Athreshold issue for any corporation engaged in interstate commerce is determining the states in which it must file income tax returns and pay taxes. Public Law 86-272 provides corporations that sell tangible personal property with a limited safe harbor from the imposition of state income taxes. In 2021, the Multistate Tax Commission (MTC) adopted a statement regarding how to apply Public Law 86-272 to business activities conducted on the Internet. In 2022, California and New York issued regulatory guidance that closely parallels the statement issued by the MTC. Examples of Internet activities that are not protected by Public Law 86-272 under these pronouncements include a business using its website to provide post-sale assistance via electronic chat, sell extended warranty plans, accept job applications for non-sales positions, or gather customer search information that is used to adjust production schedules. These recent pronouncements by California and New York put a spotlight on the limits of the federal safe harbor.

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Both California and New York have adopted bright-line economic nexus tests for determining whether an out-of-state corporation is subject to the state’s corporate franchise tax. For example, a corporation organized outside of New York is subject to the New York corporate franchise tax if the corporation derives $1,138,000 or more of receipts from New York during the year (N.Y. Tax Law section 209.1). Likewise, a corporation organized outside of California is subject to the California corporate franchise tax if the corporation’s sales in California during the year exceed the lesser of $711,538 (2023) or 25% of its total annual sales (Cal. Rev. and Tax Code section 23101). Numerous other states have adopted a corporate income tax nexus threshold of $500,000 of in-state sales during the year, including Massachusetts [830 Code Mass. Regs. 63.39.1(3)(d)], Pennsylvania [72 Pa. Stat. Ann. section 7402(a)(5)(iii)] and Texas [34 Tex. Admin. Code section 3.586(f)].

It is important to keep in mind that even if an out-of-state corporation has significant in-state sales, the corporation is still protected from the imposition of the state’s income tax if the corporation strictly limits its in-state activities to those protected by federal Public Law 86-272. Consequently, even if an out-of-state corporation’s sales in New York exceed the statutory nexus threshold of $1,138,000, Public Law 86-272 protections still apply if the corporation satisfies all the qualification requirements of the federal safe harbor [N.Y. Reg. section 1-3.2(a)(3).] Likewise, if a corporation’s activities in California stay within the protections of Public Law 86-272, the corporation remains protected from the imposition of the California corporate franchise tax, even if its California sales exceed the state’s statutory threshold for economic nexus (General Information on New Rules for Doing Business in California, Cal. Fran. Tax Bd., Mar. 4, 2011).

Applying Public Law 86-272 to Internet Activities

In 1959, Congress enacted Public Law 86-272 (15 USC section 381) to prohibit states from imposing a net income tax on a corporation if the corporation’s only in-state activity is the “solicitation of orders” for sales of tangible personal property that are sent outside the state for approval and are filled by shipment from a point outside the state. Although business practices have changed significantly since 1959, Congress has not updated Public Law 86-272 and the federal government has not provided any administrative guidance for implementing the law.

Multistate Tax Commission.

The MTC is an agency of state governments whose mission is to promote fairness and uniformity in state tax laws. Virtually all states participate in the MTC in one manner or another (http://tinyurl.com/49xhx8pu), and many states eventually enact into law part or all of the model laws and regulations promulgated by the MTC.

In 1986, the MTC adopted the “Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272,” a policy statement regarding the proper application of Public Law 86-272. The MTC modified the statement in 1993, 1994, 2001, and most recently in August 2021. The August 2021 revisions include guidance regarding how to apply Public Law 86-272 to business activities conducted on the Internet. (For a detailed discussion of the August 2021 revisions, see http://tinyurl.com/mwzzkb3n.)

The protection provided by Public Law 86-272 is available only if the corporation strictly limits its in-state activities to the solicitation of orders. Public Law 86-272 does not define the phrase “solicitation of orders.” However, the U.S. Supreme Court has ruled that solicitation of orders encompasses “requests for purchases” and “those activities that are entirely ancillary to requests for purchases—those that serve no independent business function apart from their connection to the soliciting of orders.” [Wisconsin Department of Revenue v. William Wrigley, Jr., Co. (505 U.S. 214, 1992)] Examples of business activities that are generally considered entirely ancillary to requests for purchases and therefore are protected by Public Law 86-272 include distributing free samples of a product, checking a customer’s inventory level without charge (for reorder, not quality control), and sales personnel mediating a customer complaint solely to ingratiate themselves with customers and to facilitate requests for purchases in the future. Examples of business activities that are not entirely ancillary to requests for purchases and therefore are not protected by Public Law 86-272 include installation and start-up, customer training, engineering and design assistance, technical assistance, maintenance and repair, and credit and collection activities.

In South Dakota v. Wayfair, Inc. (138 S. Ct. 2080, 2018), the U.S. Supreme Court ruled that a state can require an online seller to collect sales taxes on sales to in-state customers even if that seller does not have a physical presence in the state. The Court reasoned that an online seller “may be present in a State in a meaningful way without that presence being physical in the traditional sense of the term.” Based on this logic, the MTC statement provides that “when a business interacts with a customer via the business’s website or app, the business engages in a business activity within the customer’s state.” To illustrate what the term “interacts” means, the statement provides 11 examples of activities conducted by a business that operates a website offering for sale items of tangible personal property. In all cases, the business has no contacts with the customer’s state other than what is indicated in the example, and orders are approved and the property is shipped from a point outside the customer’s state.

