Unconstitutional Burdens

Tax Schemes

The most recent legislative session produced two new schemes by which states are trying to force out-of-state retailers to collect sales and use tax from in-state customers.

A law adopted by Colorado ' and then in a less onerous form by Oklahoma, with variations under consideration by Tennessee and California ' is an effort to force online retailers to reveal their customers' identities and purchases to state revenue agencies. Colo. Rev. Stat. '39-21-112; Okl. Stat. tit. 68 '1406.1(A).

Oklahoma also enacted a provision that essentially declares a long-established Commerce Clause restriction on states to be unnecessary because Oklahoma has simplified its sales-tax administration enough that it is no longer a burden on interstate commerce. Okl. Stat. tit. 68 '1407.5(C).

The Colorado law is being challenged as unconstitutional under the Commerce Clause and the First Amendment free-speech provision of the Constitution. This challenge is founded on well-established constitutional principles. The Oklahoma law will certainly be challenged on similar grounds.

This article reviews the constitutional principles at play in these challenges, and the manner in which these two new approaches are constitutionally suspect. One thing is clear, however: States are ready to challenge old Commerce Clause precedent as outdated and unnecessary in today's economy. Yet, as this article demonstrates, these principles are even more important today than when the rule was first articulated by the U.S. Supreme Court.

Dormant Commerce Clause, State Sales Taxes

Article I, '8, of the U.S. Constitution grants Congress the power to regulate commerce “among the several states.” The degree to which state regulation of interstate commerce is thereby forbidden has been the subject of much litigation. One area that is relatively certain is the U.S. Supreme Court's application of the Commerce Clause to sales and use taxation. In a string of cases decided by the Court, culminating in the “substantial nexus” standard of Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the Court has articulated a “physical presence” standard to judge the constitutionality of a state's imposition of a sales or use tax collection obligation on an out-of-state vendor. Under that standard, a state may require a vendor to collect tax only if the vendor has a physical presence in the jurisdiction.

The Colorado Reporting Law

Recognizing that Quill's physical-presence rule prevented the state from forcing remote vendors to collect tax, Colorado adopted a law that attempts to burden out-of-state businesses with a notice and reporting regime applicable to their sales into the state such that the vendor would find it easier to just collect the tax. This coercive law requires that each retailer that does not collect Colorado sales tax must “notify Colorado purchasers that sales or use tax is due on purchases made from the retailer and that the State of Colorado requires the purchaser to file a sales or use tax return.” C.R.S. '39-21-112(3.5)(c)(I). A Department of Revenue (“DOR”) regulation explains the specific information that the retailer must provide to the purchaser at the time of purchase. In particular, consumers in Colorado must be notified that:

• The retailer is not obligated to, and does not, collect Colorado sales tax;
• The purchase is subject to Colorado sales tax unless it is specifically exempt from taxation; and
• Colorado requires that the taxpayer file a sales/use tax return at the end of the year, reporting all of the purchases that were not taxed, and to pay tax on those purchases. Colo. Code Regs. 39-21-112.3.5.

The law also requires that a non-collecting retailer mail a notice to each purchaser at the end of each year that includes the following information:

• Total amount paid by the purchaser for Colorado purchases from the retailer during the previous calendar year;
• Dates of purchases;
• Amounts of each purchase;
• A description of the type(s) of items purchased; and
• A notice that Colorado requires a sales or use tax return to be filed by the Colorado purchaser. Id.

Finally, the law requires that the out-of-state retailer must file a separate end-of-year statement with the DOR for each purchaser, reporting the total amount of purchases made by that person during the previous year. C.R.S. '39-21-112(3.5)(d)(II)(A). Penalties for violations of any of the requirements are $5 or $10 per instance.

The burden of compliance with this new law is substantial. Under the traditional Colorado collection and remittal scheme, a seller must file one monthly return with the DOR for all sales made during the month. C.R.S. '39-21-105(1)(a). Under the new Colorado reporting scheme, the retailer must file a separate statement per Colorado purchaser, and must send an end-of-year report to each purchaser. If other states and local jurisdictions follow suit, the burden on an e-commerce business may be untenable. Furthermore, the notices and reports may serve to scare off consumers from purchasing from out-of-state Internet retailers, thus hampering an important part of interstate commerce. This burden may very well result in the law being declared unconstitutional as an undue burden on interstate commerce.

