South Dakota’s Use Tax Threatens Basic Principles of Fair Tax Policy

It’s not a new development that states have been able to get away with aggressive applications of their tax codes on out-of-state residents because of judicial deference. But the South Dakota Supreme Court allowing a tax assessment on a Minnesota-based business in the latest salvo in the interstate taxing battle should compel U.S. Supreme Court review — not to mention a more comprehensive reassessment of its recent pattern of overlooking mounting burdens state tax policy is placing upon multistate taxpayers.

Ellingson Drainage, Inc. is a Minnesota-based construction company specializing in installing drain tile. Between 2017 and 2020, Ellingson brought pieces of construction equipment that had been purchased in other states into South Dakota to complete jobs. 

Despite the fact that some of the equipment had only been present in South Dakota for a single day, South Dakota applied its 4.5 percent use tax to the entire value of all the equipment. Adding on interest, the resulting tax assessment came out to over $75,000. 

Ellingson challenged the assessment, claiming that the assessment violated the Due Process and Commerce clauses of the Constitution.  Ellingson had a point: since the equipment was not used exclusively in South Dakota, the tax should have been apportioned based on where it was used. Instead, South Dakota’s tax assessment ignored the fact that 90 percent of the equipment’s use was outside the state of South Dakota, taxing the equipment as if it was used entirely in South Dakota.

The test commonly applied to such disputes over whether an external tax assessment presents an unconstitutional burden to interstate commerce was established under Complete Auto v. Brady. The test required a tax to satisfy four prongs to be considered constitutional: 

  1. The taxed activity is sufficiently connected to the state to justify the tax.

  2. The tax is fairly related to benefits provided to the taxpayer.

  3. The tax does not discriminate against interstate commerce.

  4. The tax is fairly apportioned.

Ellingson did not take issue with the tax as it related to prongs one and three, but did argue that the tax was invalid under prongs two and four. The South Dakota Supreme Court disagreed.

Prong Two

Prong two exists to ensure that states do not assess the same burdens on out-of-state taxpayers as if they enjoyed all the benefits taxpayers residing within the state enjoy. It is an acknowledgement of the fact that while taxpayers with a passing connection to a state can be made to contribute to that state government’s functioning based on that connection, the state must make an effort to account for the extent of the benefits received.

The South Dakota Supreme Court argued that prong two of the Complete Auto test is satisfied because “the only benefit a taxpayer is entitled to is that of living in an organized society.” In doing so, it betrayed a fundamental misunderstanding of prong two and what it means.

There is truth in the assertion that a taxpayer need not receive a direct, tangible benefit in order to face tax obligations. Taxpayers do not face higher income tax obligations based on whether or not they receive unemployment benefits or tax credits — in fact, the inverse is often the case. This is even true for out-of-state taxpayers.

However, where the South Dakota Supreme Court erred was in assuming that this general truism represents a sufficient analysis of prong two. Not so — prong two does not require a state to come up with an abstract justification for imposing tax obligations, it requires the state to consider the actual benefits enjoyed by a taxpayer and determine whether they are proportionate to the tax obligations they face, particularly in the context of what is being taxed.

For instance, a resident of another state who drives through South Dakota for a few hours in the course of a road trip derives some benefit from the proper functioning of South Dakota society. They use the roads the state maintains, benefit from police protection, and so on. And consequently, this person can be expected to pay the state’s gas tax on fuel purchased within the state. 

However, it would be absurd for South Dakota to claim the power to tax, for example, the value of the car the driver used to travel through South Dakota, or the income that enabled the driver to purchase it, based on these abstract and intangible benefits. However, if “living in an organized society” alone were a sufficient benefit to justify tax obligations, as the South Dakota Supreme Court argues, there is no reason why not. 

Obviously, the fact that a taxpayer does not need to receive a direct, tangible benefit in return for their taxes is not enough reason to ignore prong two. Otherwise, there would be almost no reason why a tax assessment on nonresidents would ever not be justified. In order for prong two to mean anything at all, it cannot mean what South Dakota’s Supreme Court seems to think it means. 

Prong Four

Related to prong two is prong four, which requires taxes to be fairly apportioned — the word “fairly” necessitating an analysis of the relative benefits Ellingson receives from South Dakota versus other states. Here again, South Dakota’s Supreme Court erred in dismissing Ellingson’s claims.

Generally speaking, a tax that affects multistate businesses should be apportioned between those states with nexus. While pitfalls — such as different apportionment formulas between states — remain, and can still lead to multiple taxation, generally apportionment eliminates the most blatant forms. Interstate compacts, such as reciprocity agreements that simplify tax obligations, provide even more comprehensive protection for taxpayers from multiple taxation.

The Court’s reasoning for believing that the tax is fairly apportioned boils down to two points. First, that even though some of the equipment was only used in South Dakota for a single day, payment of the state’s use tax enables Ellingson to use it in South Dakota in perpetuity. And second, that Ellingson is not facing multiple taxation because the equipment was not taxed in the states in which it was purchased.

Here is where a more thorough examination of the factors intended to be considered in prong two would have benefited South Dakota’s Supreme Court. While Ellingson could use the equipment in South Dakota in the future, that fact alone is not sufficient to avoid apportioning the tax. The potential for future unlimited use in South Dakota does not counteract the actual limited nature of the equipment’s use. 

This leads to the second point. The fact that another state did not choose to tax the equipment at issue is not an excuse for South Dakota to tax it to its heart’s content. In other words, another state’s tax exemption should not translate to South Dakota’s windfall. 

In this case, whether or not they chose to do so, other states had the power to tax the vast majority of the equipment’s sale value. The fact that South Dakota offers a credit for sales and use tax paid in other states is not enough to consider the tax apportioned, particularly considering that the vast majority of other states do not tax equipment. 

Failure to apportion taxes such as this renders other states’ tax policies meaningless. Minnesota cannot achieve the goals intended by its decision to exempt manufacturing equipment sold within the state from taxation as long as a single day of use in another state means that the entire sales value is taxable there. Absent apportionment, any state exempting items or activities from tax are simply allowing another more aggressive state to tax them instead.


When the result of an interpretation of a law is manifestly unfair and illogical, it should cause the advocates of that interpretation to engage in self-reflection. In this case, the idea that equipment used temporarily in South Dakota should face the same tax obligations as equipment used in South Dakota for an entire year is so self-evidently wrong that the U.S. Supreme Court should view the South Dakota Supreme Court’s application of the Complete Auto test with extreme suspicion.

The state Supreme Court’s decision in Ellingson Drainage v. South Dakota shows that state jurisprudence on the Complete Auto test, and the Commerce Clause more broadly, has become so jumbled as to necessitate a correction by the highest court in the land.