California Attempts to Modernize State Income Tax Safe Harbor Guidance

The groundbreaking sales tax case South Dakota v. Wayfair may have been decided by the US Supreme Court four years ago, but the case’s ripple effect for multistate income taxes is likely to continue well into the future.

What started as the Multistate Tax Commission’s (MTC) adoption of a revised statement of information on the application of Public Law 86-272 in today’s digital age has recently resulted in the California Franchise Tax Board issuing a Technical Advice Memorandum, TAM 2022-01. The TAM evaluates PL 86-272’s protection of certain fact patterns “common in the current economy due to technological advancements” for purposes of California’s income and franchise tax.

California is the first state to provide PL 86-272 guidance following MTC’s revised statement, but it likely won’t be the last. Both the MTC’s revised statement and the FTB’s TAM further limit the applicability of PL 86-272, widening the net for out-of-state taxpayers to be subject to a state’s income tax.

What is PL 86-272?

In 1959, business owners lobbied heavily to limit the states’ ability to impose income taxes on out-of-state sellers of tangible personal property that have little to no physical connection to the taxing state. As a result, PL 86-272 was enacted at the federal level to provide income tax immunity to out-of-state sellers of tangible personal property whose only activities within a state is sales solicitation or activities ancillary to sales solicitation.

Because of PL 86-272’s relatively quick adoption, the federal law fails to define key terms such as “solicitation,” “tangible personal property,” and “business activities.” The law also failed to assign responsibility to any administrative board to provide guidance to taxpayers. In 1986, the MTC stepped forward and developed the first version of their statement of information to address these problems. Since then, it has been updated several times.

Statement of Information Updates

Over the years, the MTC has updated its statement of information for PL 86-272 in an attempt to modernize guidance as the economy has changed. Lawmakers in 1959 couldn’t have predicted what doing business would look like in 2022, with business owners now using websites, mobile apps, and a remote workforce to sell their tangible goods.

The MTC’s latest revised statement of information was released Aug. 4, 2021, and states, “as a general rule, 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.” However, presentation of “static text or photos on [a business’s] website ... does not in itself constitute a business activity within those states where the business’s customers are located.”

The MTC leveraged language discussed in Wayfair around internet sellers to reinforce the idea that while a business may not have a physical presence in a state in the traditional sense, they may maintain a presence through the internet. Technically, Wayfair does not interpret PL 86-272, but the connection between the two is relevant.

In 1986, at the time of the initial statement of information, the number of MTC member states—those that had agreements to uniformly adopt the commission’s positions and interpretations—was growing, hoping to unify state taxes. Today, only 16 states remain full members, with most states now looking at the MTC’s positions as general guidance rather than law.

California Makes the First Move

California, a non-MTC member, issued TAM 2022-01 on Feb. 14, 2022, which updated the state’s interpretation of PL 86-272 activities to include internet-based activities, similar to MTC’s latest version of the statement of information. While California is the first state to address PL 86-272 and internet-based activities, other non-member states will likely follow California’s lead and look to tax out-of-state taxpayers whose only connection with the state is through the internet.

Specifically, TAM 2022-01 provides 12 different business scenarios and discusses whether the scenarios disqualify an out-of-state business from the protection of PL 86-272.

Activities That Void PL 86-272 Protection:

1. Providing online, post-sale assistance to California customers via either electronic chat or email that customers initiate by clicking on an icon on the business’s website.
2. Soliciting and receiving online applications for the business’s branded credit card via the taxpayer’s website.
3. Posting on the business’s website that invites viewers in California to apply for non-sales positions via an electronic application.
4. Placing internet cookies on electronic devices of California customers which gathers information to be used to adjust production schedules, inventory amounts, develop new products, or identify new items to offer for sale.
5. Providing remote upgrades or fixes to products previously purchased by California customers via code or other instructions via the internet.
6. Selling extended warranty plans via the business’s website to California customers.
7. Contracting with a marketplace facilitator for sales of the business’s products on the facilitator’s online marketplace but maintains the business’s inventory at fulfillment centers where the business’s customers are located.
8. Providing online video and/or music streaming services to California customers.
9. Employees telecommuting (even temporarily) whose role and activities within the state are not related to sales solicitation.

Activities That Do Not Void PL 86-272 Protection

1. Providing post-sale assistance by displaying a static online list of FAQs with answers on the business’s website.
2. Placing internet cookies on electronic devices of California customers, which gathers information that is only to be used for purposes entirely ancillary to sales solicitation of orders for tangible personal property. Examples include: saving customers’ items in their shopping cart, storing personal customer information that has been provided to avoid the need to re-input information when revisiting the business’s website.
3. Offering for sale via the business’s website only items of tangible personal property. This includes allowing customers to search for items, read product descriptions, select delivery options, and pay for the items.

What Does This Mean for Businesses?

It should be noted that both the MTC’s updated statement of information and California’s TAM 2022-01 are recommendations and meant to be use as guidance. The states have continually made efforts to erode PL 86-272 protection, especially in light of Wayfair and the need to increase state revenue due to the pandemic.

However, these new interpretations have yet to be challenged in court. If California’s TAM 2022-01 is ultimately sustained, it will greatly increase the number of out-of-state businesses that will be considered to have exceeded PL 86-272’s protections and then be subject to California’s income tax.

Out-of-state businesses should evaluate their electronic activities within California and document their PL 86-272 position to address the potential California income tax exposure. Businesses within California also need to consider California’s throwback rule. They will need to evaluate their electronic activities and consider their PL 86-272 protection positions and the application of California’s TAM 2022-01 to determine the number of sales subject to throwback could result in a taxpayer favorable position.

There is still a lot we don’t know about both the MTC’s statement and California’s TAM 2022-01, so while these updates do provide some clarification, it is important to consider your business’s specific facts and circumstances when evaluating your PL 86-272 position both in California and other states.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Kaylyn Kleinhans is Sensiba San Filippo LLP’s State & Local Tax Practice leader. She specializes in multi-state corporate income tax, business activity tax, nexus analysis, revenue sourcing analysis, local taxes, and unitary/consolidated state income tax compliance.