Some argue that the Colorado approach is not an actual tax, and thus the Quill standard does not apply. But the Quill Court was concerned about the administrative burden a taxing regime placed on interstate commerce, rather than simply the burden of collecting the tax. The Court expressed concern that “similar obligations might be imposed by the Nation's 6,000-plus taxing jurisdictions” and, quoting a prior case, noted that “many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle [a mail-order house] in a virtual welter of complicated obligations.” Quill, 504 U.S. at 313 n.6 (quoting and relying on its earlier decision in National Bellas Hess, Inc. v. Dep't of Rev. of Ill., 386 U.S. 753, 759-760 (1967) (alteration in original). The physical-presence standard established in Quill was invoked not to prevent the state from requiring the collection of the tax, but to prevent the state from imposing the burden of collecting the tax. Thus, the focus was not on the tax itself, but rather the efforts required to comply with the specific sales and use tax laws. The fact that Colorado gives an out-of-state retailer the “option” to just collect the tax does nothing to render this notice and reporting regime less onerous.

Oklahoma Writes Quill's Obituary

Oklahoma adopted a notice regime modeled on Colorado's, and also passed a law that simply declares that Quill no longer applies to its sales and use tax collection requirement. Oklahoma HB 2359, in part, states: “[T]he sales and use tax system established under Oklahoma law does not pose an undue burden on out-of-state retailers and provides sufficient simplification to warrant the collection and remittance of use taxes by out-of-state retailers that are due and owing to the State of Oklahoma and its local jurisdictions.” Okl. Stat. tit. 68 '1407.5(C). The legislation also lists the various steps Oklahoma has taken to simplify its state and local sales and use tax as justification for abandoning Quill's physical-presence nexus standard.

By enacting this legislation, Oklahoma has unilaterally declared that it has eliminated the burdens on interstate commerce that the U.S. Supreme Court held were too high to require remote sellers to collect sales and use taxes. This tactic ignores Supreme Court precedent and directly usurps the authority reserved for Congress under the Commerce Clause of the Constitution to regulate “[c]ommerce ' among the several States.” U.S. Const. art. I, '8, cl. 3. Such a bold move will inevitably be subject to constitutional challenge, and according to some commentators, that is exactly its goal: a “test case statute ' that directly confronts Quill and sets the stage for a constitutional challenge to Quill.” (Robert D. Plattner, Daniel Smirlock and Mary Ellen Ladouceur, “A New Way Forward for Remote Vendor Sales Tax Collection,” State Tax Notes, Jan. 18, 2010, at 187.)

The Quill Court, in reaffirming the bright-line physical-presence standard, noted that a purpose of the “substantial nexus” requirement is to “limit the reach of state taxing authority so as to ensure that state taxation does not unduly burden interstate commerce.” Quill, 504 U.S. at 313. As noted above, the Court was concerned about the thousands of taxing jurisdictions that could impose similar burdens. The Quill Court outright rejected “a case-by-case evaluation of the actual burdens imposed by particular regulations or taxes,” and instead adopted the Bellas Hess approach of a “demarcation of a discrete realm of commercial activity that is free from interstate taxation,” noting that Bellas Hess “created a safe harbor for vendors whose only connection with customers in the [taxing] State is by common carrier or the United States mail.” Id. at 315 (internal quotations omitted) (alteration in original). These concerns are perhaps even more critical in today's economy, which has shifted heavily toward e-commerce.

Multistate Compliance Is Target

The decisions in Quill and Bellas Hess were based on the aggregated burden that retailers must contemplate when attempting to comply with all the state and local sales and use tax impositions. Likewise, the Supreme Court has rejected other state regulations of interstate commerce not because of the burden imposed by one state in isolation, but by evaluating the burden imposed because of the differences in regulations among the states. In Bibb v. Navaho Freight Lines, Inc., the Court determined that a non-discriminatory trucking safety regulation was contrary to the Commerce Clause because it was different from the regulations in other states and therefore created a “heavy burden ' on the interstate movement of trucks and trailers.” Bibb v. Navaho Freight Lines, 359 U.S. 520, 529-30 (1959). In another trucking regulation case, the Court also considered the regulations of neighboring states to determine that an inconsistent regulation would impose an undue burden on interstate commerce. (See, Kassel v. Consolidated Freightways Corp. of Delaware, 45 U.S. 662, 668 (1981) (noting that, even in the case of safety regulations where states are granted great deference, regulations that “impair significantly the federal interest in efficient and safe interstate transportation ' cannot be harmonized with the Commerce Clause” and that the challenged law “is now out of step with all other Midwestern and Western states.”)) Thus, the Court has long considered the impact of a state tax or regulation in the context of other states' regimes, rather than purely the impact of that tax or regulation in isolation.

