Supreme Court’s 2014-15 Term: Case Will Test an Important Limitation on the Ability to Challenge State Tax Laws

By on October 30, 2014

On December 8, 2014, the United States Supreme Court will hear oral argument in a case that could have significant implications for the ability to use the federal courts to challenge state attempts to tax remote sellers of goods.

In Direct Marketing Association v. Brohl, 735 F.3d 904 (10th Cir. 2013), the Tenth Circuit Court of Appeals found that the Direct Marketing Association’s (DMA) challenge to a Colorado revenue statute was barred by the federal Tax Injunction Act (TIA).  Current Commerce Clause precedent bans a state from requiring a retailer with no in-state presence from collecting sales or use taxes, see Quill Corp. v. North Dakota, 504 U.S. 298 (1992), an important shield against state taxation of remote online and catalogue sellers of goods.  This precedent, however, allows states to collect sales and use tax from the buyers of the goods (i.e., citizens) located within the state.

Seeking to reach this significant source of potential tax revenues, in 2010 the Colorado legislature enacted legislation requiring major out-of-state sellers to provide a series of notices and reports related to sales taxes.  First, the selling retailers must notify Colorado purchasers that tax is due on their purchases.  Second, these retailers must send annual notices to Colorado customers who purchased more than $500 in goods in the preceding year, “reminding” these purchasers of their obligation to pay sales tax to the state.  Third, the law requires these out-of-state retailers to report information on Colorado purchasers to the state’s tax authorities.  Not surprisingly, the law gives retailers the ability to avoid these obligations by simply collecting sales tax from Colorado consumers and providing those collections to the state.

The DMA filed suit, challenging the Colorado law on several Commerce Clause grounds.  The District Court granted summary judgment in favor of DMA, relying on Quill to hold that the law placed an impermissible burden on interstate commerce.

On appeal, the Tenth Circuit did not reach the merits of the Commerce Clause issue.  Instead, the Court held that the TIA barred DMA’s lawsuit and required dismissal.  The Tax Injunction Act prohibits federal courts from interfering with the collection of state taxes.  DMA argued that because it was not a taxpayer subject to the new reporting requirements, the TIA should not apply.  Moreover, TIA reasoned that the Colorado law in question only imposed notice and reporting obligations, and therefore was merely a tax collection method, not an actual tax.  The Tenth Circuit rejected both arguments, concluding that any suit that would hamper a state’s ability to collect a tax falls within the TIA’s jurisdictional bar.

The Supreme Court has agreed to review the Tenth Circuit’s decision.  Its ultimate decision about the reach of the TIA could have implications to operations involved in the direct shipping of wine.

Current state licensing systems for direct alcohol shippers already require the payment of state taxes as a condition of licensure.  Nevertheless, statutes like Colorado’s law, if left unchallenged due to operation of the TIA, could allow states to gain more control over the direct shipment of any number of products.  Indeed, by making it harder to challenge state laws seeking to regulate online sellers in general, a Supreme Court affirmance could alter the current political balance in which many states legislatures have authorized licensed direct shipping in exchange for securing a means to collect taxes on such wine sales.

A decision from the Supreme Court on the application of the TIA to DMA’s legal challenge will likely occur in the first half of 2015.  In the meantime, DMA refiled its Commerce Clause challenge in state court (where the TIA does not apply) and obtained a preliminary injunction barring enforcement of the Colorado statute while the case proceeds.