The Marketplace Fairness Act & Its Impact on Sales Tax

The rise of internet commerce created a complex sales tax problem, as a company’s obligation to collect sales tax historically depended on its physical location. The Marketplace Fairness Act was a legislative proposal in the early 2010s designed to modernize these rules for the digital age by creating a uniform standard for remote sellers. The Act’s goal was to grant states the authority to require out-of-state sellers to collect and remit sales taxes on purchases made by their residents. This aimed to level the playing field between online retailers and local stores and address the revenue losses states experienced from the growth of e-commerce.

The Proposed Framework of the Act

The Marketplace Fairness Act (MFA) was designed to address a legal standard from the Supreme Court’s 1992 decision in Quill Corp. v. North Dakota. The Court had affirmed that states could not force a business to collect sales tax unless it had a “physical presence,” such as an office or warehouse, within the state. This ruling became problematic as e-commerce grew, allowing many online retailers to sell goods nationwide without collecting sales tax.

To receive authority under the MFA, states would have been required to simplify their sales tax systems. The legislation offered two pathways for this simplification. The first option was to join the Streamlined Sales and Use Tax Agreement (SSUTA), a multi-state pact to standardize tax definitions, rules, and administration procedures.

Alternatively, a state could implement minimum simplification requirements outlined in the bill. These mandates included:

• Designating a single, statewide entity for all remote sales tax registrations, filings, and audits.
• Establishing a uniform tax base across all state and local levels.
• Providing advance notice of any rate changes.
• Supplying free software to calculate taxes and prepare returns.

The software provision included a hold-harmless clause, protecting businesses from liability for errors caused by the state-provided systems.

The proposed law also included a small-seller exception. This provision would have exempted businesses with annual gross receipts from remote sales under a certain threshold, initially set at $1 million. The Act specified that sales would be sourced to the destination, meaning the tax rate applied would be based on the buyer’s location.

The Legislative Outcome

Despite bipartisan support, the Marketplace Fairness Act ultimately failed to become law. The bill passed the U.S. Senate in May 2013 with a 69-27 vote.

After passing the Senate, the bill was sent to the U.S. House of Representatives and referred to the Judiciary Committee, where its momentum stalled. The House leadership did not bring the bill to the floor for a vote, and it expired at the end of the congressional session. Subsequent attempts to re-introduce similar legislation also failed to pass Congress.

The Act’s failure in the House can be attributed to several factors. A primary concern was the potential compliance burden on small and medium-sized online businesses, despite the proposed simplifications. There was also strong anti-tax sentiment and a reluctance to grant states what was perceived as new taxing authority.

The Supreme Court’s Intervention

With Congress unable to pass a legislative solution, the focus of the online sales tax debate shifted to the judicial system. States began to directly challenge the physical presence standard established by Quill. This effort culminated in the 2018 Supreme Court case, South Dakota v. Wayfair, Inc., which reshaped the landscape of sales tax in the United States.

South Dakota enacted a law directly contradicting the Quill precedent, requiring remote sellers to collect sales tax if they met certain economic thresholds: over $100,000 in sales to the state’s residents or 200 or more separate transactions within a year. The state then sued major online retailers, including Wayfair, to validate its law, creating a legal test case designed to reach the Supreme Court.

In a 5-4 decision, the Supreme Court overturned its previous rulings in Quill and National Bellas Hess. The majority opinion argued that the physical presence rule was “unsound and incorrect” in the age of e-commerce, as the growth of online retail had rendered the standard obsolete. The decision concluded that the rule was an artificial interpretation of the Commerce Clause and that a business’s economic and virtual contacts with a state could be sufficient to establish a “substantial nexus” for tax purposes.

Current Online Sales Tax Rules

The Supreme Court’s decision in South Dakota v. Wayfair, Inc. did not create a new tax but affirmed the ability of states to enforce the collection of existing sales taxes by remote sellers. This ruling ushered in the era of “economic nexus,” a standard allowing a state to require tax collection from a business based on its economic activity within that state, regardless of physical location.

In the wake of the Wayfair decision, nearly every state with a sales tax has enacted its own economic nexus law. While the specifics vary, the most common threshold that triggers a sales tax collection obligation is exceeding $100,000 in gross sales into a state within the previous or current calendar year. Although a secondary threshold based on conducting 200 or more separate transactions was once common, a growing number of states have eliminated this transaction-count test. Some states have higher sales thresholds, such as $500,000.

This legal framework requires businesses to track their sales volume on a state-by-state basis. Once a company crosses a state’s economic nexus threshold, it must:

• Register for a sales tax permit in that state.
• Calculate the correct state and local tax rates for each sale.
• Collect the tax from the customer.
• Remit the funds to the state’s tax authority.

The timing for when a business must register after crossing a threshold also differs by state, with some requiring registration on the next transaction and others providing a grace period. The result is a complex compliance map for any business selling online to a national market.