The Post-Wayfair Future of SALT Controversies: The Due Process Clause
This is the fourth in a series of articles written for MICPA members examining the far-reaching impact of the Supreme Court’s decision in South Dakota v. Wayfair, Inc.
As discussed in a previous E-News article, (MICPA News June 26, 2018), the recent Wayfair decision removed the physical presence requirement of the Commerce Clause.[i] In general, a state may tax an out-of-state company if two constitutional limitations are satisfied – one under the Commerce Clause and another under the Due Process Clause. The Commerce Clause requires that a state tax does not unduly burden interstate commerce. The Due Process Clause requires that a company has at least minimal contacts with the state that seeks to impose a tax.
Although many state tax disputes previously focused on the Commerce Clause, the fact that Wayfair lowered the Commerce Clause's bar likely means that the Due Process Clause will be significantly more important in deciding whether a state can require out-of-state companies to collect sales tax. Companies must now consider the due process doctrine to determine if enough connection exists for the state to have jurisdiction over them.
What is the Due Process Clause and How Does it Affect a State's Ability to Tax Out-of-State Companies?
The Due Process Clause generally requires state actions to be fundamentally fair. A state acts unfairly when it exercises power over a person or business that has very little connection to that state. To aid in this determination, courts engage in a two-step inquiry.
The first part of the inquiry focuses on whether there is “some definite link, some minimum connection, between a state and the person . . . it seeks to tax.”[ii] The taxing state and taxpayer must have sufficient connection so as not to “offend the traditional notions of fair play and justice.”[iii] An out-of-state company that “purposefully avails” itself to the benefits of the state’s economic markets is deemed to have sufficient connections.[iv] Purposeful availment involves systemic and continuous actions that extend beyond casual or irregular activities.
In a seminal 1985 case, Burger King Corp. v. Rudzewicz, the Supreme Court expanded on the concept of purposeful availment. The Court found that states cannot exercise jurisdiction over a business that has only “random, fortuitous or attenuated” contacts with the taxing state.[v]
Rather, jurisdiction only springs from a person’s deliberate engagement in significant activities within a state. When a company purposefully directs commercial actions towards a state resident, it voluntarily assumes that state's obligations.
For example, the plaintiffs in Wayfair (Wayfair, Inc., Overstock.com, Inc. and Newegg, Inc.) had no merchants or employees in South Dakota. The companies' only links to South Dakota were many sales and shipments to South Dakota residents. Although the Court previously found that directing mail order catalogues to potential out-of-state customers allowed those states to tax the company,[vi] it is arguably more difficult to reach the same conclusion when a website is open to orders from the state but does not specifically target it.
The Court did not explain its reasoning, but it may be that knowingly doing significant business in a state is evidence enough to satisfy Due Process.
The second part of the inquiry focuses on whether the state’s exercise of jurisdiction over the company is rationally related to values connected with the taxing state. In other words, has the state given anything of value to the company that allows it to ask for something in return?
The state clearly provides valuable services to in-state companies, such as roads for the business's employees to drive on, fire and police protection to its property, and education to its workforce. Therefore, the protections provided by the state and enjoyed by the company are benefits sufficient to pass this inquiry. For an out-of-state company, in particular an online retailer, it can be more difficult to show what value the state provides that allows it to tax the business in return.
The Supreme Court in Wayfair stated that taxes are essential “to create and secure the active market.”[vii] The Court noted that Wayfair benefits from solvent governments, the protection of customers’ homes (holding furniture purchased from Wayfair) by police and fire, the maintenance of roads and municipal services that allow customers to receive Wayfair's shipments, and the availability of competent banks and courts to support payment and collection of the purchase price. The Court concluded that “there is nothing unfair about requiring companies that avail themselves of the States’ benefits to bear an equal share of the burden of tax collection.”[viii]
How Will Wayfair Impact a State's Ability to Tax Out-of-State Companies?
The Court in Wayfair described an expansive concept of the value that out-of-state companies receive from states, which signals that the second prong of the Due Process inquiry is very likely met if the first prong's minimum contacts test is met. In other words, it is hard to conceive of a company that has a sufficient connection with the taxing state but does not enjoy the sort of "value" described in the Wayfair opinion.
Therefore, the important question that a company must consider is whether it has sufficient contacts with other states such that those states may impose sales, use or other taxes on it. Historically, there is no shortage of cases and opinions considering minimum contacts. What have emerged from this large body of law are numerous factors that, when present, may indicate that a company's activities are extensive enough to allow a state to exercise jurisdiction over it.
The next article in this series will examine these factors.
[i] See generally South Dakota v, Wayfair, Inc., 585 U.S. __ (2018) (concluding the “physical presence rule of Quill is unsound and incorrect.”).
[ii] Quill Corp. v. N.D., 504 U.S. 298, 306 (1992) (quoting Miller Bros. Co. v. Maryland, 347 U.S. 340 (1954)), overruled by South Dakota v. Wayfair, Inc., 585 U.S. __ (2018).
[iii] Id. at 307 (quoting International Shoe Co. v. Washington, 326 U.S. 310 (1945)).
[iv] Burger King Corp. v. Rudzewicz, 471 U.S. 462, 476 (1985).
[vi] National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977)
[vii] Wayfair, supra note 1 at 16.
[viii] Id. at 17.
Taylor helps businesses and business owners solve and prevent problems as a member of Foster Swift's Business and Tax practice group. He handles business formation and transactions, tax controversies, employee benefits, and technology related issues.View All Posts by Author ›
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