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A recent United States Supreme Court opinion regarding the emerging issue of sales tax collection for online sales will be a game changer for state tax policy, leaving states such as Tennessee with their online tax policies in limbo. It could also have complex and extensive impact on small and medium sized online retailers, leaving them with steep compliance costs.


In a 5–4 decision on June 21, 2018, the Supreme Court upheld South Dakota’s online sales tax collection statute and ruled that the “physical presence” test, under the Court’s 1992 case Quill Corp. v. North Dakota,1 no longer limits a state’s ability to collect sales tax on purchases by instate customers. In order for a state to impose a duty on sellers to collect online sales tax, the seller must have a substantial nexus with the taxing state. “Such a nexus is established when the taxpayer or collector avails itself of the substantial privilege of carrying on business in that jurisdiction.”2 Before Wayfair, a business had to have a physical presence in a state to satisfy this substantial nexus requirement. However, writing for the majority, Justice Kennedy, joined by Justices Alito, Ginsburg, Thomas, and Gorsuch, held the “physical presence rule” was not a “necessary interpretation” of the substantial nexus requirement. In the majority’s view, earlier decisions like Quill “serve[d] as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State’s consumers.” 

In support of its decision to overrule prior precedent, the Court highlighted the immense changes in the way consumers buy and sell goods today. 

The Court also made clear that the four-pronged test from Complete Auto Transit, Inc. v. Brady remains the standard for Commerce Clause disputes such as these.3 South Dakota’s law will be valid and enforceable, like any similar tax affecting interstate commerce, if it: (1) applies to an activity with a substantial nexus with the taxing state; (2) is fairly proportioned; (3) does not discriminate against interstate commerce; and (4) is fairly related to the services the state provides.4 By ruling physical presence is no longer required for nexus, the Court eliminated the major hurdle for states seeking to collect sales tax from online retailers. The Court assumed without deciding that South Dakota’s law met the other elements; however, the state’s Supreme Court will have to rule formally on the issue on remand. 

Justice Roberts, writing for the dissent, believed the decision to act “on this important question of current economic policy” belonged to Congress.5 He also illustrated the burden the Court’s decision would have on small businesses trying to comply with as many as 10,000 potential tax jurisdictions. To illustrate his point, he wrote

Texas taxes sales of plain deodorant at 6.25 percent but imposes no tax on deodorant with antiperspirant. Illinois categorizes Twix and Snickers bars—chocolate-and-caramel confections usually displayed side-by-side in the candy aisle— as food and candy, respectively (Twix have flour; Snickers don’t), and taxes them differently.6

These seemingly arbitrary distinctions are present in every tax jurisdiction across the country, making compliance a potential nightmare for small retailers. Chief Justice Roberts elaborated that the Court’s decision would “surely have the effect of dampening opportunities for commerce in a broad range of new markets” and that Congress is better suited to “more directly consider the competing interests at stake.”7 Of note, Roberts felt that Congress could have answered many questions the Court left open in its decision, such as “whether any change will have retroactive effect.”8 

For states looking to enact their own online sales tax statutes, the Court cited certain aspects of South Dakota’s law that helped it pass constitutional muster under the Commerce Clause. First, the law provides a safe harbor for companies transacting limited business within the state by “prevent[ing] discrimination against or undue burdens upon interstate commerce.”9 Second, the law states that taxes shall be collected on future sales only, meaning the law does not apply retroactively. Third, the Court cites South Dakota’s membership in the Streamlined Sales and Use Tax Agreement as an endorsement of simplicity and keeping administrative and compliance costs to a minimum.10

Impact of South Dakota v. Wayfair

Wayfair’s impact will be far reaching and complex, and small and medium sized businesses are likely to be affected most by the Supreme Court’s decision. On the one hand, small businesses with brick-and-mortar operations cheered the ruling as a way to level the playing field with large online retailers—like Amazon—who were previously able to offer artificially lower prices because they lacked a physical presence in a state. On the other hand, small businesses who sell primarily online may now face steep compliance costs as they try to collect and remit taxes across the approximately 10,000 U.S. sales tax jurisdictions.

