{"id":1080,"date":"2018-09-26T11:17:52","date_gmt":"2018-09-26T16:17:52","guid":{"rendered":"https:\/\/illinoistax.org\/?p=1080"},"modified":"2018-09-28T14:02:43","modified_gmt":"2018-09-28T19:02:43","slug":"the-wayfair-decision-what-is-it-and-what-does-it-mean-for-illinois-carol-portman","status":"publish","type":"post","link":"https:\/\/illinoistax.org\/?p=1080","title":{"rendered":"The Wayfair Decision – What is it and What Does it Mean for Illinois? – Carol Portman"},"content":{"rendered":"

The Wayfair<\/em> Decision – What is it and What Does it Mean for Illinois?<\/u><\/strong><\/h3>\n

 <\/p>\n

July 2018 (71.6)<\/strong><\/p>\n


\nCarol Portman
\n<\/strong>Taxpayers’ Federation of Illinois
\n<\/strong>Springfield, Illinois<\/strong>\u00a0<\/strong><\/p>\n

 <\/p>\n

Tax nerds all over the country got a rare treat last month, when the United States Supreme Court decided a major state tax case.\u00a0 South Dakota<\/em> v. Wayfair, Inc. <\/em>(585 U.S. ____, Docket No. 17-494) drew the attention of not only tax-oriented publications, but traditional press as well.[1]<\/a> \u00a0\u00a0The decision was exciting for a number of reasons:\u00a0 the Court seldom addresses state tax issues; long-standing precedent was overturned; and now there are new questions to answer.\u00a0 In Illinois, we too will be pondering and debating the consequences of the Wayfair<\/em> decision, probably for years to come.<\/p>\n

Background<\/u><\/p>\n

For many years (the past 51, to be exact), there has been one absolute in the frequently ambiguous world of state and local taxes:\u00a0 a seller had to have a physical presence in a state before it could be forced to collect that state\u2019s sales tax.\u00a0 This \u201cphysical presence nexus\u201d requirement was first articulated by the United States Supreme Court in 1967, in National Bellas Hess, Inc. v. Department of Revenue of Illinois<\/em>, 386 U.S. 753 (1967).\u00a0 In 1992, the Court reiterated the requirement, in Quill Corp. v. North Dakota,<\/em> 504 U.S. 498 (1992).<\/p>\n

National Bellas Hess<\/em> and Quill<\/em> dealt with mail order sales, and pre-dated the advent and subsequent explosion of e-commerce.\u00a0 Although customers still owe the tax even if the seller does not collect it, compliance in the form of self-assessment has always been spotty to nonexistent,[2]<\/a> so the amount of taxes due but uncollected and unpaid has grown dramatically. The exact amount is unknown, of course, and estimates vary widely.\u00a0 In a report issued in November 2017, the US General Accounting Office estimated the lost state and local tax revenues in Illinois from untaxed ecommerce ranged from $383 million to $626 million per year.[3]<\/a> Dr. Natalie Davila, former Director of Research for the Illinois Department of Revenue, has estimated the 2016 state revenue loss to be roughly $215 million and the local revenue loss to be another $54 million.[4]<\/a><\/p>\n

After the Quill<\/em> decision, many states and brick-and-mortar retailers (who were losing market share to their online competitors due in part, at least, to the price differential from the uncollected taxes) tried various approaches to effectively overturn Quill<\/em>, either by simplifying sales and use tax collection to the point where the complexities of collecting taxes in the plethora of jurisdictions around the country[5]<\/a> cited as unduly burdensome in Quill<\/em> were no longer an issue (see \u201cWhat is Streamlining?\u201d at the bottom of the page), or through Congressional action (See, for example, the Marketplace Fairness Act of 2017, S.976, or its predecessor bills, including a 2013 version that passed the Senate).\u00a0 Over the course of 25 years, these efforts made some headway, but encountered various roadblocks.<\/p>\n

Encouraged by a declaration that it was time for the Court to revisit Quill<\/em> by Justice Kennedy in his concurring opinion in Direct Marketing Association v. Brohl<\/em>, 135 S. Ct. 1124, 1135 (2015), several states adopted aggressive statutes or policies, abandoning physical presence nexus.\u00a0 Interestingly, this is very similar to what happened in the years before the Quill<\/em> decision\u2014states were frustrated by the physical presence standard articulated in National Bellas Hess<\/em> and decided it was time for a change. \u00a0\u00a0This time around, it was a challenge to South Dakota\u2019s new statute that became the test case.<\/p>\n

