California Attempts to Modernize State Income Tax Safe Harbor Guidance – Bloomberg Tax

California is the first state to update its state income tax safe harbor guidance to include examples of unprotected internet-based activities post-Wayfair, but likely not the last. As such, out-of-state businesses selling tangible personal property should consider their specific facts and circumstances when evaluating their tax position in California and in other states, says Sensiba San Filippo LLP’s Kaylyn Kleinhans.
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.
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.
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, 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:
Activities That Do Not Void PL 86-272 Protection
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.
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.
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