Op-Ed by Jeff Babener in the World of Direct Selling: U.S. Supreme Court Sales Tax Reversal… Where To From Here?

August 1, 2018

Jeff Babener PortraitJeffrey A. Babener, of Portland, Oregon, is the principal attorney in the law firm of Babener & Associates. For more than 30 years, he has advised leading U.S. and foreign companies in the direct selling industry, including many members of the U.S. Direct Selling Association. He has served as legal advisor to various major direct selling companies, including AvonAmway, HerbalifeUSANA, and Nu Skin. He has lectured and published extensively on direct selling.

Jeff is a graduate of the University of Southern California Law School. He is an active member of the State Bars of California and Oregon.


U.S. Supreme Court Sales Tax Reversal…Where To From Here?
By Jeffrey Babener © 2018
First published in World of Direct Selling

The future ain’t what it used to be.
Yogi Berra

Or maybe it is. In ancient Egypt the pharaohs placed a general tax on the sale of all commodities at the rate of 5% of sale price.  The Romans obviously thought this was a good idea and, after their conquest of Egypt, the rate rose to 10%.  For the next 2,000 years, to this day, bureaucrats have found sales tax a favorite revenue raiser.

The Bombshell…Deja vu, all over again.

In South Dakota v. Wayfair, Inc. June 21, 2018. Slip Opinion 17-494, 585 U.S. ____ (2018). The U.S. Supreme Court overturned a 50 year old precedent on how states can tax sales by out-of-state retailers, holding that its earlier 1967 and 1992 decisions were wrong, and that it needed to rectify its mistake to reflect the economic reality of today's interstate commerce to prevent discrimination against local brick and mortar retailers that favored online out-of-state retailers. Effectively, it abandoned a decades old bright line analysis that the “physical presence” nexus that justified states to impair interstate commerce, in violation of the Commerce clause of the Constitution was being replaced by a more “amorphous” standard of an “economic reality” impact of out-of-state sellers in states that sought to impose sales and use taxes. 

Impact and Response to this “missile” on contact:

For most online sellers: a thermonuclear explosion...life will never be the same.

(Keep in mind that one of the largest online sellers, Amazon, recognized the future, and had already undertaken to collect sales tax in the 45 states that impose sales/use taxes, although most of its third party vendors have not.)

For direct sellers, who sell both online and offline:

More like momentary eclipse of the sun...back to business; they have already been collecting and paying sales/use tax for decades.

Actually, says direct selling, “thank you for leveling the playing field.”

And, as to all online sellers, whether direct sellers or not, “no thank you” long term for an expected flood of creative new state taxes that will develop over the next 20 years in our “virtual and gig” economy. This is just the beginning.

First, What Just Happened?

As summarized by the Court in its syllabus and majority and dissenting opinions:

Wayfair is a major online retailer of home furnishings. Although it has substantial sales into South Dakota, it has no physical presence in South Dakota. Until the Wayfair case, 50 years of court precedent prevented states from impairing interstate commerce, in violation of Commerce Clause, U.S. Const. art. I, § 8, cl. 3, by imposing a duty on out-of-state retailers who had no “nexus” with the state. And for the Supreme Court, “nexus” required physical presence. Two famous cases set the bright line mandate of physical presence: National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Both National Bellas Hess and Quill involved interstate shipment from products ordered from catalogs.

It is estimated that these two cases caused South Dakota to miss out on $48 million to $58 million annually. And so, like many states, South Dakota sought to test the issue again, claiming that the Internet had changed things, i.e., we had a new economic reality of “nexus” that went beyond physical presence. Based on this half century standard, Wayfair refused to collect sales tax imposed by a relatively new South Dakota sales tax law that sought to impose sales tax responsibilities on out-of-state sellers who sold more than $100,000 in goods and services into the state or carried out more than 200 sales transactions.  

Litigation followed, led by South Dakota requesting a declaratory judgment that its new tax was valid. Wayfair raised the long time defense of lack of “nexus” via physical presence. South Dakota lost at the trial court and State Supreme Court and requested review by the U.S. Supreme Court.

