Companies that conduct business online are determining how recently revised guidelines from the Multistate Tax Commission (MTC) will impact their tax obligations – and are discovering that they may be subject to new state income tax liabilities and filing requirements.
Adapting 1950s Tax Rules to the Internet Age
In 1959, Congress passed the Interstate Income Act—usually referred to by its public law designation, P.L. 86-272. This legislation prohibits states from imposing state income taxes on out-of-state businesses as long as those businesses’ in-state activities involve only the solicitation of orders for tangible personal property. It does not apply to other types of sales, such as real property, intangibles, services, or software.
Much has changed since 1959, especially in the ways that businesses interact with customers. Many states have raised questions about how P.L. 86-272 should be applied to internet-based transactions, where out-of-state sellers of tangible personal property use their websites not only to solicit orders, but also to provide customer service, warranty protections, product upgrades, and other non-sales activities.
Further uncertainty arose after the U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair Inc. Although the Wayfair decision addressed sales taxes, not income taxes, it specifically stated that an internet seller “may be present in a state in a meaningful way without that presence being physical.” This language suggests the court would be open to the idea that sellers who interact with customers online are engaging in business activities that go beyond the mere solicitation of orders.
To address the uncertainty, the MTC in 2021 added a section to its P.L. 86-272 guidelines addressing internet activities. The new guidance states that, “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.” In other words, P.L. 86-272 would no longer apply to those transactions, and the businesses would no longer be protected from paying income taxes in their customers’ states.
Note, however, that the MTC’s position is simply its interpretation of P.L. 86-272. It does not have the force of law. It is up to the individual states to decide if they will adopt all or part of the MTC guidelines.
What’s Protected—and What’s Not
The MTC statement lists eight examples of internet-based activities that would subject a business to state income tax in a customer’s state. These include common online features such as:
- Providing post-sale assistance to customers using chatbots or emails initiated by clicking on an icon on the company’s website
- Placing “cookies” onto customers’ computers to track their interests or purchase plans
- Allowing visitors to submit credit card applications or job applications through the website
- Remotely fixing or upgrading customers’ products by transmitting code to those products
- Offering extended warranty plans to existing customers
- Contracting with a marketplace facilitator (such as Amazon) to maintain inventory and ship directly to customers from an in-state fulfillment center
As mentioned, it is up to individual states to decide if they will adopt the MTC’s position. California was the first state to do so, when the California Franchise Tax Board announced in February 2022 that it would adopt the MTC examples and apply them retroactively. Two months later, the New York Department of Taxation and Finance issued draft regulations that closely track the MTC’s revised interpretation.
Tax authorities in several other states have also announced their intention to adopt the MTC standard but have not yet issued draft regulations. It is also possible that some tax authorities could decide to apply the MTC’s revised interpretation without issuing advance guidance, catching taxpayers off guard during an audit.
As one might expect, these changes are not going unchallenged. In August 2022, the American Catalog Mailers Association brought the first lawsuit challenging California’s new rules. The case is currently awaiting trial. Other organizations are almost certain to file similar suits as other states adopt the MTC’s revised interpretation.
The MTC’s revised guidelines will limit the protections available through P.L. 86-272. New rules are being adopted in states and lawsuits challenging them are being filed by companies doing business online. Businesses conducting online transactions could be uncertain how the revised guidelines and their state’s interpretation will impact them.
The tax professionals at Dembo Jones are available to help determine your potential tax position. Give us a call to discuss this – and other – potential tax obligations.