A case for updating P.L. 86-272.

• Author: Mudford, Scott
• Position: Interstate Income Tax Act of 1959

P.L. 86-272, the Interstate Income Tax Act of 1959, was passed by Congress nearly 45 years ago to prevent states from dissuading interstate commerce by asserting nexus toward out-of-state businesses, thereby casting them into a web of compliance issues. Its passage has raised two common concerns. First, its narrow scope in protecting sellers of tangible property has become a contentious issue. Second, its limit to state income taxes leaves a gaping loophole in the law, which Congress needs to address. Several states impose business activity taxes not based on income, and, thus, not subject to the P.L. 86-272'S constraints.

P.L. 86-272 essentially extends greater protection to certain taxpayers, above and beyond the Constitutional protections (the Due Process and Commerce Clauses), afforded to all taxpayers. It applies only to taxpayers that sell tangible property, and only to income taxes.

In addition to the existing Constitutional protections, P.L. 86-272 provides that no state can assert income tax nexus on the basis of mere solicitation. However, the courts have construed "mere solicitation" very narrowly.

The Problem

Although many taxes like the business activity tax were in place when Congress passed EL. 86-272, two recent developments in state taxation demand Congressional action in closing the loophole. With increasingly powerful technology, states can easily find taxpayers operating within their borders, but just outside of the very slight Congressional protections. This alone creates the burden on interstate commerce that P.L. 86-272 was supposed to avoid. The courts have ruled that as little as two days of mere solicitation in a state in which substantial sales result, can create nexus in absence of P.L. 86-272 protection; see Michigan Sugar Co. v. Michigan Dep't of Treasury, MI Tax Tribunal, No. 220328 (5/21/97).

The growing trend for states to weight the sales factor more heavily in their apportionment formulas is bolstering a call for Congress to act. It is common knowledge that one court-approved way for states to favor in-state taxpayers is either to rely on the sales factor in calculating the tax due or to weight it more heavily. However, applying a sales-heavy apportionment formula to a nonincome tax base usually produces large liabilities for out-of-state taxpayers.

In considering both the administrative burden on interstate commerce noted above and the economic burden caused by applying a heavily weighted sales-factor to...