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

(00:00) [Music] welcome to the Cherry Bekaert tax beat a conversation about tax that [Music] matters welcome to this edition of the Cherry Bekaert tax beat podcast today we're talking about State taxation of Interstate commercial activity um we're primarily uh talking about the shifting stands beneath a longstanding federal tax law for determining if a state can tax the income of a business we're limiting this discussion to income taxation today uh lots of other ramifications in other state and local taxes but income tax uh

(00:54) the star of the statute for today is public law 86- 2 72 it's been around since 1959 but the way companies conduct business today versus the middle lastest Century continues to put pressure on its applicability and how courts and tax and authorities and businesses Define doing business in the state so joining in today's conversation are LS Cole partner and leader of our state and local tax Consulting practice and Kathy Shaw partner with our firm's National Tax team covering state and local tax issues so Lewis how you doing today I'm doing

(01:32) fantastic how are you Brooks I'm doing great and where are you sitting today Lewis in Atlanta Georgia where the where I reside all right and Kathy how's it going today pretty good nice and sunny up here in Ohio we're all jealous we're getting dumped getting dumped on in the rain down here in the South last couple days and uh joining me my partner in crime as always Sarah McGregor from Greenville office Miss McGregor house life treating you life is good it's almost time for another holiday and the start of summer

(02:08) um and so uh yeah it's pretty exciting to be talking about state tax Nexus issues all righty let's do a little bit of background um before we start the conversation Public Law 86-272 prevents States from asserting the uh authority to tax a business for income taxes if the business is an out state tax seller of tangible goods and the business limits its activity within the state to the mere solicitation of sales that's a mouth fool but anyway stepping forward to 2021 when the multi-state Tax Commission provided a

(02:46) reinterpretation what act what activities go beyond the mere solicitation of sales um then things start getting more complicated uh mtc's guid suggested the use of the internet for post celles Communications or to drop cookies for data mining or request resumés or activities that are not mere solicitation of sales companies can then be subject to tax by that state all right lots of complicated Concepts in there but before we uh jump too far into 86-272 let's explore a term that Sarah just mentioned Nexus so Kathy how about

(03:25) given a Layman's definition of the term Nexus yeah so Nexus is like a disease you don't want to catch it um it's really hard to get rid of once you do catch it uh but Nexus simply means you have enough connection with a taxing jurisdiction to become subject to the tax so if you have enough connection they're G attacks you so you don't want to have it if you don't if you can get away with not having it just like a disease all right all right all right well I think sometimes you might want to create Nexus if it's to your advantage

(04:00) though right it's not always that's a good point that's a good point not always terrible but anyway but 99% of the time all right all right so LS for background uh let's go to public law 86-272 uh which businesses most benefit from this law and which companies do not well 86 272 protects companies that sell tangible personal property so manufacturing distribution retail type of clients um May uh get the protection depending on the activities that they perform in a particular State service companies such as software as of service

(04:37) or SAS um combined sellers of you know property and service at the same time if you if you if you're only selling tangible personal property you may qualify if you sell anything else any other services it's very clear you would not qualify and a lot of companies like retail and Manufacturing distribution clients have used the 8 62 72 for planning purposes for a lot of years so um the states uh don't particularly like um companies using um any method to not pay taxes in the states and so now they are continued to erode

(05:18) 86-72 through a variety of different uh activities so we'll talk about those as we go through the discussion great so Kathy uh you defined Nexus for us could you help out with the multi-state tax commission what is that and what sort of Authority or influence do they have yeah the MTC is a quasi governmental organization uh so states can choose to belong to the MTC uh as a full member associate member or they don't they don't have to be a member at all but they can adopt some of the model statutes that the MTC comes up with and

(05:54) so what happens is the MTC chooses certain projects they try to bring uniformity to all state tax laws and there's really a a self motivation there because if they don't have enough uniformity and States become very difficult to work with and comply with you could have Congress stepping in and enacting laws just like public law 86 272 so it's definitely to their benefit to bring some uniformity so the states get together and they discuss how things uh should be structured within the states and they try to adopt um similar

