Erosion of nexus protection and the burden on small businesses.

• Author: McCann, Bridget

Gone are the days of determining income tax filing obligations by simply looking to where the business has a physical presence created by property or payroll. Long before the U.S. Supreme Court's landmark ruling in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), states had been applying an economic nexus theory to income taxation. A pivotal departure between income tax and sales tax nexus occurred in Tax Commissioner v. MBNA America Bank, NA., 640 S.E.2d 226 (W. Va. 2006), where West Virginia's highest court determined the physical presence standard of nexus did not apply for income tax purposes. From that point forward states have been emboldened to interpret income tax nexus more aggressively.

One last lifeline was available to sellers of tangible personal property--the protection afforded by P.L. 86-272 (the federal Interstate Income Act of 1959). Most practitioners are familiar with the protection that was established decades ago. If tangible personal property is sold and only solicitation activities are occurring in a state, there is no resulting income tax filing obligation. The product must be shipped in from outside the state, and no other activities can be taking place in the state. Under this federal protection, sales representatives may even be permanendy located in the state without creating an income tax fding obligation.

Guidance regarding application of the federal law has been provided by the Multistate Tax Commission (MTC) in its "Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272."The original statement of information was adopted by the MTC in 1986, with subsequent updates made in 1993, 1994, and 2001. With the advancement in technologies over the past 20 years and their impact on how business is now being conducted, the MTC determined significant modifications were needed. A work group was formed, and a revised version was submitted to the MTC's Uniformity Committee for consideration. A public hearing was conducted in August 2020, and the hearing officer's report was completed on Oct. 30, 2020.

The MTC's revised statement

It is clear from the revised statement of information that states are of the opinion that federal law should no longer protect businesses from the imposition of income tax when they are engaged in internet activity with customers. Internet-based activity is now being viewed as activity taking place within the customer's state, even though the seller has never entered the state or employed property in the state.

Article IV, Section C, of the revised statement states, in part:

As a general rule, when a business interacts with a customer via the business's website or app, the business engages in a business activity within the customer's state...