South Dakota v. Wayfair, Inc.<\/u><\/em><\/p>\n

Justice Kennedy (who announced his retirement days later) wrote for the 5-4 majority in Wayfair<\/em>, stating that the \u201cphysical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.\u201d \u00a0The Quill<\/em> and National Bellas Hess<\/em> decisions focused on the administrative burden associated with having to track and properly comply with the multitude of state and local sales taxes, but in Wayfair<\/em>, the Court held that the \u201cphysical presence rule is a poor proxy for the compliance costs faced by companies that do business in multiple States,\u201d providing numerous hypothetical fact patterns illustrating that, in the Court\u2019s opinion, the old rule did not work.\u00a0 The Court concluded that \u201cQuill<\/em> creates rather than resolves market distortions\u201d and that the \u201carbitrary, formalistic distinction\u201d of the physical presence nexus standard \u201csimply makes no sense.\u201d<\/p>\n

The Court acknowledged that the complexity of state taxes can be a burden, particularly to small sellers, but pointed to three ways that the South Dakota statute, the one at issue in the case, provided \u201csmall merchants a reasonable degree of protection\u201d:\u00a0 it did not require tax collection unless the seller did a \u201cconsiderable amount of business in the State\u201d; it was not retroactive; and South Dakota is a party to the Streamlined Sales and Use Tax Agreement.\u00a0 The Court also pointed out that other aspects of the Court\u2019s Commerce Clause doctrine (not raised in the lower courts so not addressed in the decision) could also protect against any undue burden on interstate commerce.\u00a0 See \u201cCommerce Clause 101\u201d on the bottom of the page.<\/p>\n

Bottom line:\u00a0 the physical presence standard of Quill<\/em> has been declared \u201cunsound and incorrect.\u201d[6]<\/a><\/p>\n

The case was remanded\u2014sent back\u2014to the lower courts, and although the Court stated that \u201csome other principle in the Court\u2019s Commerce Clause doctrine might invalidate the [South Dakota] Act,\u201d it expressed a fair amount of skepticism that any other challenge could be successful, reiterating the 3 points made earlier:\u00a0 a sales threshold exempts small sellers from the tax collection requirement; the new law was not retroactive; and South Dakota is a \u201cStreamlined\u201d state.<\/p>\n

The concurring and dissenting opinions provided some interesting insights.\u00a0 Justice Thomas expressed regret that he had not joined in the dissent in Quill<\/em>.\u00a0 Justice Gorsuch agreed that \u201cjudges have no authority to construct a discriminatory tax shelter\u201d (but warned he might not always join the majority in other Commerce Clause matters).\u00a0 Justice Roberts wrote the dissent, joined by Justices Beyer, Sotomayor, and Kagan, agreeing that \u201cBellas Hess<\/em> was wrongly decided,\u201d but maintaining that Congress, rather than the Court, should correct the error.<\/p>\n

This is Not<\/strong> a New Tax\u2014a Quick Primer on Use Taxes<\/u><\/p>\n

\u201cSales tax\u201d is the term generally used to describe a number of transaction taxes.\u00a0 In Illinois, for example, we have the Retailers\u2019 Occupation Tax (\u201cROT\u201d), the Use Tax, the Service Occupation Tax, the Service Use Tax, and a host of state-authorized and -administered local Occupation Taxes.<\/p>\n

Previous issues of Tax Facts<\/em> have addressed the distinctions between the ROT and Use Tax, most recently in October of 2017.[7]<\/a>\u00a0 \u00a0Essentially, the ROT is imposed, as its name suggests, on a retailer for the privilege of making sales in the state, and is due on sales consummated within the state.\u00a0 In addition to the state-level ROT (at 6.25%), many local governments (cities, counties, etc.) are authorized by statute to impose their own ROTs to add to the state tax, meaning the total sales tax rate on a transaction occurring in some communities can exceed 10%.<\/p>\n

All states that impose a sales tax (including Illinois\u2019 ROT) also impose a use tax, which requires consumers to pay tax on goods that would otherwise have been subject to sales tax\/ROT but were purchased outside the state for in-state consumption.\u00a0 If the retailer does not collect the tax, it is still due<\/strong>.\u00a0 As stated above, compliance with the legal obligation to calculate and remit tax by individual consumers when the retailer does not collect it is low.<\/p>\n

