Erosion of nexus protection and the burden on small businesses

By Catherine Stanton, CPA

Editor: Bridget McCann, CPA

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, N.A.,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 permanently located in the state without creating an income tax filing 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. However, for purposes of this Statement, when a business presents static text or photos on its website, that presentation does not in itself constitute a business activity within those states where the business's customers are located.

Examples of unprotected activities have been added; they include the following:

  • Post-sale assistance to in-state customers via either electronic chat or email that customers initiate by clicking on an icon on the business's website. For example, the business regularly advises customers on how to use products after they have been delivered.
  • The business solicits and receives online applications for its branded credit card via the business's website. The issued cards will generate interest income and fees for the business.
  • The business's website invites viewers in a customer's state to apply for nonsales positions with the business. The website enables viewers to fill out and submit an electronic application, as well as to upload a cover letter and résumé.
  • The business places internet cookies onto the computers or other electronic devices of in-state customers. These 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.
  • The business remotely fixes or upgrades products previously purchased by its in-state customers by transmitting code or other electronic instructions to those products via the internet.
  • The business offers and sells extended warranty plans via its website to in-state customers who purchase the business's products.
  • The business contracts with a marketplace facilitator that facilitates the sale of the business's products on the facilitator's online marketplace. The marketplace facilitator maintains inventory, including some of the business's products, at fulfillment centers in various states where the business's customers are located.
  • The business contracts with in-state customers to stream videos and music to electronic devices for a charge.

The MTC's "P.L. 86-272 Statement of Information Project" webpage (available at contains comprehensive information regarding the revised statement, reference materials, and public comments regarding the changes. Public comment provided by the Council On State Taxation is particularly helpful in addressing the overreach that is taking place in an attempt to disarm the federal law.

The impact on sellers

The impact of these changes on small sellers of tangible personal property have been largely overlooked and cannot be overstated. P.L. 86-272 has been a saving grace for small e-commerce sellers. Today there are literally thousands of such businesses that sell their products over the internet. The COVID-19 pandemic has only added to overall internet sales traffic. Many of these small business sellers have relatively low profit margins. And it is likely the increased compliance burden placed on small sellers will far outweigh any additional revenue states collect.

Most small sellers are organized as passthrough entities and are already paying tax on all their income in their resident state. The increased compliance burden in this case would result in only shifting profit between taxing jurisdictions. This is far different from Wayfair's impact on sales tax collection, since the sales tax was generally not being paid in most jurisdictions.

It has been a treacherous journey for small sellers in America, and it appears it is about to get worse. It started with many small brick-and-mortar stores being put out of business by the fast-growing Amazon competition. Small sellers were unable to compete on price, especially in years when Amazon was not required to collect sales tax.

Small sellers then moved to the internet, often using Amazon's or other online marketing platforms, which required them to give up a sizable portion of their profit to the platforms. Then along came Wayfair, which has caused incredible anxiety. Sellers navigated the new rules of sales tax collection as best they could with their often limited resources. A significant amount of time was consumed that would have been better spent in furthering their business. Thankfully, marketplace facilitator rules are now helping to alleviate some of this burden.

Then came the next surprise. Small sellers using the Fulfillment by Amazon (FBA) program were notified that the presence of a small amount of inventory in Amazon's warehouses created sales tax nexus before the Wayfair decision. Sellers had no control of the inventory, and determining its whereabouts at all times was not an easy task. Certain states seized the opportunity by obtaining lists of sellers using the FBA program and started pursuing them aggressively. Not only did small sellers have to deal with implementing Wayfair, but they were also then presented with years of sales tax assessments and penalties, often with no ability to pay due to their low profit margins.

Small sellers successfully navigating these difficulties continue to work hard to grow their business. At some point it is essential to establish their own websites, considering the substantial costs of using online marketing platforms. The customer experience is monitored closely, and interactive websites are commonplace. Chat features attempt to answer all customers' questions before, during, or after the sale. The use of data analytics also provides sellers with competitive advantages — data that is often gathered through the use of cookies.

These activities, at least in the MTC's view, are now deemed to be the seller's activity performed in the customer's state. Since the activities are not deemed to be solicitation activities, they are not protected under federal law. No longer are a business's state tax concerns limited to sales tax. And for all those using the FBA program? They are specifically listed as having income tax nexus due to the presence of their inventory in Amazon warehouses, affirming the aggressive actions on the part of some states.

The application of this statement of information to small sellers is egregious. To avoid the high cost of filing income tax returns across the country, a small seller would not be able to use the same tools as larger competitors. Websites can provide only a static listing of products where orders are made. That is it. No improving their customer experience or benefiting from the use of cookies. Until their profits can absorb the cost of filing income tax returns in states they sell into, they are hamstrung.

Most small sellers engage sole practitioners to prepare their income tax returns, and often these practitioners are not comfortable filing state income tax returns outside of the state they are located in, and maybe surrounding states. Adding a substantial number of income tax returns to their annual tax compliance will likely force small sellers to move to larger firms, increasing their tax preparation costs substantially.

Lack of sales thresholds

One would think a certain sales threshold must be met before such onerous reporting requirements are imposed, especially in light of Wayfair. However, thresholds provided for sales tax do not apply to income tax, unless the state has specifically adopted them. Unfortunately, thresholds have not been provided in most jurisdictions for income tax purposes. In addition, it is questionable whether factor presence nexus standards in states that have adopted them would protect small sellers. Thresholds apply to businesses that are only selling into the state, without any other activities occurring in the state (i.e., economic nexus). In this case, the MTC has determined that internet-based activities are equivalent to the seller's actually performing activities within the state.

For example, California has adopted the MTC's sales factor presence nexus standard of $500,000 ($601,967 in 2019 after being indexed for inflation). California is currently an associate member state of the MTC. If it adopts the MTC's expanded interpretation of "unprotected" activities, the state would consider internet activities as business activities occurring in the state. The threshold does not act as a safe harbor. If the seller is actively engaging in transactions for profit within the state of California, income tax is due regardless of the sales amount. The threshold becomes irrelevant.

Clear protections for small sellers are desperately needed. Factor presence nexus standards should be adopted by all states, and internet activities with customers should not nullify the use of those thresholds. Thresholds should be at least $500,000 as opposed to the lower Wayfair threshold of $100,000, considering tax is being applied to profits, not gross sales, and income is not likely escaping tax in a passthrough entity environment. There should also be a simple "no tax due" form provided for sellers that are not profitable or whose profits are immaterial.

Next steps

The MTC Executive Committee on Nov. 20, 2020, voted to move the amended P.L. 86-272 statement of information forward, and it will now conduct a survey of the states. The statement is not binding law, but the expectation would be for MTC member states, and likely others, to adopt the changes. As one can imagine, the business community is largely opposed to the changes, and litigation is sure to result.

Complying with sales tax has its costs for sure. But income tax compliance is another level entirely. Unfortunately, not enough emphasis has been placed on protecting small sellers or, if one might be bold enough to say, to even give small sellers a chance to survive.   



Catherine Stanton, CPA, is a partner and the National Leader of State & Local Tax (SALT) Services with Cherry Bekaert LLP in Rockville, Md. Ms. Stanton is the immediate past chair of the AICPA State & Local Tax Technical Resource Panel. Bridget McCann, CPA, is managing director of State Tax at Grant Thornton LLP in the Philadelphia area. Ms. McCann is the chair of the AICPA State & Local Taxation Technical Resource Panel. For more information about this column, contact


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