What Happened to the House OBBBA Provision on P.L. 86-272?

Over the years there have been various proposals to modify P.L. 86-272 enacted in 1959, to address income tax nexus for companies that only sell tangible personal property. Proposals usually call for expanding the application of this rule beyond sellers of tangible personal property and perhaps to taxes other than income taxes. See, for example, H.R. 3063, Business Activity Tax Simplification Act of 2019 (116th Congress).

The key premise of P.L. 86-272 is that a state may not impose income tax obligations on a company selling tangible personal property if the only activity in the state is solicitation of orders that are approved and shipped from outside of the state. The public law doesn't define solicitation of orders.

There was recent activity, including a provision in the House passed version of the OBBBA, to modify P.L 86-272. But it was not included in the Senate version of the bill or the final bill.  Will it return in another tax bill or standalone legislation? Perhaps.

H.R. 427 in the 119th Congress includes this House OBBBA provision. The change involves adding a definition of "solicitation of orders" that is broader than defined by the U.S. Supreme Court since 1992 when the decided Wisconsin Dep't of Revenue v William Wrigley, Jr., Co., 505 US 214. Here is the additional term proposed to be added to P.L. 86-272:

Likely the proposal ties to a new interpretation of P.L. 86-272 by the Multistate Tax Commission in 2021 to consider our digital era that did not exist when this law was enacted in 1959. It might also be aiming to provide greater clarify per recent court cases such as Uline, Inc. v. CIR Minnesota, No. 9435-R (Tax Court, 6/23/23). In this case, sales reps prepared some sales notes and market news notes and helped with a few product returns. This market research was found to be beyond mere solicitation of orders. There were some other activities going on including job fairs in MN.

Query: Why was this multistate provision in the House OBBBA bill but not in the Senate or final bill? Possibly it was dropped since it doesn't directly involve federal revenues so did not meet the requirements for a budget reconciliation bill.

Should this change make its way into another federal bill this year?

What do you think?

60th Anniversary of P.L. 86-272

State Tax Notes, 9/5/19

Today, September 14, 2019 marks the 60th anniversary of the enactment of P.L. 86-272 dealing with nexus for net income tax purposes for a limited category of sellers (those selling tangible personal property). This legislation was intended to be temporary while Congress studied numerous state/multistate tax issues that went beyond the initial reach of P.L. 86-272. Despite lots of study and a 1,000+ detailed report with recommendations issued in the early 1960's, no change was ever made.

Meanwhile, issues continue to grow including exactly how to interpret P.L. 86-272 in the modern era with new ways of doing business.

I've got an article in State Tax Notes about this law and its issues and recent developments.  I was hoping not to have to consider even writing this article after I wrote an article in 2009 on the 50th anniversary.  There are proposals for change in each session of Congress and lots of commentary and analysis on nexus, including the U.S. Supreme Court's decision in Wayfair in 2018. But, still no update.

I hope you'll take a look at the article and post your comments on what you think should be the next step in providing useful and appropriate nexus rules for taxpayers and states.  See "Public Law 86-272 Reaches Its 60-Year Anniversary," State Tax Notes, 9/5/19. I've also updated the website I created for the 50th anniversary - here.

What do you think?

Two States Using Wayfair Economic Nexus Standard More Broadly

As we know, the June 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., et al, allows for an economic nexus threshold for all types of taxes. Many states already had an economic nexus threshold for income taxes. Many states have adopted the South Dakota threshold for nexus. This standard generally starts use tax obligations when a vendor has over $100,000 of sales in the prior calendar year or the current year to date or 200 or more transactions.

Now, one state - Hawaii, has adopted that same threshold for its state income tax effective for tax years beginning after 12/31/19.  [SB 495 (Act 221, 7/2/19)] Hawaii's sales tax nexus threshold based on the South Dakota law upheld by the Court started 7/1/18.

Also, the Texas Comptroller has proposed the same via a proposed regulatory change for its franchise tax. The Texas sales tax Wayfair threshold though is over $500,000 of sales and it doesn't matter how many transactions there are (there is only a dollar sales threshold).

