More States Eyeing Expansion of the Corporate Income Tax
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In June of 2018, the Supreme Court handed down its decision in South Dakota v. Wayfair, allowing states to require remote retailers to collect and remit sales taxes even in states where the retailers lacked any physical presence. The consequences of this decision have proved to be enormous for smaller retailers, who have struggled to keep up with the differences between state and local sales tax codes all around the country — with small business owners expected to do themselves work that entire corporate state and local tax departments do.

But while small businesses are already buckling under this massive new paperwork burden, some states are already thinking about taking things a step further. Why stop at sales taxes, they figure, when they could apply the logic of Wayfair to other taxes affecting businesses?

There’s one very good reason not to do that: federal law tells them not to. The Interstate Income Act of 1959, or P.L. 86-272, prohibits states from imposing business income taxes on out-of-state businesses when their only physical activity within that state is the solicitation of sales. Generally, this means that a remote retailer can enter into transactions with customers in a different state and send them their products without facing income tax obligations in the customer’s state, so long as the retailer does not have a warehouse or a fulfillment center in that state.

Much like the pre-Wayfair standard for sales taxes, states have long found P.L. 86-272 to be inconvenient to their pursuit of ever-more tax revenue, and have slowly whittled down P.L. 86-272’s protections over the years. But a recent effort by the Multistate Tax Commission (MTC) would represent an emphatic final nail in the coffin.

The MTC has encouraged states to adopt the view that just about any common function of a modern retail website extends past the solicitation of sales and therefore voids the protection of P.L. 86-272. According to the MTC, anything from offering post-sale customer service via online chat to the use of digital “cookies” should cause a business to lose P.L. 86-272’s protections. The MTC’s full list of impermissible activities has the effect of making it nearly impossible for a retailer to operate a website and still enjoy the protection of P.L. 86-272.

Soon after the MTC took this position, the usual taxation enthusiasts jumped into line. California’s Franchise Tax Board adopted this position immediately and retroactively, effectively creating income tax obligations for remote businesses going backwards. New York took a slightly more measured approach, allowing for a period of public comment, but still moved forward with the MTC’s position. For a short time, these high-tax heavyweights were the only states to take up this legally dubious position. 

Minnesota’s recent announcement that it is considering adopting the MTC’s position as well therefore represents a concerning expansion of this effort. While it is one thing for California and New York, two states which have made very clear their strategy of imposing any and all tax obligations on businesses that they can possibly get away with, to adopt the MTC’s position, for other states without that reputation to follow suit is a worrisome trend. 

While this may sound esoteric, at issue here is nothing less than whether state tax rules will allow it to be feasible for small businesses to operate, or if the sheer volume of tax compliance burdens will make compliance possible only for large businesses with the in-house accounting capability to do so. For all that politicians love to talk about how small businesses are the “backbone of our economy,” it would be a real shame if the tax codes they designed made it impossible for them to operate in the same spaces as large corporations.

Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government. 

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