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California Applies Public Law 86-272, How It Affects Taxes

At a Glance

Main Takeaway

Public Law (P.L.) 86-272 prohibits states from imposing income taxes, such as corporate or franchise tax, under specific conditions. Out-of-state businesses whose activities in California are limited to selling tangible personal property and soliciting sales may be exempt from state income tax. If your company domiciles outside of California, it is essential to understand P.L. 86-272 and how it affects your state and local tax compliance in California or any other state with limited activities.


Public Law 86-272’s Application in California

Public Law 86-272 prevents California from assessing income taxes on out-of-state businesses whose operations within the state are limited to “protected activities” (selling tangible personal property and soliciting sales) and who have no physical presence in the state.

Tangible personal property (TPP) is physical property that can be easily relocated, such as equipment or supplies. Only the solicitation of TPP sales and related ancillary activities are protected under the statute. Leasing, renting, licensing, or disposing of TPP are not protected, nor is providing maintenance on TPP sold. A complete list of protected and unprotected activities can be found in California FTB Publication 1050.

P.L. 86-272 also has additional SALT compliance ramifications. For example, apportionment calculations will be impacted depending on where a business is domiciled. Some states throw the statute-protected sales back to the state of domicile, and some throw them out of the apportionment calculation entirely. Additionally, income tax returns still need to be filed in California to claim the protection.

Multistate Tax Commission Revised Guidance

In 2018, the U.S. Supreme Court ruled in South Dakota v. Wayfair, Inc. that states can collect sales tax on purchases made from out-of-state sellers even if the seller does not have a physical presence in the state. Following the ruling, the Multistate Tax Commission (MTC) revised its guidance on P.L. 86-272, adding a section on internet activities.

The MTC now considers that most remote activities performed over the internet could no longer be protected under P.L. 86-272 unless they directly serve a sales purpose. This guidance limits the application of P.L. 86-272, which could have significant implications for out-of-state businesses. The MTC’s guidance is not automatically adopted; each state needs to explicitly adopt the guidance.

California’s Technical Advice Memorandum

The California Franchise Tax Board (FTB) also issued guidance that considers the analysis in the Wayfair ruling relevant to P.L. 86-272. In February 2022, the FTB issued a Technical Advice Memorandum (TAM) outlining revised guidance on P.L. 86-272 and what business activities remain protected under the statute:


Protected Business Activities Under the TAM

Activities protected by P.L. 86-272 can include:

  • Providing post-sale assistance to in-state customers by publishing a static list of frequently asked questions on the business’s website.
  • Using cookies on in-state customers’ electronic devices to collect search information for various purposes such as inventory management, product development, and identifying new items to offer for sale.
  • Offering only tangible personal property for sale on the business’s website. The website allows customers to search for items, read product descriptions, purchase items, and select delivery options.


Unprotected Business Activities Under the TAM

Activities not protected by P.L. 86-272 can include:

  • Providing post-sale assistance via electronic chat or email for in-state customers, accessible through an icon on the business website.
  • Placing cookies on the electronic devices and computers of in-state customers to collect customer information for purposes unrelated to requesting orders for tangible personal property. The information collected may include items added to a customer’s shopping cart during a web session, personal information provided by the customer, and reminders of items customers considered during previous visits to the website.
  • Upgrading or fixing in-state customers’ products by transmitting electronic instructions or code remotely over the internet.


Tax Implications for California Businesses

With the release of the FTB’s TAM, previously protected activities may now be deemed unprotected. The guidance lacks an effective date and does not address existing FTB Publication 1050 guidance.

Out-of-state businesses selling in California should carefully review their activities and regularly assess whether they still fall within the protection of the state’s tax laws. If your business has never filed income  tax returns in California but may now conduct activities that are no longer protected under P.L. 86-272, you may need to consider participating in the voluntary disclosure program to limit your potential liabilities and penalties for the years in question


Limiting Your Income Tax Exposure

Navigating this guidance can be challenging for business owners. There is no statute of limitations on non-compliant returns. Therefore, non-compliance can lead to significant back taxes, fines, and interest accrual. With increased income tax scrutiny, it’s more important than ever to partner with a team that understands the nuances of SALT compliance.

Windes offers comprehensive SALT compliance services to help you navigate complex state and local income tax issues. Our dedicated SALT Team has the expertise and resources to update you with changing legislation and minimize your tax burden. Contact our SALT Team to learn how these new states’ guidance affects your business’s state income tax liability.


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