Online Sales Tax in Tennessee

In his earlier 2015 concurrence in a case in 2015,11 Justice Kennedy invited litigants to challenge the Quill decision prompting South Dakota, Alabama, and other states to push the issue of online sales tax collection to the Court. In 2016, Tennessee put forward its own administrative tax proposal—Tenn. Comp. R & Regs. 1230-05-01-.129(2) (“Rule 129”)—that would require out-of-state companies to collect and remit online sales tax. Rule 129 provided that out-of-state businesses with no physical presence in Tennessee with instate sales exceeding $500,000 in in a twelve month period have a substantial nexus with the state. This rule required out-of-state dealers to register with the state by March 1, 2017 and begin collecting sales tax by July 1, 2017. Rule 129 also provided that out-of-state dealers who begin collecting tax voluntarily would not be subject to audits or assessments for periods prior to the date the dealer begin collecting and remitting the tax. 

On March 30, 2017, the American Catalog Mailers Association (“ACMA”) appealed from an administrative proceeding against the Tennessee Department of Revenue to Chancery Court to prevent implementation of Rule 129 (No. 17-0307-IV). The ACMA challenged that Tennessee’s rule was unconstitutional because it contradicted the Supreme Court’s ruling in Quill and lacked any physical presence requirement. Tennessee was not alone, as South Dakota and Alabama had similar lawsuits pending at the time. 

Two months later, in May 2017, in light of the pending litigation, the Tennessee General Assembly passed an amendment to the general omnibus rules bill prohibiting the Department of Revenue from collecting any internet sales or use taxes permitted under either Rule 129 or a ruling of any court.12 Additionally, the amendment stated that Rule 129 would not become effective until the courts decided the issue and the rule passed through the legislature again. While some legislators wanted to strike Rule 129 from the omnibus bill entirely because it clearly violated Supreme Court precedent, the sponsors’ stated that the amendment was necessary to preserve Tennessee’s standing to challenge the Court’s holding in Quill and retain legislative oversight over the state’s online sales tax policy. Senator Mike Bell (R–Riceville)—explaining the intent of the amendment—stated, “Even after the court makes a final ruling, what this amendment says is that this rule has to go back through the Government Operations Committee … and would have to come back into another omnibus rules bill [to be enacted]. We are putting this rule on hold, but we are leaving it in place, so the State can continue to have standing.” In other words, no matter the outcome of the future Wayfair or ACMA case, the Department of Revenue cannot enforce any online sales tax rule until it has been reviewed and approved by the Tennessee General Assembly. 

Even though the amendment’s House sponsor, Representative Mike Carter (R–Ooltewah), believed it may be five years or more before Tennessee would have an answer from the courts, the United States Supreme Court granted certiorari in the Wayfair case on January 12, 2018.13Later, on March 2, 2018, ACMA and the state agreed to an injunction by the Chancery Court pending the outcome of the Supreme Court’s decision.

Next Steps for Tennessee

In the wake of the Wayfair decision, Tennessee’s tax policy now hangs in limbo. Unlike South Dakota, Tennessee chose to implement its online sales tax collection policy through administrative rulemaking instead of by statute. Next session, the Tennessee General Assembly may pass a statute, similar to South Dakota’s, to avoid the risk of litigation challenging the Department of Revenue’s scope of rulemaking authority (an ancillary argument made in the American Catalog case). In the Republican dominated state legislature, the sting of voting for a tax increase is eased by the Supreme Court’s decision, and members are likely to cite it as justification for their vote on the legislation. 

However, another alternative would be for the Department of Revenue to promulgate a final rule similar to Rule 129 under Tennessee’s current economic nexus statute and submit it for approval to the House and Senate Government Operations Committees in January 2019. Unless an extraordinary special session is called, the state is likely prohibited from taking any action until next year—after a new governor’s administration. Based on the estimated $200 million increase in revenue, implementation of an online sales tax collection policy is not a matter of “if” for Tennessee but when. 