The states hit the jackpot. And it was the lucky day for the forty-one states, two Territories and the District of Columbia, all hungry for new taxes, who joined South Dakota to ask the U.S. Supreme Court to reject the test formulated in Quill. In 2017, the U.S. Government Accountability Office pegged the prospective increase to the states, if South Dakota won the Wayfair case, as being between $8 billion and $13 billion per year. 

In a 5-4 decision, in an opinion written by Justice Kennedy, the Court sided with South Dakota, changing e-commerce forever.  The reasoning:

1. The Quill "physical presence" decision was not flexible enough to apply the changing economic realities of how out-of-state businesses can, in fact, have meaningful connections with states...even with no presence.

Said the Court:

The Quill Court did not have before it the present realities of the interstate marketplace.  In 1992, less than 2 percent of Americans had Internet access…Today that number is about 89 percent…When  it  decided  Quill, the Court could not  have envisioned  a world in  which  the world’s largest retailer would  be  a remote seller...(Amazon)...

2. As such, the National Bellas Hess/Quill decisions were wrongly decided.

The physical presence rule has “been the target of criticism over many years from many quarters.”  

Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.

The physical presence rule is not a necessary interpretation of the requirement that a state tax must be “applied to an activity with a substantial nexus with the taxing State.”

Although physical presence “frequently will enhance” a business’ connection with a State, “it is an inescapable fact of modern commercial life that a substantial amount of business is transacted…[with no] need for physical presence within a State in which business is conducted.”

Having abandoned the necessity of physical presence for “nexus,” the Wayfair Court reasserted its accepted framework for state taxation as set forth in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).

The Court explained the four required factors in Complete Auto Transit:

The Court held that a State “may tax exclusively interstate commerce so long as the tax does not create any effect forbidden by the Commerce Clause.” After all, “interstate commerce may be required to pay its fair share of state taxes.” The Court will sustain a tax so long as it (1) applies to an activity with a substantial nexus with 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. (emphasis added)

The Court held that, in this case, taxing Wayfair met the tests…again, even without physical presence.

3. In the current legal framework, the prohibition on taxation discriminated against in-state sellers in favor of out-of-state sellers.

The current tax approach that shields online retailers unfairly discriminates against local brick and mortar retailers.

The physical presence rule has long been criticized as giving out-of-state sellers an advantage. Each year, it becomes further removed from economic reality and results in significant revenue losses to the States.  These critiques underscore that the rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.  

In effect, it (Quill) is a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers, something that has become easier and more prevalent as technology has advanced.  

By giving some online retailers an arbitrary advantage over their competitors who collect state sales taxes, Quill’s physical presence rule has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.

4. States are unfairly losing vast needed revenue.

It is estimated that National Bellas Hess and Quill cause the States to lose between $8 and $33 billion every year.

5. Congress had taken no action to remedy the situation.

Of course, when Congress exercises its power to regulate commerce by enacting legislation, the legislation controls…But this Court has observed that “in general Congress has left it to the courts to formulate the rules” to preserve “the free flow of interstate commerce.”

A Faint Hearted Dissent

Interestingly, after letting the physical presence legal standard stand, the dissenting Justices, as led by conservative Chief Justice Roberts, did not disagree on the merits of the issue, but rather on whether it was the proper role of the Court to enter the controversy when Congress should decide what state action does or does not interfere with interstate commerce, i.e., our job is to interpret the law and not legislate the law.

In National Bellas Hess, Inc. v. Department of Revenue of Ill., this Court held that, under the dormant Commerce Clause, a State could not require retailers without a physical presence in that State to collect taxes on the sale of goods to its residents. A quarter century later, in Quill Corp. v. North Dakota, this Court was invited to overrule Bellas Hess but declined to do so. Another quarter century has passed, and another State now asks us to abandon the physical presence rule.  I would decline that invitation as well. I agree that Bellas Hess was wrongly decided, for many of the reasons given by the Court.

The Court should not act on this important question of current economic policy, solely to expiate a mistake it made over 50 years ago.

