For years, merchants with customers in more than one state have relied on the relatively simple rule that sales and use taxes only need to be collected and remitted on sales to  customers in states where the merchant has an office, a storefront, employees or some other physical presence.

This rule had its origin in two pre-Internet Supreme Court decisions: National Bellas Hess, Inc. v. Illinois Department of Revenue and Quill Corp. v. North Dakota. In Bellas Hess, the Court held that the Commerce and Due Process Clauses prohibit states from imposing use tax collection obligations on businesses that do not have a physical presence in the taxing state. Twenty-five years later, Quill clarified that it is the Commerce Clause, not the Due Process Clause, that requires physical presence in the taxing state.

These cases were decided in the twentieth century. In the new millennium, the Internet has made it considerably easier to conduct cross-border sales without setting foot in another state. Ecommerce has grown exponentially. By selling products and services online instead of establishing physical storefronts or hiring salespeople in different states, many ecommerce businesses have been able to avoid liability for taxes in every state except the one in which the company is physically located. This has resulted in severe revenue shortfalls for states and municipalities.

Several states responded to revenue shortfalls by expanding their tax bases to include services and/or digital products, enacting “affiliate nexus” tax laws, treating cookies on a person’s computer as a “physical presence” in the computer owner’s state, and imposing tax obligations on online service providers (such as Amazon, Shopify, or Etsy) that facilitate other vendors’ sales. Another common approach has been to require out-of-state retailers to report untaxed sales, to notify buyers of the obligation to pay use taxes, or both.

Other states took a bolder approach. They deliberately imposed use tax collection obligations on out-of-state sellers with no physical presence in the state, hoping to provoke a constitutional challenge that would give the United States Supreme Court an opportunity to overrule Bellas Hess and Quill. South Dakota was one of these states. It required an out-of-state seller, whether it was physically present in the state or not, to collect and remit use tax if the seller either delivered more than $100,000 of goods or services into the state or conducted 200 or more transactions for the delivery of goods or services into the state.

The strategy was successful. Wayfair, Inc. and other large Internet retailers with no physical presence in South Dakota refused to collect the tax. South Dakota courts declared the law unconstitutional and the U.S. Supreme Court granted certiorari to reconsider the physical presence requirement. Finding Quill to have been “flawed on its own terms,” the Court overruled Bellas Hess and Quill to the extent they prohibited states from imposing tax obligations on merchants without a physical presence in the state. The decision, South Dakota v. Wayfair, Inc., established that a state may impose tax obligations on a business if it has an “economic nexus” with the state even if it has no physical presence there.

The elimination of the physical presence requirement created a great deal of uncertainty. Language in Wayfair seemed to suggest that physical presence, large sales volume, or large revenues are needed to establish the requisite nexus with a state for tax purposes. States therefore scrambled to enact volume- and revenue-based use tax thresholds.  Unfortunately, volume and revenue thresholds are not a great improvement over the physical presence standard. They are vulnerable to the same kinds of criticisms. A better solution is needed.