(06:28) model statutes but the C itself doesn't have any Authority on its own the states have to adopt the laws model statutes regulations that the MTC comes up with into their own statutes and regulations in order for them to be authoritative well then Lewis have any states adopted the mtc's interpretation of doing business that's causing causing a lot of concern here about internet-based activities so there are a number of states that have adopted U the Mt see interpretations of doing business and that would be California New York

(07:04) New Jersey and several others that that have it on their agenda as we speak as Kathy mentioned states are free to pick and choose their level of MTC activities that they adopt many states are very aggressive in eroding the effectiveness of 86 272 protection and this is just another bite at the Apple they also share information with other states that are also financially strapped are looking at ways to expand the roles of the taxpayers and I would say you know even if a state doesn't adopt it at all right this a public law 86 272 is a federal

(07:45) law the states are only interpreting the federal law so they don't have to adopt anything and still apply that interpretation so it's very interesting like California they issued guidance that has been recently struck down in the courts because they didn't go through the proper regulatory rul making procedure and I'm like and they want to they're going to apply it retroactively too which is awful and I I sat on a lot of these MTC calls discussing this revised guidance and they were clear that they didn't believe States should

(08:15) be applying it retroactively because everybody thought these internet-based type activities were protected and now we're changing and saying no they're not protected well how do you go back and make that retroactive it's not fair well California is seeking to do that um and New York the regulations became final and there was just a lawsuit last or May 8th uh just proposed by the same organization that sued California trying to make it invalid but in my in my mind you know even if they make it invalid it's still an interpretation right so um

(08:48) you know it's just going to be interesting it's going to be the courts decide do you have Nexus or not does law apply or not and so whatever interpretation Vermont they put it in there instructions we adopt the MTC you know in their instructions that's not authoritative but they're just saying what their interpretation is going to be but I just want to comment the thing that most practitioners including myself have a significant problem with is that there you know the telephone's been around a long time the the federal law

(09:19) was enacted in 1959 since 1959 forward people were calling asking technical issues postale uh information sending res reses by US mail all of those things never created Nexus the states themselves never considered those actions is creating Nexus but now all of a sudden because youre doing it viip you know voice over internet or you're doing it just through a chat or an upload all of a sudden that's business activity that's occurring in the state you know we're having a really hard problem with that and I think the courts

(09:53) are going to have a significant issue with that as well unfortunately at the end of the day it's always the attorneys that make out in these situations well Kathy know you're I don't chaos may be too strong a term but I mean certainly a lot of confusion well how do you see this confusion affecting small and mediumsized businesses that they can't afford a team of attorneys and 20 accountants yeah and that's that is my biggest most significant concern because especially you have small business or even individuals that are just selling

(10:32) one item right maybe selling one item over the Internet never leave their state um but then they get really successful and they're you know some substantial sales but they're just selling into the state traditionally public6 272 would always protect them but if they're having any postale Chats on the internet they're saying nope you have it it's not an economic Nexus issue it's a physical presence issue they're saying that you have physical presence in that state because you are utilizing that Communication channel in that state

(11:05) and so you can have small seller and sellers that have huge losses and all of a sudden this uh public law has been taken away from them that protection now they have to file in all these different states and you know as well as I do uh that state tax compliance isn't cheap and and also if they have a sole proprietor tax preparer they usually only know their state that they're in or maybe a couple states that are surrounding all of a sudden if this small business has to file in all these different states their tax preparer is

(11:38) going to say we're not familiar with any of those States you're going to have to get another firm to do your taxes so they have to come to a Cherry Bekaert that charges more than that sole proprietor so not only um the tax compliance cost um but you know the systems cost of tracking all of this they could have losses uh it's just terrible so uh from my perspective and I'll just move on to my thought on how to potentially remediate that would be to call on Congress and I wrote an article in Bloomberg text for this but

(12:11) to call on Congress to set safe harbors so not just thresholds of exceeding that create economic Nexus because this is more of a physical presence issue that they're taking but having a safe harbor if you don't exceed the sales amount you do not have to file a return so only Michigan to my knowledge really has that kind of a a safe harbor where they say if it you don't reach $350,000 at sales um it's okay uh but otherwise either physical presence or a substantial amount of sales are going to create Nexus so cavy you know you just talked

