Understanding PL 86-272 and What it Means to Your Clients

In short: Public Law 86-272 is a 1959 federal law. It stops states from taxing the net income of out-of-state businesses whose only in-state activity is soliciting sales of tangible goods. The Multistate Tax Commission reinterpreted it for e-commerce in 2021. California followed in 2022, putting many online seller protections at risk.

Update: In December 2023, the San Francisco County Superior Court ruled that the California FTB's 2022 guidance (TAM 2022-01 and the related Publication 1050 changes) was invalid. The court found it had not been adopted through formal rulemaking.

What is Public Law 86-272?

Public Law 86-272 is a federal law that protects out-of-state businesses from state income tax. States and localities can't tax a business's income if its only activity in the state is soliciting sales of tangible personal property.

This means a state can't impose a tax based on net income, such as corporate income tax or franchise tax, on that business.

P.L. 86-272 was enacted in 1959. Many states have recently examined and re-examined how it should apply to modern e-commerce. That business category didn't exist when the law was written.

How did the MTC reinterpret P.L. 86-272?

In August 2021, the Multistate Tax Commission (MTC) re-interpreted Federal Public Law 86-272. In doing so, it effectively removed several key state income tax protections for out-of-state retailers.

These protections had been in place since the law began over sixty years ago. They became much more relevant in the past couple of decades.

The MTC made a sweeping statement that, if widely adopted, could harm small and mid-size businesses. Paul Rafelson, Executive Director of the Online Merchant’s Guild, shared his concern in a recent Bloomberg article. He said, “It’s like (the MTC) doesn’t understand the difference between Google and a kitchen table sales enterprise. If every other state starts doing this, we’re toast.”

Brian Hamer, an MTC council member, was the lead author of the commission’s interpretation. He responded to the backlash by saying, “This is not a change but an effort to apply a 60-year-old statute to modern facts. It is incumbent upon the states themselves to interpret that statute until the courts say otherwise.”

With that, he passed the responsibility to the states. Let’s look at two very different examples of how states are responding.

How do states interpret P.L. 86-272?

States interpret P.L. 86-272 in very different ways. Some states issued detailed guidance on how P.L. 86-272 affects their tax laws before the federal law became national news in 2022.

For example, New Mexico published a highly detailed tax information briefing, revised in July 2020. It explains to business owners how New Mexico interprets P.L. 86-272.

Here’s some of the language from that briefing.

New Mexico requires corporations to meet all of the following criteria to be immune to taxation under P.L. 86-272:

• The corporation does not maintain a business location or office in New Mexico.
• The corporation is not incorporated in New Mexico.
• All sales occur in interstate commerce.
• The corporation sells only tangible personal property in the state. Immunity does not extend to a corporation that leases, rents, or licenses tangible personal property. It also does not extend to transactions involving intangibles such as franchises, patents, copyrights, trademarks, and the like.
• All sales solicited in New Mexico depend on approval (acceptance) outside the state. To keep immunity from corporate income tax under P.L. 86-272, a corporation must limit its New Mexico activities to soliciting sales of tangible personal property.

New Mexico also lists the types of business activity that are “protected” under P.L. 86-272.

When corporations perform these activities alongside soliciting sales of tangible personal property, they are immune in New Mexico under P.L. 86-272:

• Soliciting orders by any medium of advertising.
• Soliciting orders through an in-state resident employee or corporation representative.
• Carrying samples and promotional materials only for display or distribution.
• Furnishing and setting up display racks and advising customers on the display.
• Providing automobiles to sales personnel for their use in conducting protected activities.
• Passing orders, inquiries, and complaints to the home office.
• Missionary sales activities; that is, soliciting indirect customers for the company's goods.
• Coordinating shipment or delivery and providing information about shipment or delivery.
• Checking customers' inventories without charge for reorder but not for other purposes.
• Maintaining a sample or display room for up to two weeks (14 days) at any one location.
• Recruiting, training, or evaluating sales personnel.
• Mediating direct customer complaints. The sole purpose must be to keep the customer's goodwill toward sales staff and to help with requests for orders.
• Owning, leasing, using, or maintaining personal property for use in the employee's or representative's in-home office.

New Mexico also sets specific rules for independent contractors. These let them keep immunity in the state under certain conditions.

Finally, New Mexico clearly defines which activities are unprotected.

Here are a few specific examples:

• Making repairs or providing maintenance or service to the property sold or to be sold.
• Collecting current or delinquent accounts directly or by third parties.
• Investigating creditworthiness.
• Installing or supervising installation during or after shipment or delivery.
• Conducting training courses, seminars, or lectures for personnel other than personnel involved in solicitation only.
• Providing any kind of technical assistance or service, such as engineering assistance or design service. This applies when one of the purposes is something other than helping to solicit orders.
• Approving or accepting orders.

This list is far from complete. But it shows the level of detail some states provide as they decide how this federal law affects businesses’ tax obligations in their state.