Remember that a state cannot override P.L. 86-272 which still applies to limit nexus if a taxpayer has no physical presence other than sales personnel who solicit orders that are approved and shipped from out-of-state. This is relevant for Hawaii's state income tax, but doesn't apply to the Texas franchise tax because it is not a net income tax.

Making the thresholds the same should be a lot simpler for small businesses. I don't agree with the South Dakota threshold's 200 or more transactions because for many small businesses though because that can be a small dollar amount, such as if selling items that cost less than $10 each. I think that is not sufficient nexus for commerce clause purposes.  I think states should do like California and Texas did and drop the transaction threshold and only use a dollar of sales gross receipts that is at least $100,000 and perhaps higher in large states (after all, buyers not charged sales tax still have to pay use tax on their own, and the higher threshold keeps the burden on the state tax agency more manageable and more likely that most remote vendors will be found and have to collect.

Not all states define sales the same for these purposes so there is still complexity for multistate sellers. But for a remote seller to know that once they have use tax collection obligations in a state they also have income tax obligations (assuming they are not protected by PL 86-272), should provide greater certainty to businesses and state tax agencies and simplify recordkeeping.

What do you think?

50th Anniversary of Willis Commission Report

Today marks the 50th Anniversary of the issuance of the last volume of the 4-volume, 1,200+ page Willis Commission Report. The four volumes were issued in 1964-1965. The official name of the report and the commission that wrote it - the House Special Subcommittee on State Taxation of Interstate Commerce (Rep Willis chaired the commission). This is likely the most comprehensive study and report ever done on state and multistate issues covering income tax, sales and use tax, gross receipts tax, and capital stock tax.

The report was issued in response to a 1959 US Supreme Court decision (Northwestern States Portland Cement Co. v. Minnesota, and Stockham Valves and Fittings, Inc., 358 US 450 (1959)). Congress was concerned that this decision would lead states to go overboard in assessing income taxes on multistate businesses. So within seven months of the decision, Public Law 86-2782 was enacted (9/14/59).  It limited when states could impose income tax obligations on a business.  This legislation also called for a study on state income tax and solutions to improve how multistate income is taxed.  While PL 86-272 remains in effect today, it was intended to be temporary - the study was to help come up with a long-term remedy for state income tax.  I have more on that anniversary and related information - here.

The study was later expanded to cover more types of taxes.  The report is an interesting (and long) read.  I describe much of it as something that could be written today. The problems described in the 1960s are mostly still with us, only with more digital and more businesses. For example, consider this statement:

"It has been found that the present system of State taxation as it affects interstate commerce works badly for both business and the States. It has also been found that the major problems encountered are not those of any one of the taxes studied but rather are common to all of them. This is not surprising in that all of these problems reflect the pervasive conflict between the approach to the taxation of interstate companies as it appears in State and local law, and the practical difficulties of realistic compliance expectations and effective enforcement. Increasingly the States, reinforced by judicial sanction, have broadened the spread of tax obligations of multistate sellers. As the principle of taxation by the State of the market has been accepted, the law has prescribed substantially nationwide responsibility for more and more companies. The expanding spread of tax obligations has not, however, been accompanied by the development of an approach by the States which would allow these companies to take a national view of their tax obligations. The result is a pattern of State and local taxation which cannot be made to operate efficiently and equitably when applied to those companies whose activities bring them into contact with many States." [Vol. 4, page 1127]

Today's system of state taxation of interstate commerce also works badly for both businesses and states.  In fact, that is one reason for my blog and 21st century taxation website- to discuss ways to move our taxation systems into the 21st century and follow principles of good tax policy. As clear from reviewing the Willis Commission report, we still have a lot of 20th century problems.

What do you think?

 

PL 86-272, UDITPA and the CPA Exam

The CPA exam change getting the greatest attention is the addition of questions on International Financial Reporting Standards (IFRS). But, another one of interest is that starting July 1, 2011, there will be questions on Public Law 86-272 - the income tax nexus law enacted in 1959! Also added - Uniform Division of Income for Tax Purposes Act (UDITPA) which has been around since 1957!

While these are very old laws to finally be added to the CPA exam (which already has plenty of varied content), I think it must be due to the growing importance of these rules to businesses of all sizes that today can easily engage in interstate commerce. I wonder though why the content is described so narrowly. For example, why not add:

• Nexus concepts for state income tax purposes.
• Basic rules and concepts for determining state income tax of a multistate business.

