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State Taxation of Internet Sales

By: Robert W. Hesselbacher, Jr.

A recent concurring opinion by Supreme Court Justice Kennedy might provoke reconsideration of whether states can require e-commerce and mail-order businesses to collect use taxes (the equivalent of sales taxes) for out-of-state purchases by state residents.  Nearly 50 years ago, the Supreme Court decided that, consistent with the Commerce Clause of the Constitution, a state cannot require a business to collect use taxes if the business does not have a physical presence in the state.  Although the states still could impose use taxes, they must be collected from the in-state buyer, not the out-of-state seller.  The Court revisited and reaffirmed this decision in 1992, although several justices questioned whether the earlier case still should be followed.  These decisions have had the practical result of dramatically reducing state tax collections by making use taxes difficult to collect.

In Direct Marketing Ass’n v. Brohl, decided March 3, 2015, the Court unanimously decided a fairly limited question of whether a federal court had jurisdiction to decide a matter relating to use taxes.  Much more interesting than the decision in the case was Justice Kennedy’s concurring opinion.  He expressed great doubt that the earlier decisions were decided correctly and stated that they should be reevaluated, particularly in view of the “dramatic technological and social changes” that have taken place in recent years, including the astounding increase in interstate purchases through the Internet.  In Justice Kennedy’s view, the Internet has caused such changes in the economy that requiring a business to collect taxes should no longer depend on whether it has a physical presence in a state.  If states are permitted to require all Internet sellers to collect taxes, the changes will be far-reaching – increased payments of taxes by consumers on Internet purchases, increased state tax revenues, and an increased ability of “bricks and mortar” stores to compete with e-commerce businesses.

The Brohl case did not raise the question of whether the “physical presence” requirement should continued to be followed.  However, Justice Kennedy concluded his opinion by saying that “the legal system should find an appropriate case” for the Supreme Court to reexamine this issue.  Especially in light of Justice Kennedy’s explicit invitation, the Court may have such an opportunity in the not too distant future.