Public Law 86-272, We Hardly Knew Ye

“Ye’re an armless, boneless, chicken-less egg

You’ll have to be left with a bowl out to beg

Oh Johnny I hardly knew ye. . .” 

You would know the tune to these lyrics to Oh Johnny I Hardly Knew Ye from its later appropriation for When Johnny Comes Marching Home Again.  In the original 1867 song penned by English music hall notable Joseph B. Geoghegan, the protagonist went off to war. There, he proceeded to lose limbs—arms, legs, and in some versions, even eyes!

That unfortunate progression of events parallels the history of the Interstate Income Act of 1959, commonly known as Public Law 86-272.  The Law was enacted when our 34th president, Dwight D. Eisenhower, was nearing the end of his second term in response to an outcry over a SCOTUS decision upholding a Minnesota tax on an Iowa corporation that leased office space and solicited orders in The North Star State.

Still on the books today, 86-272 prohibits imposition of a net income tax on sales of tangible personal property (TPP) where the business activity of a remote seller in the state was limited to the solicitation of sales. All orders must be both approved and shipped from outside the solicitation state.  SCOTUS clarified in 1992 that activities ancillary to the solicitation of sales (serving no independent business purpose aside from securing new orders) and de minimis activities (those not technically protected but comprising only a trivial connection with the state) are also encompassed by 86-272.

Upon enactment, 86-272 was already self-eroding.  It did not apply to the imposition of other taxes not imposed on the net income of a taxpayer such as sales, payroll, franchise or gross receipts taxes.  One limb gone.

“It is strange that one company could have boots on the ground in a state and escape tax while another company could limit its activity to online sales yet be subject to tax.”   

It also applied only to sales of TPP.  Thus, sales of services in conjunction with sales of TPP could taint the latter and strip away all protection.  Another limb lost.

Earlier this year, SCOTUS found cause to shape the realm of multistate taxation once again in South Dakota v. Wayfair, Inc.  The court overturned its 1992 decision in Quill Corp. v. North Dakota, which imposed a requirement for the physical presence of a seller in a state before the state could impose a sales tax collection responsibility on the merchant.  While Wayfair is commonly regarded as a sales tax case, it would be difficult to claim there will be no impact on multistate income tax.

Even before Wayfair, states rode roughshod on constitutional constraints on interstate taxation in the wake of Geoffrey, Inc. v. South Carolina Tax Comm’n.  This 1993 decision by that state’s high court introduced the notion, commonly called “economic nexus,” that the mere presence of intangible property—trademarks or tradenames—in a state could be sufficient to impose income tax on their owner.

While Geoffrey already seemed facially contrary to 86-272 and, in the minds of many practitioners, arguably in opposition to aspects of Quill and other case law, SCOTUS declined to review the decision.  Dozens of states took this as tacit approval for the tactic, and it soon became commonplace throughout the U.S.  The coexistence of 86-272, Quill and Geoffrey lead to a variety of strange results.  One company could have dozens of salespeople permanently living in and hawking TPP worth tens of millions of dollars annually in a state, but 86-272 prevented imposition of an income tax.  However, because the Quill physical presence requirement was met, the state could require the company to collect sales tax.

Another company could sell TPP in the form of, say, industrial equipment.  By sending a couple of employees to the state for a few days for installation or repair, the ancillary and de minimis facets of 86-272 might be exceeded, subjecting the company to income tax. If no exemption applied to the equipment, sales tax would also be applicable.

A third company might have no physical connection with a state whatsoever—no employees soliciting sales, no business travel and no real or tangible property in the state.  Even no sales of TPP or services to customers there.  Yet, if the company licensed intangible property in the state, for example a patent, income tax might be imposed. Incidentally, if this company did sell property subject to sales tax, because the Quill physical presence standard was not met, sales tax need not be collected.

Yet another anomalous scenario could arise where a company used salespeople in a state to solicit sales of services, say programming or consulting, that were to be performed outside the state.  Even if the salespeople otherwise met all the other requirements of 86-272, that company could still be subject to income tax because the public law protects only sales of TPP.

Note that even in the world of sales tax, where prior to Wayfair, practitioners could pound the table and exclaim to anyone who would listen, “No physical presence means no sales tax!” – things were not so certain.  Agency nexus, click-through nexus and similar concepts put sellers into the shoes of seemingly independent parties present in remote customer states to attribute nexus.

After Wayfair, 86-272 does have one limb left.  A state still cannot impose income tax on a company that sells only TPP to the state if there are either no personnel resident in or traveling to the state, or if those personnel are salespeople who perform no unprotected activity in the state.

But how is that result fair to other companies with demonstrably less activity in the state who either don’t sell TPP or don’t employ salespeople in the state, but occasionally send in an employee to perform unprotected activity?  How does it comport with the legislative intent of 86-272 to protect remote sellers with limited activity in the state from income tax where other sellers with demonstrably less activity are subject to tax?

Is the law even constitutional?  It is strange that one company could have boots on the ground in a state and escape tax while another company could limit its activity to online sales yet be subject to tax.  What is the rational basis for this?

Also, how many companies that could otherwise qualify for 86-272 protection are immune to state claims that unprotected activity exceeds the de minimis threshold?  How can a company ever isolate protected activity in a state when the mere presence of intangibles apparently permits imposition of income tax?

A client of mine recently had an auditor point out the sponsorship of an obscure sporting event held by a charitable organization – and the temporary presence in the state of an employee to help at the event – as unprotected activity exceeding the de minimis threshold.  This occurrence was so isolated, the tax department was unaware it had transpired. The auditor identified this activity by searching the company name in connection with the state.  I agree, this was not ancillary to sales.  In fact, it was barely ancillary to the company’s business, and more intended as an example of good corporate citizenship. Certainly, my client didn’t expect that it would generate profit.

Folks, the venerable 86-272 is teetering on its remaining limb, and while we don’t know for sure from the song whether armless Johnny was also toothless, four out of five dentists might well agree that Public Law 86-272 is so.

What do you think? Does the Wayfair decision spell the demise of Public Law 86-272? Leave your comments below.

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Carl Roscoe
Carl Roscoe

croscoe@gagnontax.com

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