But another question - isn't the exam already complicated enough? The multistate rules added (even though just income tax and apparently just for sales of tangible goods to which PL 86-272 applies), are quite complicated. I suspect that the questions have to be fairly general. Do they adequately measure understanding of these important tax concepts?

References:

• List of 7/1/11 changes from the AICPA - here.
• Complete list of exam content - here.

What do you think? How would you word a question on PL 86-272 and UDITPA for the CPA exam?

Ohio Tax Reform - Success or Not?

In 2005, Ohio made significant changes in its tax law. It added a gross receipts tax called the Commercial Activity Tax (CAT) and phased out its corporate income tax and personal property tax; reduced the individual income and sales tax; and increased the cigarette excise tax. The CAT used a factor presence nexus standard and sourcing rules designed to tax companies with sales into Ohio and not those located in Ohio that make sales out-of-state.

With the 5 year anniversary of the changes approaching, I've seen a few stories telling of the success of the changes. For example, today's (April 5) Akron Beacon Journal had an article - "Tax reform brings kudos to Ohio - Analysis finds burden improves in last 5 years; changes are positive draw for business, leaders say" by Paula Schleis. It refers to a Federation of Tax Administrators (FTA) survey ranking Ohio as having the 16th lowest tax burden. Per the author, that ranking is 9 places better than in 2005.

Meanwhile, the Tax Foundation notes that the poor tax climate in Ohio drives businesses out of the state. In its blog post of January 7, 2010 - "Ohio's Poor Tax Climate at the Heart of the State's Economic and Fiscal Woes," the Tax Foundation suggests Ohio undertake tax reform. Ohio tax problems noted by the Tax Foundation include the use of a gross receipts tax and its inherent pyramiding problem and imposition even when a business has a loss for the year (for more on pyramiding, see my report here and some articles on gross receipts taxes here). Additional problems noted are Ohio's complex personal income tax and imposition of an income tax by most cities and school districts, as well as a sales tax that applies to many business purchases.

So, why the discrepancy in the views on Ohio's tax reform? Some of the difference may be due to the 5-year phase-in/phase-out of the changes where two types of businesses taxes applied. Another cause is varying perspectives on gross receipts taxes. Some say they are good in that they have a broad base (very broad) and thus, a low rate. Also, they are not subject to Public Law 86-272 or the physical presence nexus standard of Quill. This gives states more leeway in stating who is subject to the tax (within Due Process and Commerce Clause restraints) and the ability to "export" the tax. Of course, that would change if Congress enacts an update to PL 86-272 that calls for some degree of physical presence for any "business activity tax" which includes a gross receipts tax.

So, different perspectives on the nature of taxes, ways to measure tax burdens among the states, and the effect of transition rules for tax changes complicates the picture as to whether the Ohio tax reform has been a success. I think it is impressive that something was actually done rather than only talked about for decades with no changes made (as happens in many states including California which has already had two tax reform commissions in the 21st century with no changes enacted). (I don't think a gross receipts tax with its inherent pyramiding is an effective way to tax.) In addition, differences in the meaning of "successful tax reform" can lead to differences in opinion as to whether tax reform in Ohio has been successful.

What is your take on whether the Ohio tax reform effort enacted in 2005 has been a success or not?

Software and Income Tax Nexus

Companies that transfer software to customers that are not in the same state and the software company face issues as to whether income tax is owed in the state where customers are located. Nexus guidance of PL 86-272 only applies if the transaction involved the "sale" of "tangible personal property." Software transactions generally challenge both of these terms. That is,

• Software is typically "licensed" rather than "sold." However, for prewritten/canned software, the result looks a lot like when one buys a book. Tax rules have typically viewed this as equivalent of a "sale" (such as Income Tax Reg. Section 1.186-18).
• Software is really intangible. Considering physics, it has no mass. However, cases and state laws have sometimes either just labeled prewritten software as tangible (typically so they can apply sales tax to it) or may find it to be tangible because it is on tangible media or needs to be on tangible media (such as a hard drive) to function. However, for federal depreciation rules, software is intangible (see for example, Internal Revenue Code Section 197).