The MTC concludes that the following eight business activities are not protected by Public Law 86-272:

  • ▪ Post-sale assistance. The business regularly provides post-sale assistance to in-state customers via electronic chat or email that customers initiate by clicking on an icon on the business’s website. For example, the business regularly advises customers on how to use products after they have been delivered (Example 2).
  • ▪ Credit card applications. The business solicits and receives on-line applications for its branded credit card on its website. The cards generate interest income and fees for the business (Example 3).
  • ▪ Job applications. The business’s website invites individuals in a customer’s state to apply for non-sales positions with the business. Applicants can fill out and submit an electronic application, as well as upload a cover letter and resume (Example 4).
  • ▪ Internet cookies related to nonsolicitation activities. The business places cookies onto the electronic devices of in-state customers that gather customer search information used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale (Example 5).
  • ▪ Remote repairs or upgrades. The business remotely fixes or upgrades products previously purchased by in-state customers by transmitting code or other electronic instructions via the Internet (Example 7).
  • ▪ Extended warranties. The business offers and sells extended warranty plans on its website to in-state customers who purchase the business’s products (Example 8).
  • ▪ Marketplace facilitator contracts. The business contracts with a marketplace facilitator that facilitates the sale of the business’s products on the facilitator’s on-line marketplace. The marketplace facilitator maintains inventory, including some of the business’s products, at fulfillment centers in states where the business’s customers are located (Example 9).
  • ▪ Streaming services. The business contracts with in-state customers to stream videos and music to electronic devices for a charge (Example 10).

On the other hand, the MTC concludes that the following three business activities are protected by Public Law 86-272:

  • ▪ Static FAQs. The business provides post-sale assistance to in-state customers by posting a list of static FAQs on its website. The mere viewing of FAQs does not result in any interaction between the customer and the business (Example 1).
  • ▪ Internet cookies that are entirely ancillary to solicitation. The business places cookies onto the computers or other electronic devices of in-state customers that gather customer information used only to solicit orders for tangible personal property (e.g., remember items that customers place in their shopping carts, store personal information customers provide, and remind customers what products they considered previously) (Example 6).
  • ▪ Offering only items of tangible personal property for sale on its website. The business’s website enables customers to search for items, read product descriptions, select items for purchase, choose among delivery options, and pay for the items (Example 11).

California.

Six months after the MTC adopted its guidelines for applying Public Law 86-272 to business activities conducted on the Internet, the California Franchise Tax Board issued Technical Advice Memorandum (TAM) 2022-01 (Calif. Fran. Tax Bd., Feb. 14, 2022), which also includes 11 examples of business activities conducted on the Internet. Although TAM 2022-01 does not mention the MTC, the 11 examples closely parallel the examples described in the MTC’s 2021 statement, as well as the conclusions reached therein.

TAM 2022-01 includes a 12th example involving a remote worker who telecommutes on a regular basis from within California and performs business management and accounting tasks. The presence of a remote worker in the state performing business activities other than solicitation is not protected by Public Law 86-272.

In December 2023, a California court ruled that TAM 2022-01 is invalid because it was not promulgated in compliance with the state’s administrative procedure laws [American Catalog Mailers Association v. Franchise Tax Board, No. CGC-22-601363 (Cal. Superior Ct., San Francisco Cnty., Dec. 13, 2023)]. Because the ruling was on procedural grounds, the merits of the Franchise Tax Board’s position regarding the application of Public Law 86-272 to Internet activities remains uncertain.

Satisfying this requirement has become more difficult as e-commerce has evolved and expanded over the years.

New York.

In April 2022, the New York State Department of Taxation and Finance (DTF) updated its draft proposed amendments to New York State Article 9-A Business Corporation Franchise Tax Regulations (previously posted April 2021), including revisions to the nexus provisions. The new provisions include revisions to N.Y. Tax Law section 1-2.10, Foreign Corporations—Public Law 86-272, which address the application of Public Law 86-272 to business activities conducted on the Internet. The DTF indicates that these revisions are “largely modeled” after the MTC’s 2021 statement. Consequently, there are the same eight examples of Internet activities that do not qualify for protection under Public Law 86-272, and the same three examples of Internet activities that qualify for protection under Public Law 86-272. On December 27, 2023, the DTF finalized these regulations.

Other states.

The MTC adopted its new guidance regarding the application of Public Law 86-272 to business activities conducted on the Internet in August 2021. California and New York were the first states to issue guidance, but other states are expected to follow. For example, in September 2023, the New Jersey Division of Taxation issued Technical Bulletin TB-108, Nexus for Corporation Business Tax for Privilege Periods Ending on and after July 31, 2023 (N.J. Div. of Taxn., Sept. 5, 2023), which generally follows the guidance issued by the MTC.

Reconsideration Needed

Historically, Public Law 86-272 has provided important protections for corporations that sell tangible personal property to customers in states in which the corporation has no employees or facilities. However, these protections are available only if the corporation strictly limits its in-state activities to the solicitation of orders for tangible personal property. Satisfying this requirement has become more difficult as e-commerce has evolved and expanded over the years. Consequently, tax preparers must carefully consider whether claiming immunity from state tax under Public Law 86-272 is still consistent with the facts in each state in which the taxpayer has customers.

Michael S. Schadewald, PhD, CPA, is a clinical professor at the Fisher School of Accounting, Warrington College of Business, University of Florida, Gainesville, Fla.