December 6, 2024 - Dating back several decades, manufacturing and distribution businesses have enjoyed the benefit of the Interstate Act of 1959 (otherwise known as Public Law 86-272), which prohibits a state or locality from imposing net income taxes on companies whose activities are limited to soliciting orders for tangible personal property that are approved and shipped from outside the state to customers in the state. Since being enacted, Public Law 86-272 has allowed companies selling tangible goods to enter new markets throughout the U.S. without being concerned about having to report and pay net income taxes to new states—whether that tax is imposed at the company level or owner level as in the case of pass-through entities.

This protection has been essential for manufacturing and distribution businesses selling across several states and through their own or third-party e-commerce channels because of the U.S. Supreme Court’s 2018 decision in a case referred to as Wayfair. In Wayfair, the Court held that states could impose sales tax collection and remittance obligations on companies selling above a certain revenue or transaction threshold into the taxing state. This legal theory opened the door to several states and localities looking to adopt similar revenue thresholds for imposing net income taxes on companies selling products into the state above the specific amount adopted by the state in question. Accordingly, Public Law 86-272 has been relied on extensively by most manufacturing and distribution companies in today’s e-commerce and digital-based economy.

Since the enactment of Public Law 86-272, the Multistate Tax Commission (”MTC“) has issued several policy statements which provide a list of recommended ”protected“ and ”unprotected“ activities under the federal law. Since the MTC is comprised of many states and regularly solicits policy analysis and recommendations from state revenue and taxing departments, many jurisdictions across the U.S. have adopted guidance or regulations that mirror the recommendations of the MTC.

In late 2021, the MTC revised its policy statements to provide additional examples of protected and unprotected activities which specifically involve internet and digital activities. Under the examples, there were several internet-based activities considered to be unprotected, including:

• Regularly providing assistance following the sale by either electronic chat or email that customers initiate by clicking an icon on the business’s website;
• Soliciting and receiving online applications for its branded credit card via its website;
• The business’s website invites viewers in a customer’s state to apply for non-sales positions with the business;
• Placing internet cookies onto the computers or other electronic devices of in-state customers; and the cookies gather customer search information that will be used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale;
• Remotely fixing or upgrading products previously purchased by in-state customers by transmitting code or other electronic instructions to those products over the internet;
• Offering and selling extended warranty plans on its website to in-state customers who purchase the business’s products;
• Contracting with a marketplace facilitator that facilitates the sale of the business’s products on the facilitator’s online marketplace and the marketplace facilitator maintains some of the business’s inventory in fulfillment centers in states where the business’s customers are located; and
• Contracting to provide to in-state customers streaming videos and music to electronic devices for a charge.

In response to the MTC’s revised list of unprotected activities, a few states, including California, New Jersey, New York, and Wisconsin have explicitly adopted similar changes in their own regulations and guidance. While some of these efforts are being challenged in state courts, manufacturing and distribution businesses are left with having to determine whether to comply or take a position to the contrary based on the status of current litigation. Alternatively, manufacturing and distribution businesses may decide to change or curtail their behavior in terms of the specific activities which are being conducted that have been determined to be unprotected under Public Law 86-272.

As more states follow the MTC’s guidance and the narrowing of protection available under Public Law 86-272 continues, manufacturing and distribution businesses face new challenges in having to account for and understand the myriad of different state and local rules when it comes to whether the company is subject to tax and how much of its net income may be subject to tax. This will likely be unchartered territory for many of these companies that have relied on federal protection in past years. If your business needs assistance navigating these new rules, please contact Jaime Reichardt at jreichardt@citrincooperman.com.