South Dakota law will be a test case for a US Internet sales tax

A state law that went into effect this week has already prompted two lawsuits

A new South Dakota law may end up determining whether most U.S. residents are required to pay sales taxes on their Internet purchases.

The South Dakota law, passed by the Legislature there in March, requires many out-of-state online and catalog retailers to collect the state's sales tax from customers. The law is shaping up to be a legal test case challenging a 25-year-old U.S. Supreme Court ruling that prohibits states from levying sales taxes on remote purchases.

Unless courts overturn the South Dakota law, it will embolden other states to pass similar Internet sales tax rules, critics said. The law could "set the course for enormous tax and administrative burdens on businesses across the country," Steve DelBianco, executive director of e-commerce trade group NetChoice, said in a statement.

If dozens of states adopt Internet sales taxes, online sellers could face audits and changing tax rules in thousands of taxing jurisdictions nationwide. Even with software that could make tax calculations easier, that would be a burden, NetChoice says. And online shoppers could end up paying up to 10 percent more for many products.

Supporters defended the law. It's time to provide a "level playing field" for bricks-and-mortar retailers that are required to collect sales taxes, said state Senator Deb Peters, a Republican and the main sponsor of the tax legislation.

With South Dakota's sales tax going up from 4 percent to 4.5 percent in June, out-of-state sellers have an advantage.

Even before the law went into effect Sunday, it prompted two lawsuits. Last Thursday, the state sued four online sellers, including Newegg and Overstock.com, in an effort to force them to register with the state and collect its sales tax. The law requires out-of-state retailers to collect sales tax if they have more than US$100,000 in sales, or 200 remote transactions, in South Dakota each year.

Then, on Friday, NetChoice and the American Catalog Mailers Association sued the state, arguing the new law violates the Supreme Court's Quill v. North Dakota decision from 1992.

South Dakota lawmakers passed the law "with the express understanding that its terms contradict" the Supreme Court, lawyers for the two trade groups wrote in their lawsuit. The law is "plainly unconstitutional" because it usurps the U.S. Congress's authority to regulate interstate commerce, they said.

In the Quill decision, the Supreme Court ruled that states could not impose sales taxes on sales by out-of-state retailers because the taxes, with varying rules across thousands of jurisdictions, would be burdensome for sellers to collect. After the ruling, retailers with no store or warehouse in a state were not required to collect the state's sales tax.

The court left an opening for the U.S. Congress to streamline sales tax collection and allow states to extend it to out-of-state businesses. Lawmakers in Congress have been trying to pass Internet sales tax legislation for more than a decade, but opponents have stalled it.

Software and smartphone apps now make sales tax calculations easy, Peters said by email. "The burdens outlined in Quill no longer exist," she said.

Peters encouraged the Supreme Court to rule on the South Dakota sales tax law. 

"We've been petitioning Congress for almost two decades to address the issue of remote sales tax collection because the ever-growing problem has negatively impacted local businesses and state revenue," she said. "To date, Congress has failed to act, leaving states to take action on their own."

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