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Navigating Public Law 86-272 tax protections in the internet age

Sep 20, 2022

Many people may have heard of Public Law 86-272, but fewer people have a good understanding of why it was enacted and how it works, especially given the surprising actions of several states during 2022.

Learn the history of this law and how it protected business from state income taxes. It’s useful to understand how Congress has tried to change it over the years, and perhaps most importantly why the efforts of several states and the Multistate Tax Commission (MTC) during 2021-2022 may ultimately prove to be this law’s demise.

What is Public Law 86-272?

Public Law 86-272 takes its title from its status as the 272nd Act of the 86th Congress, and is commonly referred to as P.L. 86-272. It is a federal statute (15 U.S.C. §§ 381-384) that Congress enacted in 1959 to limit states’ authority to impose income-based taxes in certain cases.

Even though Congress tends to avoid limiting states’ taxing power, it did so by enacting P.L. 86-272 to legislatively overturn the 1959 U.S. Supreme Court opinion in Northwestern States due to the uncertainty that opinion had created for the national economy.

What happened in Northwestern States?

In Northwestern States, the court had approved Minnesota’s imposition of an income-based tax upon an out-of-state manufacturer, whose activities in the state were limited to soliciting sales of its products. Orders for these products were approved from outside of the state and were fulfilled from a stock of goods outside of the state.

What does Public Law 86-272 say?

P.L. 86-272 prohibits states from imposing an income-based tax over any person (such as a business) whose in-state activities are limited to activities of the company in Northwestern States, specifically, “the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside such State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State.”

What are the major ways that P.L. 86-272 can help my business, and what are its major limitations?

If a business’s only presence in a state is that its employees or independent contractors working on its behalf are soliciting sales of tangible personal property (TPP), where orders are approved in and fulfilled from outside that state, then despite the business having created nexus in that state, the state is not legally permitted to impose an income-based tax on that business.

Even though this is a powerful outcome for qualifying companies, there are a few major limitations:

1.  It doesn’t keep the underlying sales solicitation activity from creating nexus in the state

As the Supreme Court has repeatedly ruled, soliciting sales in a state — whether through a company’s employees or independent contractors — is one of the most nexus-creating activities that a company can perform in a state. It is a common misconception that having P.L. 86-272 protection in a state means a company doesn’t have nexus there.

2. It only applies to companies soliciting sales of TPP (goods)

For example, it does not apply to the solicitation of sales of anything else, such as real property, intangibles, services or most software. Even though various bills have been introduced in Congress over the years (often called the Business Activity Tax Simplification Act, or BATSA) to modernize P.L. 86-272 to offer protection from non-income-based taxes, such as those based on net worth (franchise taxes) or gross receipts, this legislation has never been enacted.

3.  It doesn’t protect against conducting in-state activities that are related to soliciting sales but that are not technically limited to soliciting sales

For example, activities like collecting delinquent accounts, or providing training to customers about how to use the product you just sold then, aren’t protected. The Supreme Court has only interpreted the meaning of “solicitation” once, in the 1992 Wrigley case, and while the court’s guidance was helpful, it wasn’t very specific. As a result, many companies have historically looked to guidance about P.L. 86-272 issued by a policy organization called the Multistate Tax Commission (MTC).

What does the MTC’s guidance about P.L. 86-272 look like?

The MTC first issued its policy guidance about P.L. 86-272 in 1986, and has since revised it four times:

in 1993, 1994, 2001 and in 2021. For the last 20 years, companies have often relied upon the MTC’s 2001 revision to guide their activities and have evaluated its in-state activities in light of that revision’s list of “Unprotected Activities”. These included:

  • Making repairs or providing maintenance or service to the property sold or to be sold
  • Collecting current or delinquent accounts, whether directly or by third parties
  • Investigating creditworthiness
  • Installation or supervision of installation at or after shipment or delivery
  • Conducting training courses, seminars or lectures for personnel other than personnel involved only in solicitation

All of these things are activities that a business or its representative might physically perform in a state.

However, in its fourth (2021) revision, the MTC turned a lot of heads by adding a new list of activities that a business might virtually perform in a state: “Activities Conducted via the Internet.” When asked what prompted it to add this new list of activities, the MTC explained that it was reacting to the Court’s pronouncements (in its 2018 Wayfair opinion) that nexus could be created by having a sufficient virtual presence in a state. However, many taxpayers who read this new list of guidance concluded that almost any company who used the internet would lose the P.L. 86-272 protection that it might otherwise have. Here is an example of an activity that, in the MTC’s view, would cause a company to create nexus in a state beyond the protections of P.L. 86-272:

“The business solicits and receives on-line applications for its branded credit card via the business’s website. The issued cards will generate interest income and fees for the business. This in-state business activity defeats the business’s P.L. 86-272 immunity in states where the on-line application for cards is available to customers because it does not constitute, and is not entirely ancillary to, the in-state solicitation of orders for sales of tangible personal property.”

Are states going to follow the MTC’s view of how internet activities affect P.L. 86-272?

Because MTC uniformity recommendations are not automatically adopted by states, including those who are MTC members, it’s hard to predict how states will respond. However, during 2022, two large states have announced that they will follow the MTC’s lead. In February 2022, California issued TAM 2022-01, and in April, New York issued draft regulations that are largely modeled after the MTC’s newly-revised P.L. 86-272 guidance.

Because California and New York are so influential, their actions may prompt other states to adopt the MTC’s guidance. For example, on August 22, 2022, Oregon announced that it would hold a virtual hearing the next day to discuss the potential for adopting the MTC’s new P.L. 86-272 statement.

One recent development, however, may cause states to become less excited about the prospect of adopting the MTC’s new P.L. 86-272 pronouncement. At its most recent meeting on August 3, 2022, the MTC adopted a resolution recommending that states who adopt that new pronouncement should also adopt its 2002 model “Factor Presence” nexus standard for purposes of their income, franchise and gross receipts taxes (business activity tax or BAT). If adopted, this standard would cause a state to assert nexus over a company for BAT purposes only if, during the tax year, it had more than $50,000 of in-state property or payroll (physical presence nexus) or more than $500,000 of in-state sales (economic nexus).

Some states, such as Colorado, Ohio and Tennessee, already use this $500,000 in-state sales economic nexus threshold for BAT purposes, as indicated by Wipfli’s economic nexus matrix. By contrast, other states such as Iowa, Minnesota and Wisconsin effectively use a $1.00 in-state sales threshold for BAT economic nexus, where adopting the MTC’s standard might result in less tax revenue for the state. The MTC nonetheless encourages such states to adopt its $500,000 in-state sales threshold for economic nexus as a “means of reducing the burdens of multistate tax compliance on businesses with minimal presence in states and also of reducing unnecessary burdens on state revenue departments.”

How should you react to all of this?

Companies that operate in California or New York should carefully consider their state tax filing posture there in light of this new P.L. 86-272 guidance and revise their filing positions accordingly. For other states such as Oregon, however, companies will need to take a “wait-and-see” approach until those other states publish guidance about their interpretation of this issue. Unfortunately, concrete answers to these questions — or whether the MTC’s interpretation would even be upheld by the Supreme Court — is likely years away.

How Wipfli can help

Your state and local tax filing strategy benefits from careful analysis of your specific situation. Wipfli advisors can help you understand the complexities of P.L. 86-272 and recommend the appropriate filing position. Our experienced team can address sales tax filing requirements as well as income tax and economic nexus for non-income taxes.

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Author(s)

Daniel N. Kidney, CPA, JD
Director
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