(12:45) about um how this was expanding for sellers of goods what about the issues for companies that don't sell tangible goods um do they already have these Nexus issues is that is that what you're they already are facing these this compliance nightmare yeah that's a great question um because uh Public Law 86 272 only applies as Lewis said in the beginning to sellers of tangible personal property right not services not technology anything like that so you don't have any protection from public law so then you get into the issue of is the connection

(13:23) with the state substantial under constitutional standards so it really comes down to us constitutional standards which under Complete Auto Transit requires you to have a substantial connection so what's substantial that's in the eye of the beholder so what what does that mean you know if if you have just one post sale chat even for tangible property you know is that substantial what is substantial is it a certain dollar threshold um from our perspective when we're looking at Nexus we're looking at at some of those

(13:55) Wayfair thresholds really because the US Supreme Court had said at least for sales tax which has is different than income tax now but at least for sales tax they're saying 100,000 is substantial so on the income tax side we're saying well the US Supreme Court has determined 100,000 is substantial for a connection that likely will be the case on the income tax side too um but then you know some like Texas enacted legislation that it has to be 500,000 so there are some states but there's only about 12 or so that have given a

(14:29) specific threshold like Wayfair we really need those thresholds on the income tax side um but in like I said before in addition to the threshold we need a safe harbor so that the physical presence questions don't come into play as well but to answer your question in short it comes back to us constitutional standards so yes they could have Nexus depending on if their connection is substantial so Lewis uh taking the all to extreme I mean uh you know almost every business can sit there and say oh my God I have Nexus everywhere uh so um

(15:05) talk to us about what a Nexus study is and why it why it may be a good thing for a business to do one yeah thanks Brooks uh an Nexus study is that review of all of the activities that if known would subject you to tax in a particular State and it's key to make sure that you look at a Nexus study with with with eyes wide open and making sure that you answer the questions truly the way that the facts are instead of the way you wish the facts were uh realize that a company may still have a filing responsibility

(15:43) despite the fact that the state can I impose the state income tax so there may be minimum taxes that you still may be due also recognize that often if you don't file a return even if it says 86 272 on it and you're not subject to the tax the statute limitations may never start and so when companies go through an m&a transaction this is one of the issues that they often look at to determine have you filed in all of the states that you're required to file also keep in mind an ancillary benefit to this is that there are additional taxes

(16:19) that are not covered by 86 272 such as sales and use taxes franchise taxes property taxes hopefully you don't you don't have property in the state and going through this Nexus review would also lead to identification of those issues which by the way sales tax in an m&a transaction of course is one of the largest taxes that people often miss and didn't file correctly and so going through this process with 86 272 uh a true Nexus uh review with the facts all known leads you to a lot of additional benefits in addition to just determining

(16:56) if you have a filing responsibility there for state income tax purposes okay one um one uh drill down question here Lewis uh because I think this is kind of the scariest of all the topical uh issues here is back to the internet activity I mean how you know the whole record keeping the analysis of what all this internet activity what states sort taking what positions with it uh are companies ready for this I I don't think that companies really are ready for this because times have changed from the traditional um salesman walking into a

(17:36) state and technology has changed to where even if you don't go into a particular State you may be subject to state income taxes because of the activities that you've got I say that you know technology changes have outp passed the traditional salesman activities um who have been historically protected by 86 272 and now a click cck of a button from a customer or a targeted solicitation while the client is on the website may be sufficient to exceed um 86 272 and the solicitation activities um the good thing is that

(18:14) technology and internet activity lives on forever it seems and when you go back and the state comes to do a review and they test the activities that you conducted they may be testing it where you have exceeded that activity based on what the states have said that you can do if you're soliciting people online but you have to keep a record as to when that started because it may not have started three years ago it may have only started with the last iteration and update of the technology so the companies will need to keep and maintain

(18:48) documentation as to what activities occur with each technology upgrade because that latest technology upgrade likely is going to be the one that kills you that's keeping copies of you know what did your uh your homepage look like what did your uh uh post sale emails look like uh to to customers over a years gosh thinking Kathy you were talking about retroactive application who has all that information I mean you know what did what did your internet connection look like your internet interface look like two years ago and

(19:23) that's where the states are just very happy campers here right because they if you don't have the information they'll estimate it for you so yeah what a nice what a nice customer friendly service that's great well Kathy what would you like to see the states uh you mentioned Congress passing some laws what about the states to help mitigate this compliance burden uh is there anything that they can do yeah even in you know the the introduction when the new interpretation was issued in August of 21 of the MTC guidance their

