With the Multistate Tax Commission's statement that many online activities, including interaction with a website, could defeat the protection of P.L. 86-272, the concern about lack of income tax thresholds is heightened. (AP Photo/Jenny Kane)
Some businesses have long considered the lack of state income thresholds in most states problematic, saying they are left to guess as to whether their activities have created income tax nexus within the state. Now, with the MTC's statement that many online activities, including interaction with a website, could defeat the protection of P.L. 86-272, the concern about lack of income tax thresholds is heightened.
Such thresholds, also known as factor presence nexus, would set clear sales figures for businesses. If their receipts into the state meet or exceed the threshold then they will be liable for tax, but if receipts fall below the threshold, they will not. Every state with a sales and use tax has adopted such a threshold in the wake of the landmark Wayfair
decision, which permitted states to require out-of-state businesses to collect and remit tax, but only about 15 have set out similar thresholds for income tax.The lack of thresholds, coupled with the MTC's updated statement, opens up big new avenues for states to tax, businesses say, potentially leaving them open to tax in many states just because they interacted with another business' website. This could be particularly burdensome for smaller businesses, they add, as they ask for guidance to know exactly what level of activity would subject them to tax.
Sales thresholds for income tax could answer that question, said Brian Kirkell, principal of Washington national tax at RSM US LLP.
"Why do we have two standards? One for sales which says if you have $500,000 or whatever worth of sales you owe tax and another one for income tax which says if you blink funny at the state you're subject to the state's jurisdiction," Kirkell said.
He said he is seeing more support from businesses, particularly in the middle market, for "wholesale adoption of factor presence standards," adding that it would be optimal if states adopted the same threshold for both the sales and the income tax.
The lack of factor presence standards for income tax in most states coupled with the updated guidance from the MTC on P.L. 86-272 presents several dilemmas, especially for small businesses, according to Cathie Stanton, national leader for state and local tax at Cherry Bekaert LLP. One of them is that looking something up on a website might now subject a business to tax in the state where the site is hosted. She said a business owner might never suspect that would be a tax trigger, especially since the same activity conducted over the telephone would not be a tax trigger.
States never considered that P.L. 86-272 protections would be threatened by a telephone conversation, Stanton said.
"And now to take it to internet activity, where you're conducting the exact same thing that might have been done over the phone, a technical assistance question or something like that, and they're saying that's actually the company's business activity in the state," Stanton said.
Many states simply follow a "doing business" standard that subjects businesses to tax if they have income from sources within the state and could easily apply it to interacting with websites in the absence of specific thresholds to trigger taxation, Stanton said. She said businesses could end up with obligations in every state, creating compliance issues they cannot handle alone. Most cannot afford to hire a professional to handle that much compliance for them, Stanton said.
"There is an extremely negative consequence to the MTC's adoption of this standard," Stanton said. "States need to step up and enact factor presence nexus so they don't suffocate small businesses any further."
Stanton said the sales tax thresholds states established following Wayfair have helped smaller businesses with compliance, especially if they are vendors on the platform of a marketplace facilitator. Under companion marketplace laws states passed along with their threshold laws for remote sellers, marketplace facilitators such as Amazon collect and remit the tax for vendors selling on their platforms.
But that doesn't help the business if the marketplace facilitator takes the business' inventory and stores it in a warehouse in a state near its customers, but where the business is unaware its merchandise is now located. Now the business has property in the state and could be liable for tax. Nothing in P.L. 86-272 can help with that, Stanton said, noting that the business is not protected even though it may not have known its property was moved.
"Well, certainly they have some kind of threshold, would be the small business community's mindset,'' Stanton said. "Well, no. The majority of states don't."
The MTC, for its part, agrees with most of these concerns. When adopting its updated statement on P.L. 86-272 on Aug. 4, it attached to the statement a copy of its 2002 model act on factor presence nexus for income tax.
"As states consider adopting the revised statement of information on Public Law 86-272, I want to reiterate that at the same time, they should consider adopting income tax thresholds," Brian Hamer, the MTC counsel who chaired the work group on the P.L. 86-272 revisions, told Law360. "The two can beautifully go together."
The MTC's model standard speaks to three factors for determining whether a business has substantial nexus with a state — property, payroll and sales — the standard that was more common at the time. The MTC standard considers a business to have substantial nexus with a state if it exceeds $50,000 of property, $50,000 of payroll, $500,000 of sales or 25% of its total property, payroll or sales in the state for a tax period.
But now, most states have adopted a single sales factor for apportionment and market-based sourcing. So it is the sales factor standard that is most relevant.
In the summer and fall, at least three MTC officials — Helen Hecht, the uniformity chair, Richard Cram, the director of the MTC's nexus program, and Hamer — have spoken publicly about the need for states to adopt factor presence nexus for income tax. At a meeting in July, Hecht presented a memorandum noting that the MTC approved the model in 2002, but few states have adopted it, in part due to arguments that physical presence in a state was needed to subject businesses to state income taxes. But the U.S. Supreme Court's 2018 Wayfair decision, which did away with the physical presence requirement for sales and use taxes, "has put that argument to rest," the memorandum said.
Hamer echoed some concerns Stanton has regarding the placement of small business inventory in warehouses.
"To the extent that policymakers are looking to minimize burdens on small businesses, they need to look to a different place than this 60-year-old federal statute," Hamer said. "And the MTC's [factor presence nexus] model is an excellent example of what can be done."
Hamer also noted that the MTC established factor presence nexus standards more than 15 years before they became commonplace in the wake of Wayfair.
"In a fundamental way, the MTC model anticipated the standards that the Supreme Court pointed to in Wayfair," he said.
John Biek, co-chair of the taxation practice group at Neal Gerber & Eisenberg LLP, told Law360 that in the wake of Wayfair and the MTC's updated statement, factor presence standards could be helpful in determining nexus and in shielding businesses, especially smaller ones, from taxation. But he said he didn't think factor presence would resolve concerns that many practitioners and businesses have about internet activities that could now trigger taxation, as outlined by the MTC.
Congress "legislated a safe harbor, through enactment of Public Law 86-272," Biek said. "I think there's a fair question whether states can just totally reinterpret that by saying it's a brave new online commerce world. But I guess the courts will eventually tell us that."
--Additional reporting by Paul Williams. Editing by Tim Ruel and Roy LeBlanc.
For a reprint of this article, please contact reprints@law360.com.