So, it would seem that PL 86-272 can never apply to software. However, that was not the result found in a recent NJ Tax Court decision involving two different software vendors who transferred canned software on tangible media (AccuZIP and Quark).

I've got a short article from the AICPA Corporate Taxation Insider (11/12/09) that summarizes the case and explains some of the income nexus issues - see Software and Nexus.

50th Anniversary of PL 86-272 - Temporary Legislation!

Today - September 14, 2009, marks the 50th anniversary of Public Law 86-272 which many of its drafters viewed as a temporary law. PL 86-272 provides guidance to businesses as to when they have income tax obligations in a state. Basically, if the only thing a business does is to take orders in the state that are approved and filled from outside of the state and the business has no property in the state, the business is not subject to income tax in that state.

PL 86-272 also called for a congressional committee to study various state income tax issues as relevant to multistate businesses. Results of that study were to enable Congress to improve or broaden PL 86-272.

Despite a 1,200+ page report released in 1964 and 1965, no changes were made to PL 86-272. That's a long time to have a temporary provision. A key lesson learned is that a termination date should have been specified in the law to make it a higher priority to get the law into a final and lasting form. One of the key defects of PL 86-272 is that it only provides guidance to multistate businesses that sell tangible personal property.

I've written on this before, asking the question over 1 year ago whether PL 86-272 would get modernized prior to its 50th anniversary. Legislative proposals to do so, remain in limbo - as they have for the past few sessions of Congress.

For more information, see a website on this topic - http://www.cob.sjsu.edu/nellen_a/TaxReform/PL86-272-50thAnniversary.htm.

What do you think?

Our Flat World (except for domestic interstate commerce)

Ease of cross-border business activity has led to what Thomas Friedman describes as a flat world. However, our quagmire of state nexus rules leaves domestic commerce in a non-flat world.

States tend to take broad approaches in finding multistate sellers subject to income or gross receipts tax in the state. The 1959 federal law known as PL 86-272 provides guidance for sellers and states regarding when a state can impose income tax obligations on a seller of tangible personal property. A lot more businesses today, relative to 1959, sell something other than tangible personal property and so have no federal statute to rely on to know when they may owe income tax in a state.

Some states take the approach that an economic connection is enough - that a physical presence in the state is not needed before a seller is subject to state income tax. And, rules can vary from state to state leading to the possibility of double taxation of some income.

The 1959 law needs to be updated. It was intended to be temporary (!), but was never updated. Congress has looked at a few possibilities over the past several years, but nothing has come close to enactment.

For more on this issue that presents a challenge to interstate commerce, see my short article - Not Flat: State Income Tax Nexus.

Public Law 86-272 - Upcoming 50th Anniversary of Stopgap Legislation

In reaction to a US Supreme Court decision - Northwestern Cement v. Minn., 358 US 450 (1959), which many members of Congress thought would lead states to tax businesses beyond what they should under the commerce clause, Congress enacted Public Law 86-272 on September 14, 1959. Despite the lack of an expiration date in this legislation, it was described as a temporary measure while Congress further studied state taxation (a study established by PL 86-272). The report was completed in the mid-1960s (referred to as the Willis Commission report after the Congressman who chaired the subcommittee). However, PL 86-272 was not revised.

PL 86-272 explains when a state may impose income taxes on multistate businesses selling tangible personal property. Businesses selling services or intangibles, get no protection (or guidance) from the federal law. With more businesses selling services and intangibles today than in 1959, PL 86-272 is in need of updating. There have been various congressional proposals in the past few years, but no changes have been enacted and there are differences of opinion between state governments and businesses on what the reforms should be. Also, recent court decisions have held that "economic presence" is sufficient for a state to be able to impose income tax obligations on a business (businesses believe that "physical presence" should be the standard). The US Supreme Court has declined to hear any of these cases. Meanwhile, the 50th anniversary of this stopgap legislation is approaching.

For background on PL 86-272 and the case that led to its enactment, click here.

For links and related information on PL 86-272 and the current controversies in attempts to modernize this nexus rule - see this website.

Do you think temporary law PL 86-272 will be updated before its 50th anniversary on 9/14/09? If no, why not? If yes, what will the new version look like?