NCPA - National Center for Policy Analysis

Scholastic Books Faces State Tax Overreaching

May 22, 2012

Courts in two states (Connecticut and Tennessee) have ruled this year that bookselling company Scholastic owes back sales and use taxes, despite the fact that Scholastic has neither property nor employees in those states.  This reflects the ongoing debate about state tax authority, and the need for clearer rules on the proper extent of a state's power to impose tax obligations on out-of-state companies, say Joseph Henchman and Jordan King of the Tax Foundation.

There exist two competing views of when states may properly assert the power to tax:

  • Physical presence nexus: the state can assert the power to tax on any individual or business that has a real, tangible presence in a state, such as with the presence of property or employees.
  • Economic presence nexus: the state should have the power to tax any company that has customers in the state from which the company derives income.

Because the issue has not been settled, multistate companies remain vulnerable to uncertainties regarding their tax liabilities, as is the case with Scholastic.  Furthermore, while the Supreme Court would normally resolve such issues, the rulings it has handed down have not clarified the legalities.

  • In National Bellas Hess, Inc. v. Illinois Dept. of Revenue (1967) and Quill Corp. v. North Dakota (1992), the U.S. Supreme Court affirmed the physical presence nexus standard for determining sales tax collection obligations of out-of-state retailers.
  • Bellas Hess was a mail order company, incorporated in Delaware, that distributed catalogs to customers who would return order forms and then receive their items via common carrier.
  • Illinois argued that the company owed state taxes due to its in-state commerce.
  • Finding that Bellas Hess had no physical presence in Illinois, they ruled no tax obligation existed.
  • Quill reaffirmed this rule after North Dakota enacted a similar law.

While this may seem a definitive ruling, the narrative of state taxation remains convoluted.  The Court ruled in Scripto, Inc. v. Carson (1960) that a Georgia-based retailer (Scripto) had physical presence in Florida despite having no employees or property in that state, stating that the company's independent contractors in the state were effectively salesmen.

The judicial system should make up its mind on this matter so that businesses can get back to doing business.

Source: Joseph Henchman and Jordan King, "Scholastic Books Faces State Tax Overreaching," Tax Foundation, May 15, 2012.

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