States Continue to Challenge Quill’s Physical Presence Standard

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When a client calls us to inquire about sales tax exposure, we instinctively start asking questions about people and possessions: “Do you have property in other states? Where do you have employees? Have you sent any sales representatives to any states where you have made sales?” For decades, tax practitioners have known that a proper sales tax nexus analysis begins with physical presence. It’s black-letter law, after all. States can’t levy sales tax on someone who isn’t there.

We know this because of Quill Corp. v. North Dakota and National Bellas Hess v. Illinois before it. In these cases, the U.S. Supreme Court held—twice—that physical presence is required before sales tax collection obligations are constitutional. States have never been particularly happy with this rule, but since Quill in 1992, they have begrudgingly accepted it.

But more and more, the states are seeking to chip away at the foundations of the house that Quill built, as the explosion of online retailing is inspiring states to look for new and interesting ways around physical presence—click-through nexus, software-license nexus, even nexus because of internet cookies (seriously).

The states’ appetite for testing the boundaries of Quill was further whetted last March, when Justice Kennedy issued his concurrence in Direct Marketing Association v. Brohl. Declaring Quill outdated, he invited the legal system “to find an appropriate case for this Court to reexamine Quill and Bellas Hess.”

Not surprisingly, states wasted no time trying to set in motion events to provide Justice Kennedy with his requested “appropriate case.” Within months, the acting Commissioner of the Connecticut Department of Revenue Services published an article to consider whether it was time for states to operate as though Quill is no longer good law. A few months later, the Alabama Department of Revenue promulgated a regulation requiring out-of-state sellers who meet a certain threshold of sales to collect sales tax on sales to the state, whether or not they had any physical presence in Alabama. When asked if this was a direct attack on Quill, Alabama Commissioner of Revenue Julie Magee replied (and this is NOT a paraphrase), “Sue us.”

[Read Alston & Bird’s prior coverage of the Connecticut article and the Alabama regulation.]

Even more recently, on January 20, the National Conference of State Legislatures (NCSL) unveiled a new, provocative attack on Quill.  The NCSL issued a letter to state legislatures urging them to act with haste to expand state statutory authority to collect sales tax. With the letter, the NCSL passed along draft state legislation designed for the specific purpose of overturning Quill.

NCSL’s legislation is well-tailored to pick a fight. It expands a state’s definition of nexus to include just about any activity related to making sales in the taxing state. These include advertising in the state, selling through other companies in the state–even “collecting, analyzing, and utilizing individual data on purchasers or potential purchasers in [the] state” (which very well might occur entirely outside the state). Furthermore, the model legislation also imposes a collection requirement on marketplace sellers (e.g., Amazon and eBay) that facilitate sales in the state, and it imposes a reporting requirement on entities that list items for sale without consummating the final purchase.

Finally, in a clear indication that the model legislation is intended as a springboard to the U.S. Supreme Court (and perhaps nothing more), the legislation creates a direct appeal on the constitutionality of the legislation to the state supreme court.

Take-Aways and a Preview of Our New Series

Legislative season in the states is upon us, and we don’t know yet whether any state will take up the NCSL’s challenge, nor do we know how the newly-effective Alabama regulation will play out. But the states’ frustration with Quill—and the Congressional inability to pass national legislation—is undeniable, and all signs indicate that states will continue to push forward with their efforts to chip away, or completely reverse, Quill’s physical-presence standard.

We caution our clients to follow the developments in this arena carefully, both in order to remain in compliance and, when appropriate, to challenge laws or regulations that conflict with existing precedent under the U.S. Constitution or other governing authority. We will be tracking those developments along with you – please don’t hesitate to subscribe or contact any of us in the State & Local Tax group.