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State income tax nexus and Public Law 86-272

April 1, 2022 Article 4 min read
Authors:
Jeanette Tolar Ron Cook Jay Forester Tony Israels
Historically, Public Law 86-272 hadn’t caused any turmoil for companies when determining their income tax nexus. However, revised guidance from the Multistate Tax Commission may be changing what businesses should consider when determining state tax filing requirements.

closeup diverse man and women workingOn Aug. 4, 2021, the Multistate Tax Commission (MTC) made significant revisions to its official guidance on Public Law 86-272, which discusses protected and unprotected business activities performed through a company’s website. The updated guidance specifically addresses activities performed via the internet, since these activities weren’t being performed or otherwise discussed when the law went into effect in 1959.

Public Law 86-272 background and historical application

Under Public Law 86-272, businesses are generally exempt from a state’s net income tax if its activities in a state are limited to soliciting for sales of tangible personal property. Further, orders must be sent outside the state for approval or rejection and, if approved, shipped from a stock of goods located outside the state. Public Law 86-272 doesn’t apply to the solicitation for sales of services or other types of taxes, such as sales, net worth, and gross receipt taxes. For example, soliciting installation, maintenance, or repair services in conjunction with goods wouldn’t fall under Public Law 86-272’s protection.

Historically, state tax authorities took a narrow approach regarding activities that constituted “solicitation,” so not all activities performed by sales representatives would qualify under Public Law 86-272’s exemption. Also, states generally took the approach that a physical presence, such as in-person meetings attended by sales representatives, was required before asserting that net income tax nexus exists.

Over the years, many businesses could generally rely on a consistent set of rules with respect to Public Law 86-272, although uncertainty could exist (e.g., whether activities constituted “solicitation”).

MTC’s revised Public Law 86-272 guidelines

Prior to the revised rules, the MTC didn’t provide that web activities created nexus, despite the widespread use for many years. The MTC’s updated guidance states that determining whether selling tangible personal property through the internet is protected by Public Law 86-272 requires the same general analysis as sales of tangible personal property through other means. Based on the guidance, businesses offering customers a website or mobile app may be deemed to be conducting unprotected business activities within the customer’s state. The options available to users of the website or mobile app could go beyond sales solicitation and give rise to income tax nexus in the state the customer resides or is otherwise located while using the website or mobile app.

Based on the guidance, businesses offering customers a website or mobile app may be deemed to be conducting unprotected business activities within the customer’s state.

The MTC guidance provides examples of web-based activities that would be protected and activities that exceed the protection provided by Public Law 86-272. The examples of unprotected activities include:

  • Providing post-sale assistance to customers through electronic chat or email initiated through the company website.
  • Soliciting or receiving online credit card applications.
  • Inviting applications for nonsales positions in the company with the ability to submit an application through the website.
  • Placing internet “cookies” used for product development or product management onto computers or electronic devices of customers.
  • Providing remote fixes or upgrades to products previously purchased by transmitting code or other electronic instructions through the internet.
  • Providing extended warranty plans through the internet to customers purchasing the company’s products.
  • Contracting with a marketplace facilitator to sell the company’s products through the facilitator’s online marketplace.
  • Contracting with customers to stream videos and music to electronic devices for a charge.

The updated guidance suggests that a company’s use of a website that provides more than a display of products and the ability to place orders will likely exceed the protections provided by Public Law 86-272. As a result, owners of websites may be subject to additional state income tax liabilities if states adopt and enforce the updated guidance.

For example, on Feb. 14, 2022, the California Franchise Tax Board issued Technical Advice Memorandum 2022-01 (TAM 2022-01) analyzing 12 fact-patterns and the applicability of Public Law 86-272 in the current technological environment. The conclusions within TAM 2022-01 are consistent with the MTC’s publication, which indicates businesses performing certain internet activities in California may have an additional filing requirement or opportunity for a tax refund to the extent California applies this guidance retroactively. Retroactive treatment by California auditors is expected, since initial sentiments received from California is that TAM 2022-01 was issued to clarify its position on Public Law 86-272 versus a change to existing law.

Compliance considerations for the MTC guidance and TAM 2022-01

The MTC guidance and TAM 2022-01 leave many issues unresolved. In response, taxpayers should take these items into consideration when making state filing determinations. State auditors may now assume nexus exists in any instance a business provides any of the unprotected activities listed on its website or mobile app. Further, it may be hard to defend or document a certain position. State auditors, along with company management and its advisors, may have difficulty concluding if use of the website is or is not a protected activity due to the complexity of the technology involved.

The MTC guidance and TAM 2022-01 leave many issues unresolved. In response, taxpayers should take these items into consideration when making state filing determinations.

State successor liability concerns

In addition to a heightened income tax compliance review, this guidance may create large successor liabilities for a buyer when acquiring the stock or the assets of a business of another entity. Careful consideration and increased due diligence may be necessary to understand the state and local income tax ramifications of transactions if this guidance is adopted by other states in addition to California.

State legislative action may be required to implement the MTC’s guidance. However, some states by default include or refer to the Multistate Tax Compact’s definition of protected and unprotected activities under Public Law 86-272, which means we may see states adopt unprotected internet activities language without notifying the public.

If you have questions about how the MTC’s guidance or California’s TAM 2022-01 may impact your state and local filing requirements, please contact your Plante Moran advisor to discuss the specific facts and circumstances of your situation.

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