The Oklahoma declaration that its simplification efforts have overcome the restrictions of Quill, taken at face value, without consideration of other states, is an insufficient basis to justify abandoning Quill's physical-presence nexus standard. Oklahoma's new law is bold in its in-your-face conflict with Supreme Court precedent. This declaration creates significant uncertainty on the part of Internet retailers who sell product to Oklahoma customers: These retailers must question whether they should begin collecting tax on Oklahoma sales. If not, will the state attempt to audit and assess liability against the vendors? Only time will tell whether Oklahoma intends to enforce its declaration and whether the Court agrees with the approach.

Conclusion

These new approaches to circumvent Quill get points for creativity but that alone is not enough to overcome constitutional scrutiny. The reporting requirements enacted in Colorado result in the same kind of burden on interstate commerce that the Supreme Court found to be a violation of the (dormant) Commerce Clause in Quill.

And the Oklahoma law, which dismisses Quill outright, is founded on the flawed premise that a court should consider only the burden imposed within a particular state's borders.

These laws seek to foil the fundamental purpose of the Commerce Clause ' to ensure the free flow of trade among the states ' and will inevitably be challenged as unconstitutional. Until then, Internet retailers will face uncertainty with regard to their tax collection and notification obligations.

Record-breaking budget shortfalls have caused states to search outside the box for revenue-raising tools that many argue are unconstitutional and violate the consumer privacy that online shoppers have come to expect.

The Commerce Clause of the U.S. Constitution restricts a state's ability to require out-of-state vendors to collect sales and use taxes from in-state consumers.

Today, with so much of retail activity conducted over the Internet, states are struggling with revenue losses stemming from this constitutional restriction. States are reacting by becoming ever more creative in their attempts to capture this lost revenue by adopting new laws aimed at circumventing the Commerce Clause restrictions.

Tax Schemes

The most recent legislative session produced two new schemes by which states are trying to force out-of-state retailers to collect sales and use tax from in-state customers.

A law adopted by Colorado ' and then in a less onerous form by Oklahoma, with variations under consideration by Tennessee and California ' is an effort to force online retailers to reveal their customers' identities and purchases to state revenue agencies. Colo. Rev. Stat. '39-21-112; Okl. Stat. tit. 68 '1406.1(A).

Oklahoma also enacted a provision that essentially declares a long-established Commerce Clause restriction on states to be unnecessary because Oklahoma has simplified its sales-tax administration enough that it is no longer a burden on interstate commerce. Okl. Stat. tit. 68 '1407.5(C).

The Colorado law is being challenged as unconstitutional under the Commerce Clause and the First Amendment free-speech provision of the Constitution. This challenge is founded on well-established constitutional principles. The Oklahoma law will certainly be challenged on similar grounds.

This article reviews the constitutional principles at play in these challenges, and the manner in which these two new approaches are constitutionally suspect. One thing is clear, however: States are ready to challenge old Commerce Clause precedent as outdated and unnecessary in today's economy. Yet, as this article demonstrates, these principles are even more important today than when the rule was first articulated by the U.S. Supreme Court.

Dormant Commerce Clause, State Sales Taxes

Article I, '8, of the U.S. Constitution grants Congress the power to regulate commerce “among the several states.” The degree to which state regulation of interstate commerce is thereby forbidden has been the subject of much litigation. One area that is relatively certain is the U.S. Supreme Court's application of the Commerce Clause to sales and use taxation. In a string of cases decided by the Court, culminating in the “substantial nexus” standard of Quill Corp. v. North Dakota , 504 U.S. 298 (1992), the Court has articulated a “physical presence” standard to judge the constitutionality of a state's imposition of a sales or use tax collection obligation on an out-of-state vendor. Under that standard, a state may require a vendor to collect tax only if the vendor has a physical presence in the jurisdiction.

