Tax Policy – What Does the Wayfair Decision Really Mean for States, Businesses, and Consumers?

Various interpretations of the recent Wayfair decision from the U.S. Supreme Court has led to confusion about its impact for online sellers and consumers. Tax Foundation hopes to clear up that confusion with this Q&A.

Were internet purchases exempt from sales tax before this decision?

Internet purchases were not exempt from tax, but in many cases it looked that way to consumers. Internet sellers typically only had to collect a state’s sales tax from buyers if the company had property or employees in a state. As of 2018, state sales taxes are collected on about half of e-commerce.

It is worth noting that consumers technically owe use tax to their resident state on purchases where they did not pay sales tax. Sales taxes, which exist in 41 states, apply to most purchases of retail goods within the state. The seller has the responsibility to collect the tax and forward the money to the state. Each state with a sales tax also has a use tax at an identical rate, to be paid by the buyer in cases where a seller doesn’t collect the tax.

I thought states were prohibited by law from taxing the internet?

Yes, Congress has prohibited states from taxing internet access in a law known as the Internet Tax Freedom Act (ITFA). That law is not changed by this decision and isn’t directly related to whether states can tax e-commerce. ITFA only applies to what you pay to connect to the internet. So long as states pass e-commerce laws that apply equally to other forms of commerce, they would not conflict with ITFA.

When will we start to notice the effects of this decision?

Some states will move quickly to enact laws resembling South Dakota’s to collect sales tax on internet purchases. Other states would need to make significant changes to their sales tax system to be able to collect, particularly large states that have resisted joining other states in adopting more uniform, simplified sales tax laws. Some states, such as New Hampshire, will likely never pass a sales tax.

Another question will be whether Congress acts. Congress has pending bills (Remote Transactions Parity Act, or RTPA, and Marketplace Fairness Act, or MFA) that would specify what simplifications a state must make to be able to require online sellers to collect taxes. Such a law would be compatible with the Court’s ruling, providing more protections for sellers and consumers. But some have opposed the passage of those bills, claiming it would tax the internet.

What was wrong with only giving states tax authority over businesses with a physical presence? What is the “Wayfair test” now?

The property or employees rule, or physical presence rule, dates to 1967’s Bellas Hess case, where the Supreme Court held that Illinois could not require an out-of-state catalog company to collect sales tax. The idea was that sales tax is so complex to collect that forcing out-of-state sellers to do so put impermissible burdens on interstate commerce. That ruling was reaffirmed by the Court in 1992’s Quill case, with some misgivings over whether it was the correct rule.

Between 1992 and 2018, several factors undermined the physical presence rule. E-commerce emerged and grew sharply, resulting in some online sellers not collecting sales tax despite widespread directed sales and activity in a state. Technological advances reduced the cost of collecting sales taxes, including platforms created by some of the e-commerce websites. Finally, the physical presence rule proved to be an ineffective restraint on state tax power. Even before the Wayfair ruling, 31 states required tax collection in minimal cases of physical presence in a state, such as with airport stopovers by employees, contracts with in-state advertisers or placing website cookies on computers within the state. It is noteworthy that none of the nine justices in Wayfair, nor either of the parties in the case, asserted that the physical presence rule is the correct rule.

The new question for judges evaluating a state tax, instead of asking whether a seller’s presence in the state is sufficiently physical, is asking whether the state tax discriminates against interstate commerce. If complying with a state’s tax system is sufficiently burdensome on an interstate seller, it is unconstitutional, regardless of the level of the seller’s physical presence in the state.