Economic nexus in the United States

The concept became central to U.S. state taxation following the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc., which allowed states to require out-of-state or remote sellers to collect sales tax based solely on economic activity, even in the absence of physical presence. The ruling overturned decades of precedent, most notably the Quill Corp. v. North Dakota ruling, enabling states to expand tax compliance obligations to out-of-state or remote sellers, particularly those engaged in the e-commerce industry.

Since the decision, most U.S. states have enacted economic nexus laws, which have transformed sales tax compliance for businesses operating across state lines.

History

Background

Before 2018, the authority of U.S. states to require businesses to collect sales tax was primarily governed by the North Dakota Supreme Court’s 1992 decision in Quill Corp. v. North Dakota. In that case, the Court reaffirmed the principle that a business must have a physical presence, which may be established by having an office, warehouses, or employees, in a state before the state could impose tax collection obligations. This physical presence, also known as the physical nexus, was rooted in the Commerce Clause of the U.S. Constitution, which limits state regulation of interstate commerce.

The Quill decision limited state tax enforcement, particularly as remote commerce and online sales began to grow rapidly in the early 2000s. States argued that the rule created a tax loophole, allowing out-of-state or remote sellers to avoid collecting, reporting, and remitting sales tax even when they generated substantial sales within the state. This situation placed brick-and-mortar businesses at a disadvantage and led to growing concern about lost tax revenue.

South Dakota v. Wayfair

The legal framework surrounding state sales tax collection changed dramatically with the 2018 Supreme Court’s ruling in South Dakota v. Wayfair, Inc. The State of South Dakota enacted a law requiring out-of-state sellers to collect and remit sales tax if they exceeded specific economic thresholds set at $100,000 in sales or 200 transactions annually in the state, regardless of physical presence.

The Supreme Court upheld South Dakota’s law, ruling that the physical presence requirement established in Quill was “outdated and artificial.” The Court reasoned that the substantial economic and technological changes in commerce justified a shift in legal standards. It concluded that a seller’s economic and virtual contacts with a state could constitute a sufficient nexus under the Commerce Clause. In its ruling, the Supreme Court noted that “states were losing between $694 million and $3 billion per year in sales tax revenues as a result of the physical presence rule”.