The Colorado Reporting Law

Recognizing that Quill's physical-presence rule prevented the state from forcing remote vendors to collect tax, Colorado adopted a law that attempts to burden out-of-state businesses with a notice and reporting regime applicable to their sales into the state such that the vendor would find it easier to just collect the tax. This coercive law requires that each retailer that does not collect Colorado sales tax must “notify Colorado purchasers that sales or use tax is due on purchases made from the retailer and that the State of Colorado requires the purchaser to file a sales or use tax return.” C.R.S. '39-21-112(3.5)(c)(I). A Department of Revenue (“DOR”) regulation explains the specific information that the retailer must provide to the purchaser at the time of purchase. In particular, consumers in Colorado must be notified that:

• The retailer is not obligated to, and does not, collect Colorado sales tax;
• The purchase is subject to Colorado sales tax unless it is specifically exempt from taxation; and
• Colorado requires that the taxpayer file a sales/use tax return at the end of the year, reporting all of the purchases that were not taxed, and to pay tax on those purchases. Colo. Code Regs. 39-21-112.3.5.

The law also requires that a non-collecting retailer mail a notice to each purchaser at the end of each year that includes the following information:

• Total amount paid by the purchaser for Colorado purchases from the retailer during the previous calendar year;
• Dates of purchases;
• Amounts of each purchase;
• A description of the type(s) of items purchased; and
• A notice that Colorado requires a sales or use tax return to be filed by the Colorado purchaser. Id.

Finally, the law requires that the out-of-state retailer must file a separate end-of-year statement with the DOR for each purchaser, reporting the total amount of purchases made by that person during the previous year. C.R.S. '39-21-112(3.5)(d)(II)(A). Penalties for violations of any of the requirements are $5 or $10 per instance.

The burden of compliance with this new law is substantial. Under the traditional Colorado collection and remittal scheme, a seller must file one monthly return with the DOR for all sales made during the month. C.R.S. '39-21-105(1)(a). Under the new Colorado reporting scheme, the retailer must file a separate statement per Colorado purchaser, and must send an end-of-year report to each purchaser. If other states and local jurisdictions follow suit, the burden on an e-commerce business may be untenable. Furthermore, the notices and reports may serve to scare off consumers from purchasing from out-of-state Internet retailers, thus hampering an important part of interstate commerce. This burden may very well result in the law being declared unconstitutional as an undue burden on interstate commerce.

Some argue that the Colorado approach is not an actual tax, and thus the Quill standard does not apply. But the Quill Court was concerned about the administrative burden a taxing regime placed on interstate commerce, rather than simply the burden of collecting the tax. The Court expressed concern that “similar obligations might be imposed by the Nation's 6,000-plus taxing jurisdictions” and, quoting a prior case, noted that “many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle [a mail-order house] in a virtual welter of complicated obligations.” Quill , 504 U.S. at 313 n.6 (quoting and relying on its earlier decision in National Bellas Hess, Inc. v. Dep't of Rev. of Ill. , 386 U.S. 753, 759-760 (1967) (alteration in original). The physical-presence standard established in Quill was invoked not to prevent the state from requiring the collection of the tax, but to prevent the state from imposing the burden of collecting the tax. Thus, the focus was not on the tax itself, but rather the efforts required to comply with the specific sales and use tax laws. The fact that Colorado gives an out-of-state retailer the “option” to just collect the tax does nothing to render this notice and reporting regime less onerous.

Oklahoma Writes Quill's Obituary

Oklahoma adopted a notice regime modeled on Colorado's, and also passed a law that simply declares that Quill no longer applies to its sales and use tax collection requirement. Oklahoma HB 2359, in part, states: “[T]he sales and use tax system established under Oklahoma law does not pose an undue burden on out-of-state retailers and provides sufficient simplification to warrant the collection and remittance of use taxes by out-of-state retailers that are due and owing to the State of Oklahoma and its local jurisdictions.” Okl. Stat. tit. 68 '1407.5(C). The legislation also lists the various steps Oklahoma has taken to simplify its state and local sales and use tax as justification for abandoning Quill's physical-presence nexus standard.

