The Interstate Income Act of 1959, 15 U.S.C. § 381, Pub. L. 86-272 (“Public Law 86-272”) prohibits states from imposing a net income tax on income derived from interstate commerce if the interstate business’s only business activity within the state is the solicitation of orders for tangible personal property. The orders must be sent outside the state for approval or rejection and, if accepted, the orders must be filled from a point of shipment outside the taxing state. If the interstate business does more than solicit orders, then Public Law 86-272’s protections do not apply.
Public Law 86-272 has long frustrated state taxing authorities’ desire to tax all aspects of interstate commerce. And, in the aftermath of South Dakota v. Wayfair, Inc., 585 U.S. ___, 138 S. Ct. 2080 (2018), state taxing authorities have become more aggressive in applying their taxing statutes to interstate businesses.
1. Public Law 86-272’s Fundamental Purpose.
Public Law 86-272’s fundamental purpose is creating certainty and predictability for interstate businesses, and providing better outcomes for interstate consumers. Public Law 86-272 was enacted soon after the U.S. Supreme Court’s decision in Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 79 S. Ct. 357, 359 (1959), in which the Supreme Court concluded that a state could constitutionally tax the net income of an interstate business. The Supreme Court’s decision in Northwestern States raised concerns that its broad language might ultimately be read to suggest that a company—whose only contacts with a state consisted of sending salesmen into that state—could lawfully be subjected to income taxation based on the interstate sales the salesmen generated. Wisconsin Dept. of Rev. v. Wm. Wrigley, Jr. Co., 505 U.S. 214, 220, 112 S. Ct. 2447 (1992).
In response to the business community’s concerns about the uncertainty created by Northwestern States, Congress enacted Public Law 86-272. Wrigley, 505 U.S. at 221. Congress’s primary goal was to “define clearly the lower limit” of state taxing power and “provide clarity that would remove the uncertainty” created by Northwestern States. Id. at 221-223 (citing Heublein, Inc. v. South Carolina Tax Comm’n, 409 U.S. 275, 280, 93 S Ct. 483 (1972)).
2. The Wayfair Decision.
In prior decisions, the Supreme Court held that an out-of-state seller’s liability to collect and remit sales tax to the consumer’s state depended on whether the seller had a physical presence in the consumer’s state. See e.g., National Bellas Hess, Inc. v. Dept. of Rev. of Ill., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
In Wayfair, the Supreme Court overturned 50 years of settled precedent and held that an out-of-state seller’s obligation to collect sales tax liability does not require physical presence. In fact, the physical presence requirement became increasingly artificial as e-commerce developed. According to Wayfair, an out-of-state seller with a website accessible in a consumer’s state could reasonably be said to have physical presence in the consumer’s state because it leaves cookies—computer files that track consumers’ information—saved on consumers’ hard drives. Wayfair, Slip Op. at 15.
In any case, because of “dramatic technological and social changes” brought about by the internet, out-of-state sellers can be meaningfully connected to a consumer’s state even in the absence of physical presence. Id. Thus, under Wayfair, out-of-state sellers are liable to collect and remit sales tax to a consumer’s state as long as the seller is meaningfully connected to the state.
Importantly, the Wayfair decision concerned only the liability of out-of-state sellers to collect and remit sales tax to a consumer’s state. It did not address the liability of interstate businesses under any other kind of tax. It specifically did not address the application of a net income tax, and the protections of Public Law 86-272.
3. Multistate Tax Commission Guidance.
Following the U.S. Supreme Court’s decision in Wayfair, the Multistate Tax Commission (the “Commission”) issued guidance to its members about the Wayfair decision’s effect on Public Law 86-272 The Commission’s guidance interprets the Wayfair decision to narrow the scope of protection for interstate sellers under Public Law 86-272.
Even though the Wayfair decision does not apply to net income taxes and did not address Public Law 86-272, the Commission used Wayfair to justify narrowing the protections of Public Law 86-272. According to the Commission’s guidance, when a business interacts with customers via the business’s website or app, the business engages in a business activity within the customer’s state that goes beyond the solicitation of orders. And, therefore, the business is not protected by Public Law 86-272.
4. Actions of State Taxing Authorities.
Following the Wayfair decision and the Commission’s new guidance on Public Law 86-272, state taxing authorities—including the Ohio Department of Taxation—are aggressively pursuing interstate businesses for net income taxes. For example, Ohio imposes a net income tax on the owners of pass-through entities doing business in Ohio (the “Pass Through Entity Tax”). Under Public Law 86-272, Ohio could not legally impose the Pass Through Entity Tax on interstate businesses whose only business activities in Ohio are the solicitation of orders for tangible personal property. But, the Commission’s guidance has emboldened Ohio and other states to ignore the critical protections of Public Law 86-272 and improperly impose the Pass Through Entity Tax on protected interstate businesses.
As business and tax attorneys and advisors, we know the critical legal and public policy arguments that interstate businesses must make to protect themselves from aggressive state taxing authorities. And in an upcoming blog post, we will go deeper into the Multistate Tax Commission’s guidance and explain how the Commission’s guidance frustrates the fundamental purpose of Public Law 86-272.
The Commission’s guidance is available here.
Vince Nardone
Vince serves as a business advisor to owners and executives of closely-held businesses by counseling them on business planning, tax planning and controversy, mergers and acquisitions, succession planning, and legal issues that may arise in business operations.
Mike Sorice
Mike advises middle-market business owners on matters of business and management succession. He provides corporate and partnership tax advice to business owners and in-house accounting departments about federal income tax, state and local income tax, sales taxes, and excise taxes. In addition, Mike has represented taxpayers before the Internal Revenue Service and Ohio Department of Taxation related to federal, state, and local tax obligations.
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