State Tax Administrators: Please Do Your Part in Sending PL 86–272 off into the Sunset
Or State Tax Administrators in an Age of Statutes
This is the story of an arbitrary and destructive interstate tax shelter, one created by the federal government. No, this is not about collecting the sales and use tax. That tax shelter is largely on its way out; it was created by the Supreme Court in 1967, embraced anew in 1992 and finally ended, by the Court, in 2018, in a case called Wayfair. The tax shelter I am talking about in this post was created in 1959, by Congress. It was meant to be temporary, but is still with us and it shields certain large multistate taxpayers from the state corporate income tax.
The law in question, PL 86–272, shields taxpayers from paying the corporate income tax if certain conditions are satisfied. In particular, the taxpayer must be engaged in selling only tangible personal property in the state and the only activity in the state must be “solicitation.” Leaving aside the wisdom and propriety of Congress creating a tax shelter at all, these requirements indicate how dated the statute is now — and how poorly thought through it always was. Why are only sellers of tangible person property given the benefit of this special rule? Why only solicitation? How is solicitation a proxy for whether it would be fair and reasonable to ask a taxpayer to pay the income tax? If one remember the statute’s vintage, then one can understand the focus on tangible personal property because that was a more important part of the economy. This also explains the emphasis on solicitation as this refers to a then much more common business model of relying on an in-state sales force, though it never made a lot of sense to give a break to taxpayers large enough to engage in only solicitation.
Before proceeding to what to do with this statute, I want to quickly review the fundamentals and the history. As for the fundamentals, there is clearly a place for a rule establishing what level of connection is sufficient in order to give a state jurisdiction to impose a tax. Thanks to the Wayfair decision of June 2018, there is now a constitutional nexus standard that corresponds to what theory indicates is the right answer. A state can impose a tax (or an obligation to collect a tax) if a business has substantial nexus with a state. A large retailer, such as Wayfair in the Wayfair decision, clearly had sufficient economic and virtual contacts (the Court noted the virtual as well as the economic) to satisfy the substantial nexus requirement. This is the right answer and one that has been applied in some form for quite a while to state corporate income taxes and, to my mind, with success. One way to characterize the issue at this point is what to do with an old statute struggling to find the right nexus rule when the background constitutional rule is established and correct.
Now the history. There was no such clear rule in 1959 when PL 86–272 was drafted, much less a correct rule. This statute was drafted very quickly in order to shield interstate businesses from what Congress feared was going to be a too generous nexus standard then being developed by the Supreme Court. The idea was that Congress would give taxpayers some breathing room while it considered matters. Congress did consider the state of state taxation, in the very impressive Willis Committee Report. Congress then did not act on those recommendations, at least in part because the states replied by coordinating their tax systems through adopting the Uniform Division of Income for Tax Purposes Act (UDITPA).
So back to the current situation. It is now clear that the constitutional nexus standard grants states nexus over taxpayers with extensive economic and virtual contacts with a state. We do not yet know the lower limits of nexus, but that is not really the core concern in connection with the big taxpayers most likely to benefit from PL 86–272; they would have nexus if not for the statute. Congress, sixty years ago, created an ill-considered rule that limits nexus. As a matter of policy, this was never a good idea, but the formality and arbitrariness of the rule means that, at this point, it is primarily a tool for particularly sophisticated taxpayers, who are so inclined, to game the interstate tax system. That is, it is hard in the modern economy to sell only tangible personal property and engage only in solicitation, much less to do so without triggering a state’s throwback rule (long story: the point is that if a sale originates from a state with a throwback rule then the PL 86–272 exemption’s value will be less, perhaps lost completely.)
Ok, but even if it is silly, PL 86–272 is the law. Yes, but the question is how should state tax administrators address the law. Eventually, the related question will be how should courts analyze the law. The answer, to me, seems clear, and that is, to use Justice Scalia’s phrase, to grant the statute’s fair meaning and nothing more. So, for example, the statute chooses to protect only sellers of tangible personal property, so why should states permit taxpayers to divide up their businesses so that one corporation is only a seller of tangible personal property? I think states should take the reasonable position that if a unitary business sells more than tangible personal property into the state, then it does not matter how the taxpayer divides itself.
Or, consider solicitation. It is clear from the major case interpreting PL 86–272, written by Justice Scalia, in fact, that maintaining an in-state customer service operation would not be mere solicitation, but more, and thus any taxpayer engaging in such would not be protected by PL 86–272. Well, most major businesses maintain websites capable of attending to customer needs far beyond what could have even been done in-person in 1959, or even 1999. And, maintaining a sophisticated web presence is not a bad proxy for a firm having the infrastructure to comply with the state corporate income tax. A taxpayer should not be able to do by website what it could not do in person. If a firm has an extensive –and interactive — website accessible in-state, then it is engaging in more than solicitation.
But won’t such approaches to the statute sharply reduce its use? Yes and wouldn’t this be in tension with the spirit of the statute? Maybe, it is hard to say given the confused nature of the statute, but so what if it did? How much the spirit of the statute should matter is a very important question in general, but that is not really the relevant question here. Constitutional law instructs courts — and, I think, administrators — to read this statute narrowly (and rightly so). This statute has many strikes against it. First, Congress is presumed to preempt state law narrowly. Second, as a statute preempting state revenue authority, many of the Court’s precedents suggest that it should be held up to particularly rigorous scrutiny. Third, the statute’s very senselessness is a constitutional problem. It is one thing to preempt states’ core powers for a vital national objective, another to give a tax break premised on little more than the capacity to jump through certain formal hoops. Interpreting the statute so as to offer a permanent tax break for no good reason might actually render the statute unconstitutional — which is another reason not to interpret the statute this way.
Fortunately, the Multistate Tax Commission is aware of all of this and has convened a task force to consider PL 86–272 in light of Wayfair. I think the taskforce is clearly on the right track and I hope it publishes clear guidance to the states about how they ought to fairly — and narrowly — interpret PL 86–272. I then hope the states follow that guidance — or, just do the job themselves. State tax administrators should follow the best possible interpretation of the law. As I have argued, a narrow interpretation would be the best one. Foregoing public dollars through adopting the weaker interpretation would not be right. It also would deprive the courts of the opportunity to reach the correct decision.
To conclude and to repeat, with Wayfair in place there is a sound constitutional rule to protect taxpayers who truly have too little nexus with a state to justify taxation. Indeed, in all likelihood states generally assert nexus in fewer cases than they could because they set their statutory limits above the constitutional minimum, which I think is a good idea.