By enacting this legislation, Oklahoma has unilaterally declared that it has eliminated the burdens on interstate commerce that the U.S. Supreme Court held were too high to require remote sellers to collect sales and use taxes. This tactic ignores Supreme Court precedent and directly usurps the authority reserved for Congress under the Commerce Clause of the Constitution to regulate “[c]ommerce ' among the several States.” U.S. Const. art. I, '8, cl. 3. Such a bold move will inevitably be subject to constitutional challenge, and according to some commentators, that is exactly its goal: a “test case statute ' that directly confronts Quill and sets the stage for a constitutional challenge to Quill.” (Robert D. Plattner, Daniel Smirlock and Mary Ellen Ladouceur, “A New Way Forward for Remote Vendor Sales Tax Collection,” State Tax Notes, Jan. 18, 2010, at 187.)

The Quill Court, in reaffirming the bright-line physical-presence standard, noted that a purpose of the “substantial nexus” requirement is to “limit the reach of state taxing authority so as to ensure that state taxation does not unduly burden interstate commerce.” Quill, 504 U.S. at 313. As noted above, the Court was concerned about the thousands of taxing jurisdictions that could impose similar burdens. The Quill Court outright rejected “a case-by-case evaluation of the actual burdens imposed by particular regulations or taxes,” and instead adopted the Bellas Hess approach of a “demarcation of a discrete realm of commercial activity that is free from interstate taxation,” noting that Bellas Hess “created a safe harbor for vendors whose only connection with customers in the [taxing] State is by common carrier or the United States mail.” Id. at 315 (internal quotations omitted) (alteration in original). These concerns are perhaps even more critical in today's economy, which has shifted heavily toward e-commerce.

Multistate Compliance Is Target

The decisions in Quill and Bellas Hess were based on the aggregated burden that retailers must contemplate when attempting to comply with all the state and local sales and use tax impositions. Likewise, the Supreme Court has rejected other state regulations of interstate commerce not because of the burden imposed by one state in isolation, but by evaluating the burden imposed because of the differences in regulations among the states. In Bibb v. Navaho Freight Lines, Inc. , the Court determined that a non-discriminatory trucking safety regulation was contrary to the Commerce Clause because it was different from the regulations in other states and therefore created a “heavy burden ' on the interstate movement of trucks and trailers.” Bibb v. Navaho Freight Lines , 359 U.S. 520, 529-30 (1959). In another trucking regulation case, the Court also considered the regulations of neighboring states to determine that an inconsistent regulation would impose an undue burden on interstate commerce. ( See , Kassel v. Consolidated Freightways Corp. of Delaware , 45 U.S. 662, 668 (1981) (noting that, even in the case of safety regulations where states are granted great deference, regulations that “impair significantly the federal interest in efficient and safe interstate transportation ' cannot be harmonized with the Commerce Clause” and that the challenged law “is now out of step with all other Midwestern and Western states.”)) Thus, the Court has long considered the impact of a state tax or regulation in the context of other states' regimes, rather than purely the impact of that tax or regulation in isolation.

The Oklahoma declaration that its simplification efforts have overcome the restrictions of Quill, taken at face value, without consideration of other states, is an insufficient basis to justify abandoning Quill's physical-presence nexus standard. Oklahoma's new law is bold in its in-your-face conflict with Supreme Court precedent. This declaration creates significant uncertainty on the part of Internet retailers who sell product to Oklahoma customers: These retailers must question whether they should begin collecting tax on Oklahoma sales. If not, will the state attempt to audit and assess liability against the vendors? Only time will tell whether Oklahoma intends to enforce its declaration and whether the Court agrees with the approach.

Conclusion

These new approaches to circumvent Quill get points for creativity but that alone is not enough to overcome constitutional scrutiny. The reporting requirements enacted in Colorado result in the same kind of burden on interstate commerce that the Supreme Court found to be a violation of the (dormant) Commerce Clause in Quill.

And the Oklahoma law, which dismisses Quill outright, is founded on the flawed premise that a court should consider only the burden imposed within a particular state's borders.

These laws seek to foil the fundamental purpose of the Commerce Clause ' to ensure the free flow of trade among the states ' and will inevitably be challenged as unconstitutional. Until then, Internet retailers will face uncertainty with regard to their tax collection and notification obligations.