Wayfair<\/em> simply means that states may be able to force more retailers to collect tax that is already due.\u00a0 It is not<\/strong> a new tax, or a tax increase.\u00a0 (Except of course for consumers who have been ignoring existing law.)<\/p>\n

What Does This Mean For Illinois?<\/u><\/p>\n

Illinois revised its statutes in anticipation of the Wayfair<\/em> decision.\u00a0 In the FY19 Budget Implementation Act passed in May of this year (Public Act 100-587), the definition of the term \u201cretailer maintaining a place of business in this State\u201d (and therefore required to collect Illinois use tax) was amended to include retailers with sales to Illinois customers either totaling $100,000 or 200 separate sales during the course of a 12-month period. This new nexus standard, identical to that upheld by the Supreme Court in Wayfair<\/em>, goes into effect October 1, 2018.\u00a0 The budget passed by the General Assembly for the fiscal year ending June 30, 2019 included $150 million in new state tax revenue attributable to this new provision.<\/p>\n

The State is not the only governmental unit set to benefit from the new revenue; the statewide use tax rate is 6.25%, but only 5% goes to the State.\u00a0 The remaining 1.25% is administered as if it were a local use tax and is allocated among local governments according to a rather complicated series of formulas.\u00a0 The Illinois Department of Revenue\u2019s website<\/a> describes the process:<\/p>\n

Once the dust settles, and assuming the new nexus standard survives any challenges, Wayfair<\/em> means Illinois state and local governments will see additional revenue\u2014not a new tax or a tax increase, but the tax that has always been due but in the past has gone uncollected.\u00a0 The first question, of course, is whether Illinois\u2019 new standard will be considered constitutional, but that is only the first of many.<\/p>\n

What Next?\u00a0 Unanswered Questions Abound<\/u><\/p>\n

The saga of the Wayfair<\/em> case itself is not quite complete.\u00a0 The Supreme Court decision was limited to the issue before it: should the physical presence standard of Quill<\/em> remain. \u00a0As described above, the case was remanded to the lower courts, where the parties could raise other issues challenging South Dakota\u2019s nexus statute.\u00a0 The Wayfair<\/em> opinion suggested the Court did not expect any such challenges to succeed, but until the parties settle or further appeals are exhausted, there is a chance that there will be more to tell in the Wayfair<\/em> story.<\/p>\n

A more relevant question for us in Illinois, of course, is whether our new statute and overall sales tax landscape, like South Dakota\u2019s, meets the Constitutional requirements.[8]<\/a>\u00a0 Does Wayfair<\/em> apply in Illinois?\u00a0 The General Assembly believed it would, given the revisions to our statute and the associated revenue assumptions, but the answer to the question is not certain.<\/p>\n

For example, our nexus statute itself is identical to South Dakota\u2019s statute challenged in Wayfair<\/em>, with the same triggering levels of sales.\u00a0 Illinois is a much bigger state; should the thresholds be higher, reflecting the larger market?\u00a0 Probably not, but the thresholds in South Dakota\u2019s nexus statute were only one of the protections cited by the Court.\u00a0 Illinois, like South Dakota, is not applying its new statute retroactively, but it is the third protection that could be the most problematic.<\/p>\n

The Court twice cited approvingly the fact that South Dakota is a party to the Streamlined Sales and Use Tax Agreement (the \u201cSSTA\u201d, or \u201cAgreement\u201d).\u00a0 Illinois, however, is not<\/strong> a \u201cStreamlined\u201d state.\u00a0 Whether or not that, in and of itself, is enough to prevent Illinois from relying on Wayfair<\/em> is unclear.\u00a0 If our taxing structure contained most of the elements of the SSTA, would that be enough? And which ones?<\/p>\n

The Court referred to several aspects of the Agreement in particular:\u00a0 \u201cIt requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules.\u00a0 It also provides sellers access to sales tax administration software paid for by the State.\u00a0 Sellers who choose to use such software are immune from audit liabilities.\u201d\u00a0\u00a0\u00a0 These statements were dicta\u2014they weren\u2019t strictly related to the narrow decision overturning Quill\u2019s<\/em> bright-line physical presence nexus standard\u2014but they suggest the kinds of things the Court considers relevant in determining whether a state has adequately minimized the burden out-of-state sellers face when collecting tax throughout the country.\u00a0 How does Illinois measure up?<\/p>\n

