With billions at stake, Supreme Court urged to revisit ruling shielding internet purchases from sales tax

Reporting from Washington —  The last time the Supreme Court took a hard look at how to impose sales taxes on home shopping, it was the era of mail-order catalogs — “before Amazon was even selling books out of Jeff Bezos’ garage,” lawyers recently told the justices.

In 1992, the high court upheld a constitutional rule that barred states from requiring mail-order sellers to collect sales taxes if the vendors had no “physical presence” in that state.

The rule was immediately seen by some as legally suspect. And with the explosion of internet sales over the decades, it costs state and local governments tens of billions of dollars in lost tax revenues.

Now lawyers for 35 states, including California, are urging the high court to overturn the physical-presence rule as outdated and unfair to them as well as to the struggling “brick and mortar” retailers who must collect sales taxes.

They have on their side a crucial ally: Associate Justice Anthony M. Kennedy. Two years ago, he said the court should reexamine the 1992 Quill Corp. vs. North Dakota decision as soon as possible. The ruling was “questionable” at the time, he said, and it is “now inflicting extreme harm and unfairness on the states.”

“In view of the dramatic technological and social changes that have taken place in our increasingly interconnected economy,” he wrote, “it is unwise to delay any longer a reconsideration of the court’s holding in Quill.”

That opportunity comes before the justices Friday when they meet to review dozens of pending appeals, including South Dakota vs. Wayfair, Overstock and Newegg, which calls for scrapping the “physical presence” rule.

“If Quill was a ‘questionable’ decision in 1992, it is a senseless decision in 2018,” said Lisa Soronen, executive director of the State and Local Legal Center in Washington. “Congress has had over two decades to correct Quill but it has failed to do so.”

She was referring to the court’s parting comment in its 1992 opinion that Congress “may be better qualified” to set a national rule on collecting sales taxes from out-of-state sellers.

Since then, Congress has tried but failed to agree on a new law. The Senate approved the Marketplace Fairness Act in 2013 to authorize states to collect sales taxes from out-of-state sellers, but the House balked. Republican leaders have been wary of imposing more taxes on consumers and new burdens on online businesses.

Supporters of small web-based businesses argue that Congress should not foist on them the duty to collect taxes that are owed to more 12,000 city and county jurisdictions across the country.

The deadlock in Congress has renewed pressure on the court to rethink its rules for deciding interstate tax disputes.

The Constitution does not directly give the Supreme Court the power to police limits on interstate commerce. It says “Congress shall have the power … to regulate commerce with foreign nations and among the several states.” But for much of the court’s history, the justices have said they may strike down state laws that restrict interstate commerce, including taxes on shipments that are unfair or too heavy. The justices refer to this doctrine — sometimes sarcastically — as the “dormant” or “negative” commerce clause because it gives the court power it was never explicitly granted.

Justice Clarence Thomas, who like Kennedy concurred in the outcome in the 1992 decision but did not sign on to the court’s opinion, has been a steady skeptic of the “negative” commerce clause. It “has no basis in the text of the Constitution and makes little sense,” he wrote. And Justice Neil M. Gorsuch criticized the “physical presence” rule when he was an appellate judge in Colorado, calling it a “sort of judicially sponsored tax shelter” for online sellers.

State officials are encouraged that the court may be ready to change course.

“The Supreme Court’s earlier view of taxable nexus no longer makes sense in today’s economy,” said Nick Maduros, director of the California Department of Tax and Fee Administration. “The current interpretation places an unfair burden on those who pay their fair share of taxes and puts in-state retailers at a competitive disadvantage.”

The California state sales tax is 7.25%, and counties and cities may add to that. Los Angeles County adds 2.25%, for a total of 9.5%.

Amazon, the largest online seller, began collecting sales taxes in California after establishing warehouses in the state. And it has since agreed to collect taxes on purchases from the 45 states that levy sales taxes.

Nonetheless, California officials estimate the state loses as much as $2 billion in annual revenue because of the court’s tax rule.

In November, the Government Accountability Office estimated state and local governments are collecting 75%-80% of the taxes they are owed from “remote sellers.” It projected the annual loss for those governments as between $8.5 billion and $13.4 billion.

However, lawyers for the states cited much higher losses, including an analysis by the Marketplace Fairness Coalition, which estimates revenue losses of $33.9 billion this year and $211 billion from 2018 to 2022 if the physical presence rule is unchanged.

In November, 15 friend-of-the-court briefs were filed urging the justices to hear the South Dakota case. They came from groups that represent retailers, wholesalers and shopping centers as well as the National Governors Assn. and law professors and economists.

Last month, several anti-tax groups joined Internet sellers in urging the court to turn away the appeal.

“I really worry about the impact on small to mid-sized businesses. This would unleash tax collectors to pursue them all over the country. And they may not to be able to absorb the compliance cost,” said Carl Szabo, general counsel for NetChoice, a trade association for online businesses. He said small, web-based firms could face tax audits not just from 45 states, but from the thousands of municipalities with their own sales taxes.

The Supreme Court cited this burden in 1992, but state lawyers now say that special software makes it easy to assess proper taxes based on the ZIP Code of the buyer.

The justices will meet several times this month to vote on pending appeals. January is usually the last month for them to grant new cases that will be argued in the spring and decided by the term’s end in late June.

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