Clearly, New Mexico is thinking carefully about the impact any changes to this law could have on businesses.

Now, let’s look at a state that took a very different approach. Its interpretation came out on the heels of the MTC’s statement, in February 2022.

How did California follow in the MTC’s footsteps?

In 2022, the California State Franchise Tax Board (FTB) issued a memorandum stating that it planned to largely echo the MTC’s re-interpretation of the law in California.

The FTB did this by issuing a Technical Advice Memorandum. It sets out twelve business activity “Fact Patterns” and explains why each one is ‘protected’ or ‘unprotected’ from taxes.

According to the memorandum, the FTB's positions on protected and unprotected internet activities largely follow the MTC's recently revised Statement of Information on P.L. 86-272. However, the FTB does not specifically adopt or reference that Statement.

Under TAM 2022-01, the FTB deems the following to be protected business activities:

• Providing post-sale assistance to California customers by posting a static list of frequently asked questions on the business's website.
• Placing "cookies" on California customers' computers or other electronic devices that gather customer information for uses "entirely ancillary" to soliciting orders for tangible personal property.
• Offering only tangible personal property for sale on the business's website. The website lets customers search for items, read product descriptions, buy items, and choose delivery options.

Under TAM 2022-01, the FTB deems the following to be unprotected business activities:

• Having an employee who regularly telecommutes from California and performs non-sales activities (e.g., business management and accounting tasks).
• Regularly providing post-sale assistance to California customers through an electronic chat or email that customers start by clicking an icon on the business's website.
• Soliciting and receiving online applications for its branded credit card through the business's website.
• Placing an invitation on the business's website for California viewers to apply for non-sales positions within the business.
• Placing "cookies" on California customers' devices that gather search information. The business uses it to adjust production schedules and inventory, develop new products, or pick new items to sell.
• Remotely fixing or upgrading California customers' previously purchased products by sending code or other electronic instructions to those products over the internet.
• Offering and selling extended warranty plans through the business's website to California customers who buy the business's products.
• Contracting with a marketplace facilitator to sell the business's products on its online marketplace. In this case, the marketplace facilitator keeps inventory, including the business's, at fulfillment centers in a state where the business's customers are located.
• Contracting with California customers to stream videos and music to electronic devices for a charge.

The FTB closes with a summary. An internet seller is shielded from tax in the customer's state if its only business activity there is soliciting orders for sales of tangible personal property. Those orders must be sent outside that state for approval or rejection. If approved, the goods must ship from a point outside that state.

What does California’s stance on P.L. 86-272 mean for sellers?

California’s interpretation of P.L. 86-272 removes tax immunity for sellers that perform certain activities on their website. These include providing product support, installing cookies to gather customer search data, and offering post-sale chat support on their website.

Under this guidance, tens of thousands of businesses previously exempt from California state taxes would become responsible for collecting and remitting money to the state. Many businesses would lose tax protections they relied on to protect their profit margins.

The memorandum also advises out-of-state businesses to review their California activities. This applies to activities not previously listed as unprotected in the FTB's Publication 1050. Businesses should check whether those activities still fall within the protection.

The bulletin also says companies need to check whether their website carries out business activities that count as “unprotected” under this new interpretation.

No effective date is listed. So it was unclear whether the guidance applies from 2022 or retroactively, if a business didn't pay taxes in prior years. The state encouraged businesses with concerns to consider California’s voluntary disclosure program.

What happens if states widely adopt the MTC’s new interpretation?

If more states adopt the MTC’s interpretation of P.L. 86-272, businesses will face more tax complexity. More states are expected to follow California by adopting a mostly verbatim version of their own re-interpretations of P.L. 86-272. Doing so offers a big upside (read: profits) for state tax authorities.

When each state takes its own stance on P.L. 86-272, businesses already facing tax confusion will struggle even more. It will be harder to make sure they collect and remit taxes correctly in each state.

As audits start, we can also expect businesses to file lawsuits against states. They will fight changes they feel put their company at an unfair disadvantage.

How can you help your clients navigate P.L. 86-272 tax complexity?

Compliance is costly, but non-compliance is even more expensive. This is especially true for businesses that knowingly or unknowingly ignore their tax responsibilities.

Small and mid-size business owners trust you for accounting advice. So you need to stay on top of new state guidance or laws issued in response to the MTC’s statement on P.L. 86-272. If you’re not already working with LumaTax to support your clients as effectively as possible, now is the perfect time to partner with us. We’ll help you stay on top of changes, keep your clients compliant, and boost your advisory service offerings and profits.

How Taxually handles this

Taxually’s LumaTax runs a nexus analysis on your sales, helps you register in the states where you must collect, and prepares and files multi-state sales tax returns, including Canadian GST/HST. LumaTax is currently available to enterprises and accounting firms. For the full workflow, read how to automate US sales tax filing in every state.

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