On June 21, 2018, the United States Supreme Court decided South Dakota v. Wayfair, Inc., 585 U.S. __ (2018). In a 5-4 decision, the Court found in favor of the State of South Dakota and overturned its prior holdings in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967), which required an out-of-state seller to have a “physical presence” to establish nexus with the taxing jurisdiction for sales and use tax purposes.  

Background

South Dakota's challenge

In 2016, South Dakota enacted economic nexus legislation that required out-of-state sellers to collect and remit sales tax if the seller’s gross revenue from goods or services delivered into South Dakota exceeded $100,000 or if the seller engaged in 200 or more separate transactions for the delivery of goods or services into South Dakota, on an annual basis.  

Three major online retailers, Wayfair, Inc., Overstock.com, Inc. and Newegg, Inc., challenged the legislation on the basis that none of them had employees or real property in South Dakota, and therefore no physical presence. However, these retailers regularly shipped their goods directly to purchasers in South Dakota, thus easily meeting the minimum sales gross revenue or transaction thresholds established by the South Dakota legislation.

New standard

Wayfair, which upheld South Dakota’s economic nexus legislation, and which signals a new era by overturning the court’s prior holdings and physical presence nexus standard, referred to these prior rules as “unsound and incorrect.” The decision attempts to reflect the modern economy, in which e-commerce is growing at a faster pace than traditional brick-and-mortar retail, and attempts to level the playing field between remote sellers and those with physical presence in a state. 

Remote sellers and online retailers now face significant additional compliance requirements in a significant number of states. This is especially true given that many states have enacted legislation like South Dakota’s in anticipation of the Wayfair ruling.  

Wayfair took note of the challenges small merchants would face should they have to comply with sales and use tax rules not based on a physical presence standard, but it viewed the South Dakota law as affording small merchants a “reasonable degree of protection” by that law’s minimum sales thresholds needing to be met before requiring remote sellers to collect and remit tax. In a dissent written by Chief Justice John Roberts, it is argued that imposing a tax collection requirement on remote retailers is too burdensome, particularly for small businesses, considering there are over 10,000 taxing jurisdictions with “different tax rates, different rules governing tax-exempt goods and services, different product category definitions, and differing standards for determining whether an out-of-state seller has a substantial presence in the jurisdiction.” 

Impact on Cannabis and hemp industries

Wayfair did not have an immediate impact on the sale of adult-use marijuana. Generally, marijuana sales are intrastate sales and Wayfair has, up until this point, only affected interstate sales on the state level. We are now beginning to see unintended consequences of the Wayfair decision. Local jurisdictions in states that have enacted economic nexus rules are beginning to enact their own local economic nexus rules, and, in some jurisdictions, this will have a direct impact on the sales of adult-use marijuana. In November 2018, San Francisco passed an ordinance that will impose an additional gross receipts tax (i.e., business license tax), starting January 1, 2021, on businesses with more than $500,000 in annual gross receipts from the sale of adult-use marijuana. The ordinance expanded San Francisco’s nexus definition to include sales generated in the City by businesses located outside of it. The question becomes whether or when other cities and local jurisdictions that have business license taxes and/or other taxes will enact economic nexus standards that will encompass adult-use marijuana. 

Additionally, Wayfair will impact those in the hemp industry that are selling hemp-related products into states in which they have no physical presence. For example, the CBD market, a market that is rapidly growing and expected to reach $22 billion by 2022, is impacted by Wayfair since remote sellers of these products are selling their products across the United States into states in which they have no physical presence. These sellers should be cognizant of the different state economic nexus rules and how they apply to their business, and they should be tracking both their sales gross revenue and number of sales transactions in each state. Remote small businesses should be aware that they are also at risk of triggering economic nexus. Namely, although they may be well under the sales gross revenue threshold in a state, they can much more easily reach the 200 transactions threshold there, and, if so, they would indeed be required to collect and remit sales tax there. This can be an unwelcomed and costly burden to remote small businesses. 

For more information, please contact Ben Wexler, J.D., CohnReznick State and Local Tax services, at [email protected] or (959) 200-7087.