    \n
  1. \u201cA single state-level tax administration.\u201d Illinois allows certain local governments to impose an ROT, and many do, but there are no local use taxes (other than Chicago\u2019s, which is not collected by sellers).\u00a0 In other words, retailers selling online to Illinois customers anywhere in the State collect use tax at the same 6.25% rate.\u00a0 The state and local ROTs and the state-wide Use Tax are all administered by the Illinois Department of Revenue.\u00a0 Illinois arguably is aligned with this aspect of the Agreement, even though we are not a party to it.<\/li>\n
  2. \u201cUniform definitions of products and services.\u201d One odd quirk of Illinois\u2019 tax definitions warranted a special mention in Justice Roberts\u2019 Wayfair<\/em> dissent:\u00a0 \u201cIllinois categorizes Twix and Snickers bars\u2014chocolate-and-caramel confections usually displayed side-by-side in the candy aisle\u2014as food and candy, respectively (Twix have flour; Snickers don\u2019t), and taxes them differently.\u201d \u00a0Most of Illinois\u2019 definitions (including, interestingly, the food and candy definitions) are identical to those required of Streamlined states\u2014will that be close enough?<\/li>\n
  3. \u201cSimplified rate structures and other uniform rules.\u201d Illinois was originally a participating state in the Streamlined Sales & Use Tax Project that ultimately led to the SSTA, so many of the simplified and uniform rules are already in place.\u00a0 We don\u2019t how a court would view the remaining differences\u2014Illinois\u2019 unusual treatment of leases, for example.<\/li>\n
  4. \u201cSales tax administration software paid for by the State,\u201d and sellers using the software \u201care immune from audit liabilities.\u201d Illinois has no such software program currently.<\/li>\n<\/ol>\n

     <\/p>\n

    If Illinois wishes to become a \u201cstreamlined state\u201d, either because a post-Wayfair<\/em> court rules it is necessary before imposing remote seller collection requirements, or because the General Assembly decides it would be best to align our laws as closely as possible with South Dakota\u2019s, law-changes would be required.\u00a0 A number of groups worked on various projects analyzing what would be necessary for Illinois to join the SSTA[9]<\/a>, but even the most recent of those is now over a decade old, and both Illinois law and the requirements for becoming a party to the Agreement have changed.<\/p>\n

    Some local governments in Illinois are already suggesting they should not be limited merely to their share of the state\u2019s use tax rate but should instead be allowed to collect their additional taxes.[10]<\/a>\u00a0 Efforts to allow local governments to impose, and then force retailers to collect, local use taxes could create additional differences between Illinois\u2019 tax structure and that blessed by the Court in Wayfair<\/em>\u2014would that new level of complexity be enough to push the entire structure over the line, meaning remote sellers would once again be able to sell tax-free?\u00a0 Is it worth it for local governments seeking this additional revenue to risk losing it all?<\/p>\n

    Allowing local use taxes would require significant changes to the state\u2019s overall sales tax structure.\u00a0 For example, if local governments imposed use tax based on where a purchased item is delivered, that would upend the \u201clocal sourcing\u201d question our state has wrestled with over the years and require re-writing the complicated formula for allocating the 1.25% local share of the state use tax, meaning some communities might be winners (collecting more tax), but others would be losers.\u00a0 (See Illinois Taxation of Retail Sales:\u00a0 A Primer and Some Problems<\/em>, by Dr. Natalie Davila, Tax Facts<\/em>, October 2017 for a more thorough discussion of the sourcing rules\u2014destination versus origin\u2014and how our current tax laws work.)<\/p>\n

    Another category of open questions surrounds what could be considered \u201cother\u201d local taxes.\u00a0 Utility taxes, hotel occupancy taxes, amusement taxes, and the like.\u00a0 Generally speaking, physical presence in the state has been a prerequisite for requiring a vendor to collect these taxes.\u00a0 That may no longer be constitutionally required.\u00a0 But\u2014these taxes, particularly when taken all together, are an even bigger mishmash of standards, definitions, etc., and are not included in the Streamlined Agreement.\u00a0 What should the new standard be for requiring a vendor to collect other categories of tax?<\/p>\n

    Good News, Bad News<\/u><\/p>\n

    As with all change, there will be some good news and some bad news (and a ton of uncertainty) associated with the Wayfair<\/em> decision:<\/p>\n