Said Justice Roberts, this is a decision for Congress to make, and not the Court:

A good reason to leave these matters to Congress is that legislators may more directly consider the competing interests at stake. Unlike this Court, Congress has the flexibility to address these questions in a wide variety of ways.  As we have said in other dormant Commerce Clause cases, Congress “has the capacity to investigate and analyze facts beyond anything the Judiciary could match.” Here, after investigation, Congress could reasonably decide that current trends might sufficiently expand tax revenues, obviating the need for an abrupt policy shift with potentially adverse consequences for e-commerce. Or Congress might decide that the benefits of allowing States to secure additional tax revenue outweigh any foreseeable harm to e-commerce. Or Congress might elect to accommodate these competing interests, by, for example, allowing States to tax Internet sales by remote retailers only if revenue from such sales exceeds some set amount per year.  In any event, Congress can focus directly on current policy concerns rather than past legal mistakes. Congress can also provide a nuanced answer to the troubling question whether any change will have retroactive effect.

On a non-economic note, Wayfair may pave the way for new alliances on the court. The 5-4 decision found conservatives and liberals aligning together on each side of the issue.

Strange bedfellows.

Kennedy, Gorsuch, Thomas, Ginsberg, Alito

Roberts, Sotomayor, Breyer, Kagan

The Impact or Non-Impact on Direct Selling

Although marveling at the enormity of the Wayfair decision on American commerce, the direct selling industry may merely “yawn” at its impact on direct selling.


Well, most direct selling companies, although out-of-state sellers just about everywhere but their home state, have routinely collected sales tax for both online and offline sales for decades.

Blame the U.S. Supreme Court for this one. In 1960, in Scripto v. Carson, 362 U.S. 207 (1960),  the Court recognized “physical presence” and “nexus” arising from activity of an out-of-state seller through independent contractor sales reps who solicited purchase orders in Florida, imposing a duty to collect Florida “use” tax, the flip side of the coin to its first cousin, sales tax.

In fact, direct sellers manifested their contacts further in so many ways. “In-state” independent contractor reps sell, recruit, promote products, conduct opportunity meetings, organize training and drive “in-state” customers to the website of out-of-state direct selling companies.

It would have been difficult to deny “nexus,” and so virtually every leading direct selling company collected and remitted sales tax for in-person and online sales.

And so, as important as Wayfair is to the futures of online retailers, for direct sellers it was “much ado about nothing.” In fact, at a direct selling tax conference in the early 2000’s, the U.S. Sales Tax Administrator for one of the industry’s largest companies, revealed that the company had collected sales tax since 1971, and was undertaking to do the same for its sales in a relatively new channel, the Internet.

Actually, if there is any immediate Wayfair impact for direct sellers, it is positive. The decision levels the playing field. Now that online sellers of vitamins, skin care and other consumer products are headed for sales tax accountability, it makes direct sellers, who already are forced to collect sales tax, more competitive.

A Few Lessons Learned from Wayfair.

Let me tell you how it will be
There's one for you, nineteen for me
'Cause I'm the taxman, yeah, I'm the taxman

Should five percent appear too small
Be thankful I don't take it all
'Cause I'm the taxman, yeah I'm the taxman

If you drive a car, I'll tax the street,
If you try to sit, I'll tax your seat.
If you get too cold I'll tax the heat,
If you take a walk, I'll tax your feet.

Taxman, The Beatles

Agree or disagree, sales tax responsibilities will be a new fact of life for online commerce. It is a sea change, albeit a short-term positive one for direct sellers.

Long term may be a different story for all out of state sellers, including direct selling. The U.S. Supreme Court opened the state taxation equivalent of a Pandora’s box.

To credit Louis XV, “après moi, le deluge.” To put it in more modern colloquial terms, “once the camel’s head is in the tent, his butt is sure to follow.” State tax administrators are salivating everywhere. First look for a tidal wave of state sales tax initiatives aimed at out-of-state sellers. And then things will get creative…and costly.  Think click tax for Google. Think virtual property tax for cloud-based players. Just follow the yellow brick road into the ”cloud” and tax whoever is there. 

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You may contact Adolfo Franco, Executive Vice President.