Recordkeeping Is the Best Defense Against Interstate Tax Rules

Businesses need to understand several proposed changes and should take steps to protect themselves against new tax obligations that arise from impending developments related to recent guidance and state laws associated with Public Law 86-272, a 1959 federal law that limits the ability of states to impose income taxes on interstate commerce.

Companies also should be aware that a handful of states already have modified their interpretation of protected and unprotected activities in response to guidance from the Multistate Tax Commission.

In California, a court on Dec. 13, 2023, struck down the state Franchise Tax Board’s attempt to implement the MTC guidance using Technical Advice Memorandum 2022-01.

The court didn’t rule on the merits of the changes; it held only that the regulator’s choice to implement them through technical guidance, rather than changing California statutes or regulations, failed to comply with the state’s Administrative Procedure Act. On Dec. 29, the FTB filed a motion to vacate and modify the judgment.

In New Jersey, officials implemented the guidance in a technical bulletin, with an expanded list describing both protected and unprotected activities in more detail than the original MTC guidance. New Jersey’s list of unprotected activities includes activities such as selling or buying cryptocurrency to or from customers in the state.

In New York, the state issued final regulations on Dec. 27, which provide examples of unprotected internet activities.

Actions for Businesses

Some states are working to implement some form of the MTC interpretations of PL 86-272, and others are waiting to learn the outcome of those disputes. Businesses need to understand which activities might create a state income tax obligation if the MTC’s recommendations become the standard.

If and when states enact the MTC guidance, it’s critical to understand how activities that haven’t caused concerns may now create state income tax obligations. Businesses should compare online activities with MTC guidance.

Activities such as applying for non-sales jobs could constitute an unprotected activity and subject a business to state income taxes. Placement of cookies, especially those not related to the sales process, could be classified as an unprotected non-sales activity. Online activities, such as offering post-sale chat or email assistance, are also included in the MTC’s list of unprotected activities.

It’s also important to maintain detailed records of previous versions of websites. States can access technology that catalogs these versions. If a state chooses to implement the MTC guidance retroactively, or under an audit, it could determine that a business has conducted unprotected activities historically even if it’s not reflected on a current website.

Hidden Opportunity

Inconsistency in how states adopt the MTC’s guidance may provide taxpayers with opportunities to interpret certain guidance to their advantage. For instance, California holds that if a business ships from a place of storage in California and the taxpayer isn’t taxable in the ship-to state, the sale is sourced to California for purposes of calculating the numerator of the sales factor.

If the reverse scenario is applied and those sales are now subject to taxation in other states, per California’s guidance, taxpayers may be able to reduce their California income and qualify for refunds in prior years, given the state’s position on applying the guidance retroactively.

Furthermore, if the state to which the goods are shipped hasn’t adopted similar MTC guidance, the sale may not be sourced to any state.

Looking Ahead

Because states are still in the early stages of implementing updated PL 86-272 guidance, it’s impossible to predict which ones will follow suit and how they’ll enact the guidance. But there are a couple of questions to consider.

Which states are coming on board, and how are their interpretations unique? State-by-state guidance will vary widely. The one notion that will remain consistent is that states won’t be consistent in their application.

How are courts responding to taxpayer challenges? Court actions can fall into a variety of categories, including striking down the rules’ retroactive application; invalidating the provisions on procedural grounds, as the California court did; and ruling that the MTC’s interpretation of certain internet-based activities as unprotected oversteps the states’ authority to adhere to federal law.

There are more questions than answers about the future of PL 86-272 right now. Businesses that could be affected should pay close attention to new developments in the months ahead and begin to understand and document their internet activities.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Tony Israels is state and local tax principal at Plante Moran. He leads leading the firm’s national tax office’s state and local tax due diligence group.

David Landwehr is state and local tax manager at Plante Moran. He focuses on pass-through entities, sales tax, and state tax controversy.

Jeanette Tolar is state and local tax partner at Plante Moran and leads the state and local tax team for the Rocky Mountain region.

Write for Us: Author Guidelines