Both alternatives for Tennessee have different legal and political consequences. It may seem counterintuitive that the Tennessee General Assembly is required to approve agency rules; however, this legislative approval has more to do with the scope of rulemaking authority rather than the substance or policy of agency rules themselves. The House and Senate Government Operations Committees have a statutory mandate to oversee certain agency rulemaking actions pursuant to Tenn. Code Ann. §§ 4–5–108 and 4–5–226. Section 4–5–108 statute states in relevant part

[A]ny legislation that reestablishes, restructures or otherwise delegates any type of rulemaking authority to any new or preexisting governmental entity to which this chapter applies, shall be referred to the government operations committee according to the rules of the senate and the rules of the house of representatives.

Thus, when legislation seeks to extend the scope of an agency’s rulemaking ability—such as the Department of Revenue’s ability to collect online taxes—the government operations committees of both houses must approve that delegation of authority. If the Department of Revenue were to enact such a rule without express statutory approval by the General Assembly, that rule would be subject to legal challenges under Tennessee’s codification of the Uniform Administrative Procedures Act.14

South Dakota vs. Tennessee and the Possibility of a Federal Solution

The Supreme Court did not lay out a single standard for cities and states to follow for online tax collection. Outside of the specific parameters set forth by the Court in Wayfair, it is unclear what other laws would be constitutional. Must a state’s law be prospective only? What if a state is not a member of the Streamlined Sales and Use Tax Agreement? Can states require a lower threshold than $100,000 to begin collecting taxes? All of these open questions are unlikely to be answered quickly by the courts, so it will be up to states how to best move forward. 

There are some two important differences between Tennessee’s rule and South Dakota’s statute that may affect what future action Tennessee lawmakers decide to take. First, Tennessee’s rule differs from South Dakota’s law by requiring a higher threshold of sales before imposing a duty to collect taxes, thus making it seemingly more protective of small retailers. However, the state may decide to lower its proposed $500,000 threshold to match South Dakota’s $200,000 level in order to reel in more businesses who are required to collect taxes. Second, Tennessee’s rule did not provide a safe harbor for retroactive application meaning the state could impose the tax retroactively on businesses. While Rule 129 did provide protection for those retailers who voluntarily began collecting taxes, in light of the Court’s ruling, it is likely that any new Tennessee proposal will provide clearer retroactivity rules similar to South Dakota’s law. 

In the aftermath of Wayfair, many stakeholders are urging Congress to act. Having a single federal standard for online sales taxation would give states predictability and a uniform collection standard which would help to alleviate this issue of true interstate commerce. However, earlier bills that sought to kill the Court’s earlier decision in Quill, such as the Marketplace Fairness Act of 2017 co-sponsored by Tennessee Senator Lamar Alexander, have failed. With Wayfair as law, it may be easier for Congress to pass uniform guidelines for how states should implement the ruling.


The Supreme Court’s decision in Wayfair provides a key turning point for state tax policy and for businesses of all sizes. Whatever policy Tennessee decides to implement—statute or administrative rule—cities and states must remain cognizant of the impact on retailers. Keeping compliance costs to a minimum in addition to increasing roll out periods may leave a few online sales tax dollars on the table. However, in the long run, ensuring that Tennessee is a place where all businesses—large and small, online and brick-and-mortar—can continue to thrive and prosper is something on which all stakeholders can agree.

1 504 U.S. 298 (1992).
2 Wayfair, *17 (quoting Polar Tankers, Inc. v. City of Valdez, 557 U.S. 1, 11 (2009).
3 430 U.S. 274, 279 (1977).
Id. at *1.
Id. at *19.
Id. at *22.
7 Id.
8 Id. at *23.

9 Id. at *17.
10 “This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability.” Id. at *17.
11 Direct Marketing Assoc. v. Brohl, 135 S.Ct. 1124, 1134 (2015) (Kennedy, J. concurring).
13 See House Finance Ways & Means Committee,

14 Tenn. Code Ann. §§ 4–5–101 et seq.