Ever since the June 2018 South Dakota v. Wayfair decision, in which the U.S. Supreme Court gave the green light for broader remote sales tax collections by overturning the physical presence requirement, tax observers have wondered which state’s remote sales tax regime will be the next to show up in court. Five states—Alabama, Colorado, Kansas, Louisiana, and Texas—could be good bets.
Technically, the Wayfair decision only said that physical presence is not a necessary condition, not that any state’s remote sales tax collections system—even South Dakota’s—is constitutional, but it is widely understood that states now have significant authority to require tax collections on such out-of-state sales, and nearly every state has responded to the decision by adopting new regimes for online (and other remote) sales tax collections. Courts are usually reticent to restrict states’ taxing authority, but there are limits, particularly when a tax imposes undue burdens on interstate commerce or even outright discriminates against out-of-state transactions.
Provisions of these five states’ sales tax codes make them particularly vulnerable to legal challenges. The presumption of constitutionality is strongest when compliance costs are low, state and local sales tax regimes are uniform and unified, impositions are not retroactive, and out-of-state retailers are not disadvantaged compared to in-state sellers. There are open questions about many choices made by states, but the structure of these five stand out.
One of three states, along with Colorado and Louisiana, which permits localities to define their own sales tax bases and undertake their own sales tax administration, Alabama faced clear impediments to remote sales tax collections, since requiring sellers to comply separately with each local jurisdiction could easily be seen as imposing an undue burden. Alabama’s solution is a Simplified Seller Use Tax with a flat rate of 8 percent. That’s a good deal if one is selling into, say, Mobile, where the combined state and local tax rate is 10.5 percent, but not so great if you’re selling into tiny Saginaw, where the combined rate is only 5 percent. In fact, in 189 (mostly quite small) jurisdictions, the combined sales tax rate is less than 8 percent.
That’s a problem, because in those jurisdictions, if you make an in-state taxable purchase, you pay a lower sales tax rate than you do if you purchase the same product from an out-of-state vendor. Alabama seeks to mitigate the problem by allowing consumers to file to receive a refund for their overpayments, but this is only available for larger purchases, and imposes significant burdens for consumers who would have to file to get their refund on each sale. This disparate treatment discriminates against interstate commerce, and the solution appears to create undue burdens.
Home rule localities create challenges in Colorado, since those jurisdictions are entitled not only to handle their own sales tax administration, but also define their own sales tax base, which can vary markedly from the state base. At present, no comprehensive matrix of sales tax bases exists, and even a geographic mapping system is a year or two away. Still worse, a few local jurisdictions require vendors with sales into the jurisdiction to obtain (and pay for) business and seller licenses, which can cost hundreds of dollars.
Right now, while Colorado has rolled out its remote seller system, these home rule jurisdictions have not required remote sellers to remit to them, but that could change. Just the lack of uniformity and consolidation could support a legal challenge; should a remote seller who has nexus with the state be required, possibly upon a first transaction, to obtain licenses in a locality, the plaintiff’s brief would almost write itself. It might even present a good opportunity to explore the use of the Pike balancing test in sales tax collections requirements, something the Supreme Court unexpectedly raised in Wayfair.
Alone among states, Kansas lacks a safe harbor for small sellers. In other states, a seller must have a certain volume of sales (or number of transactions) in a state before incurring responsibility for collections and remittance. This is intended to avoid imposing undue burdens on small sellers, where compliance costs could exceed the sales tax collected.
Kansas, which implemented remote sales tax collections requirements administratively, did so without a safe harbor, meaning that a single sale (even of just $1) would establish nexus and require a remote seller to collect and remit sales tax to the state. If the legislature and governor cannot quickly agree on legislation establishing some de minimis threshold for remote sales, their approach would be ripe for challenge.
Louisiana also has locally administered sales taxes with varying tax bases, in this case generally administered by the sheriff’s office in each parish. Here too, a simplified sales tax system is in place, and here too, that system is highly vulnerable to legal challenge. The state has established a new Sales and Use Tax Commission for remote sellers to serve as a single collection entity, and a Uniform Local Sales Tax Board to promote (but not necessarily enforce) uniformity and efficiency in local sales tax administration. But neither has completed its work, and the system does not clear up some key constitutional concerns.
Like Alabama and Louisiana, Texas has adopted a simplified regime for remote sellers. Unlike those systems, Texas’s is not necessary to cure any constitutional defect in its underlying system, and it is optional for remote sellers—which, ironically, may create a legal problem. State government is responsible for the administration of local sales taxes, which are imposed on a uniform base, but out-of-state retailers have the choice of collecting and remitting at a uniform statewide rate or sourcing sales to individual jurisdictions and collecting at the local rate.
For many businesses, the benefits of simplicity may outweigh any potential overpayments (which, after all, are borne by consumers). But what of the purchaser? If the business faces a constitutionally compliant regime and chooses to waive that system for a simpler one, they have no room to complain, but what if that simplicity means that some individual purchasers have more sales tax collected from them than their actual rates would merit? They would pay more when purchasing from (select) out-of-state sellers than they do from in-state sellers, and worse, they would have more sales tax collected from them than they legally owed. Arduous refund mechanisms would seem insufficient to remedy any constitutional infirmities, and it is possible to imagine a consumer challenge to the simplification law.
These five states may be the most vulnerable to litigation, but they are not necessarily alone. States may now impose sales and use tax collections obligations on remote sellers that lack physical presence in the state, but that authority is not unlimited, especially when those regimes unduly interfere with interstate commerce or discriminate against out-of-state sellers.
Much, indeed, is up in the air: even the South Dakota legislation at issue in Wayfair has come under scrutiny for imposing remote seller requirements under its sales tax rather than, as is more typical and legally secure, its use tax. Perhaps a challenge will arise that few anticipated—but states can go a long way to protect themselves from meaningful legal challenges by adopting some straightforward, equitable provisions, like reasonable safe harbors and (more difficult in a few states) uniformity and unification in state and local taxes.