Impact for Small Businesses: MTC’s New Interpretation of P.L. 86-272

HOST: Welcome to this edition of the Cherry Bekaert Tax Beat podcast. Today, we are talking about state taxation of interstate commercial activity.

We are primarily discussing the shifting sands beneath a long-standing federal tax law used for determining if a state can tax the income of a business. We are limiting this discussion to income taxation today, though there are many other ramifications for other state and local taxes.

The star of the statute for today is Public Law 86-272. It has been around since 1959, but the way companies conduct business today versus the middle of the last century continues to put pressure on its applicability.

Joining today's conversation are Louis Cole, Partner and Leader of our State and Local Tax Consulting practice, and Cathie Shaw, Partner with our firm's National Tax team covering state and local tax issues. I am also joined by my partner, Sarah McGregor, from our Greenville office.

SARAH MCGREGOR: It is exciting to be talking about state tax Nexus issues.

HOST: Before we start the conversation, Public Law 86-272 prevents states from asserting the authority to tax a business for income taxes if the business is an out-of-state seller of tangible goods and limits its activity within the state to the mere solicitation of sales.

In 2021, the Multistate Tax Commission (MTC) provided a reinterpretation of what activities go beyond the mere solicitation of sales. The MTC’s guidance suggested that using the internet for post-sale communications, dropping cookies for data mining, or requesting resumes are activities that are not mere solicitation of sales. Companies can then be subject to tax by that state.

Let’s explore a term that Sarah mentioned: Nexus. Cathie, can you give a layman's definition of the term Nexus?

CATHIE SHAW: Nexus simply means you have enough connection with a taxing jurisdiction to become subject to the tax. If you have enough connection, they are going to tax you. You don't want to have it if you can avoid it.

HOST: Louis, for background, which businesses most benefit from Public Law 86-272 and which companies do not?

LOUIS COLE: Public Law 86-272 protects companies that sell tangible personal property, such as manufacturing, distribution, and retail clients. These companies may receive protection depending on the activities they perform in a particular state.

Service companies, such as Software as a Service (SaaS) or combined sellers of property and services, do not qualify. If you sell anything other than tangible personal property, it is clear that you would not qualify.

Many retail, manufacturing, and distribution clients have used Public Law 86-272 for planning purposes for years. States are now continuing to erode this protection through a variety of different activities.

HOST: Cathie, you mentioned the Multistate Tax Commission. What is that, and what sort of authority or influence do they have?

CATHIE SHAW: The MTC is a quasi-governmental organization that states can choose to belong to as full or associate members. They try to bring uniformity to all state tax laws to prevent Congress from enacting more federal laws like Public Law 86-272.

The MTC itself does not have authority on its own. States must adopt the model statutes and regulations into their own laws for them to be authoritative.

HOST: Louis, have any states adopted the MTC’s interpretation regarding internet-based activities?

LOUIS COLE: A number of states have adopted the MTC interpretations, including California, New York, and New Jersey. Many states are very aggressive in eroding the effectiveness of Public Law 86-272 protection.

CATHIE SHAW: California issued guidance that was recently struck down in court because they did not go through the proper regulatory rulemaking procedure. They wanted to apply it retroactively, which is significant because many believed these internet-based activities were protected.

LOUIS COLE: Federal law was enacted in 1959. Since then, people have called about technical issues or sent resumes by mail without creating Nexus. Now, because you are doing it via VoIP or a chat upload, states are claiming that is business activity occurring in the state.

HOST: Cathie, how do you see this confusion affecting small and medium-sized businesses?

CATHIE SHAW: This is a significant concern. Small businesses selling over the internet might have traditionally been protected, but now states are claiming physical presence based on internet communication channels.

State tax compliance is not cheap. Small businesses may find that their local tax preparers are unfamiliar with these multi-state issues, requiring them to move to a firm like Cherry Bekaert, which increases costs.

I believe Congress should set safe harbors or thresholds for economic Nexus. If you do not exceed a certain sales amount, you should not have to file a return.

SARAH MCGREGOR: What about companies that do not sell tangible goods? Are they already facing this compliance nightmare?

CATHIE SHAW: Yes. Without Public Law 86-272 protection, it comes down to U.S. constitutional standards. Under the Complete Auto Transit standard, you must have a substantial connection, which is often interpreted using the Wayfair thresholds of $100,000 in sales.

HOST: Louis, talk to us about what a Nexus study is and why it may be a good thing for a business to do.

LOUIS COLE: A Nexus study is a review of all activities that would subject you to tax in a particular state. It is key to look at this with eyes wide open and answer questions based on actual facts rather than desired outcomes.

Realize that a company may still have a filing responsibility for minimum taxes even if they are not subject to income tax. When companies go through an M&A transaction, this is one of the issues looked at to determine if you have filed in all required states.

A Nexus review also identifies issues with sales and use taxes, franchise taxes, and property taxes. Sales tax is often one of the largest liabilities missed in M&A transactions.

HOST: Regarding internet activity, are companies ready for the record-keeping requirements this requires?

LOUIS COLE: I do not think companies are ready. Technology changes have outpaced traditional salesman activities. A click of a button from a customer or a targeted solicitation on a website may be sufficient to exceed Public Law 86-272 protections.

Companies will need to maintain documentation regarding what activities occur with each technology upgrade. This includes keeping copies of homepages and post-sale emails sent to customers.

HOST: Cathie, what would you like to see states do to help mitigate this compliance burden?

CATHIE SHAW: I would like to see states implement safe harbors to protect small businesses. We cannot continue to increase the barrier to entry when small businesses drive so much employment in the country.

LOUIS COLE: Nothing stays the same, and states are in need of revenue. They are all challenging each other to erode Public Law 86-272.

Look at your tax planning with your eyes wide open. Business changes, such as just-in-time inventory movements, can blow tax planning. Look outside of the tax department to find out what the real business activities are.

CATHIE SHAW: Do not bury your head in the sand. If you have Nexus issues, address them before you get contacted by the state.

You can often mitigate the cost of compliance through voluntary disclosure programs that forgive penalties. If you wait until you get a notice, you no longer qualify for those programs.

SARAH MCGREGOR: States are much more inclined to assess out-of-state companies than in-state companies because out-of-state companies do not have voters in that jurisdiction. Hiding is not going to help you in this situation.

HOST: If you have not had a Nexus study done in the last year or two and you have interstate activity, it is a good time to get one. It is a necessary state tax hygiene check.

This concludes today's podcast regarding state income tax and multi-state activities. Please note that we are not providing tax advice; consult with your tax advisor at Cherry Bekaert regarding your specific issues. Check out the firm’s website at cbh.com for the latest guidance.