An Unfair Income Tax Grab by States in the Post-Wayfair World
The 2018 Supreme Court ruling in South Dakota v. Wayfair, Inc. allowed states to collect sales tax from out-of-state sellers based on economic activity alone, eliminating the long-standing physical presence requirement. Before this landmark Supreme Court decision in Wayfair, the “physical presence” standard held that a state could only require an out-of-state business to collect and remit sales tax if that business maintained a physical presence with the state (such as with an office, warehouse, or local employees). The Wayfair decision, which ruled in favor of South Dakota’s imposition of sales tax on remote sellers, overturned the physical presence standard for sales tax “nexus.”
This decision made a good deal of sense due to the rise of the internet economy. According to the Supreme Court, the “Internet’s prevalence and power have changed the dynamics of the national economy.” (South Dakota v. Wayfair, Inc., 2018). A large internet seller, such as Wayfair or Amazon, was previously able to avoid paying much sales tax by maintaining physical presence only in low-sales-tax states, while shipping throughout the country. The physical presence rule had long been criticized as providing undue advantage to out of state sellers. (South Dakota v. Wayfair, Inc., 2018). In addition, states had conflicting and overlapping definitions of sales tax nexus, which allowed sellers to manipulate or avoid their tax obligations. (Jenson, Wilps, et al, 2023.).
Since the Wayfair decision, however, states have attempted to extend this concept of economic nexus to income tax. No legal basis exists for such an extension of reasoning to the arena of income tax. The Wayfair ruling specifically addressed sales tax, which is a pass-through obligation, while income tax directly affects a business’s net earnings. Expanding economic nexus in this way raises serious constitutional concerns, creates compliance burdens, and contradicts established precedent.
Constitutional Concerns: Due Process and Commerce Clause Issues
Extending economic nexus to income tax raises serious constitutional questions under the Due Process and Commerce Clauses of the United States Constitution. Under the Due Process Clause, a state may not discriminate against interstate commerce. While Wayfair ruled that economic activity alone could satisfy this requirement for sales tax, the decision did not extend this principle to income tax, which involves a more complex assessment of business activity within a state. Under the Commerce Clause, the Constitution prohibits states from unduly burdening interstate commerce.
The Supreme Court’s Complete Auto Transit, Inc. v. Brady framework requires that a state tax be fairly apportioned and related to services provided in the state. Imposing income tax on businesses with no physical presence could violate this principle, as businesses would be subject to multiple, overlapping tax obligations in states where they do not operate in a meaningful way. In his dissent to the Wayfair decision, Chief Justice John Roberts noted that “Correctly calculating and remitting sales taxes on all e-commerce sales will likely prove baffling for many retailers,” as “[o]ver 10,000 jurisdictions levy sales taxes,” each with different rates, rules, and standards. (South Dakota v. Wayfair, Inc., 2018).
If requiring a small internet seller to comply with more than 10,000 sales tax jurisdictions does not constitute an undue burden on interstate commerce, it is unclear what would constitute such a burden.If states extend economic nexus to income tax, they risk imposing tax obligations on businesses that lack sufficient connection to justify such taxation. This would create a precedent where any company earning revenue from a state—regardless of its operational presence—could be subject to that state’s income tax, an overreach that the Constitution was designed to prevent.
Sales Tax and Income Tax Are Fundamentally Different
Beyond the problematic Constitutional issues underlying the Wayfair decision, there is a major problem with the way in which states have been applying the decision. The Supreme Court’s ruling in Wayfair did not address income tax, and the reasoning behind the decision does not automatically apply to this fundamentally different type of taxation. Most states, however, have been relying on the Wayfair decision to impose state income tax on businesses that simply sell into their states without having a physical presence there. While the assessment of sales tax may be analogous to how state income tax is assessed, the two types of tax are not the same, and the Supreme Court’s decision was narrowly addressed only to sales tax. Sales tax and income tax serve different purposes and operate under distinct legal frameworks. Sales tax is essentially a consumption tax imposed on transactions occurring within a state. It is collected from customers and remitted by businesses, making it a relatively straightforward obligation. Income tax, by contrast, is levied on a business’s net earnings. It is based on a company’s economic presence and operations within a state, not merely on its sales activity.
Conclusion: Wayfair Should Not Be Misapplied
The Wayfair decision was a major shift in state taxation, but it was strictly limited to sales tax. Even if one agrees with the majority’s ruling in Wayfair, extending its economic nexus principles to income tax lacks a legal foundation and raises serious constitutional and practical concerns. Until the Supreme Court or Congress provides further guidance, states should not attempt to unilaterally expand their tax authority in a way that imposes undue burdens on businesses and disrupts interstate commerce.
References
Jensen, J., Wilps, D., Hogroian, F., Gillespie, M. 2023. South Dakota v. Wayfair – five years later. The Tax Adviser. https://www.thetaxadviser.com/issues/2023/jun/south-dakota-v-wayfair-five-years-later/
South Dakota v. Wayfair, Inc., et al, 138 S. Ct. 2080 (2018). https://www.supremecourt.gov/opinions/17pdf/17-494_j4el.pdf