(19:58) interpretation uh they called on the states to actually Implement safe harbors or or some kind of threshold or so some activities to protect small business because you cannot keep increasing just the cost of doing business the barrier to entry when small business just drives so much of the employment in the country and I think um so many times everyone's so focused on the large companies and they're escaping all of this tax to the detriment of the small business that they can't even survive if this becomes so cumbersome and so burdensome to

(20:34) comply and and so they really the states can take steps themselves too to protect small business through those thresholds or through other relief measures or even even just giving like a hotline number that a small business could call and giving them some relief a tax advocate taxpayer Advocate uh that can help in that situation all right uh let's move on to final comments so the floor is yours leis I would say that nothing stays the same and the states are in need of Revenue it seems and they are all challenging each other

(21:14) to um again a road 86 272 looking at how the company has done business in the past is only one way to look at Nexus um things change uh you may have acquired company that has uh activities of its own you may have started selling something that you didn't know such as an extended warranty program that's going to change what you traditionally thought you did and I find that tax departments typically know about 90% of the facts and what's interesting is that it's the additional 10% that create a problem for companies that change things

(21:56) so keep in mind uh business changes such as just in time inventory where they move inventory to a new Distribution Center or outside of a particular client's location because they know Christmas is coming and they need to have that inventory more readily accessible can blow tax planning so again look at your tax planning look at it with your eyes wide open understand the facts and look outside of the tax department to find out what the real activities are and I think that that will that will assist you in looking at

(22:31) um prospective planning that can still be accomplished through 86 272 though it's a lot harder than it used to be all right thank you leis all right Kathy yeah I mean my biggest point would be don't bury your head in the sand uh if you have Nexus issues or you're concerned you could have Nexus issues address them before you get contacted by the state there are ways to remediate where you only have to file a limited number of years you get all the penalties forgiv uh you can really really mitigate the cost of compliance

(23:05) if you address it headon if you wait until you get a notice you no longer qualify for those programs to to remediate in a cost-effective manner and if you ignore and just say ah it's a state across the other side of the country I'm just ignoring it there's no way I'm paying them um just know that that states have reciprocity they can lean your bank account they can lean any bank accounts uh so they will get their money and when they estimate the tax is going to be larger likely than than what it actually is so definitely address the

(23:34) issues know what skeletons you have in the closet um that way you can sleep well at night if you want to sell your business in the future you're going to be squeaky clean uh so definitely do not bury your head on these issues good points Kathy all right Sarah uh this is why I like federal tax because there's only one Authority I have to deal with and not 50 plus uh State authorities making up the rules differently each time they pass along so uh yep I I think I made the right career decision um but echoing what Kathy and

(24:10) Lewis said you know knowing your potential exposure in uh for States particularly um that state across the country is going to be much more um inclined to assess outof State companies than they are instate companies um um because out ofate companies don't vote in their state and don't have employees voting in their state so it's much easier for them to go after tax that way um so I I I as Kathy said putting your head in the sand and hiding is not going to help you in this situation at all all right well y'all made some

(24:49) really wonderful kind of global observations I'm going to take mine way narrow and tactical and say if you hadn't got a Nexus study done in the last year or two and you have any sort of uh Interstate activity it's a good time to go get one of those done let's keep you know let's start at the beginning something practical something not too crazily expensive and that's kind of a really good starting point and a good uh kind of hygiene check I would say State H state tax hygiene check okay that's wrap on today's

(25:22) discussion about tax reporting issues for state income tax and multi-state activities particularly as it deals with uh selling tangible goods and doing business over the Internet it's a difficult topic to get concise I think in a few words here but anyway quick disclaimer that we are not providing tax advice on this podcast please consult with your Tax Advisor hopefully at Cherry Bekaert with your specific tax issues or to discuss information from today's podcast check out the firm's website at cbh.com for the latest

(25:55) guidance and materials on this and other tax and business topics this concludes today's podcast please like share and subscribe thank you Louis thank you Kathy and thank you our listeners for spending your time with us we truly appreciate it let's call it a day and go forth in peace [Music]