfair world. It is imperative that businesses understand their connections outside their economic and virtual presence outside their home state, through sales into the state or use of software in the state through cookies, apps, etc. If you need help determining your business’ sales tax collection obligations, please contact Steve or Rich for advice.


Steven A. Dimengo is practice group leader and both Steve and Richard B. Fry III are members of the Taxation Practice Group specializing in State and Local Tax.