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Are You Ready for the Shift in Income Tax Nexus?

Thomas M. Frascella Director, Tax Strategies, State & Local Tax Group Leader

Successfully Implementing Change in Your Organization

At the beginning of my career, nexus was a simple concept for businesses to understand and plan their activities accordingly. Today, understanding nexus is not so easy. In fact, it has become quite complicated. Traditional concepts supporting protected activities are under attack and evolving at a fast pace.

Many think that the Supreme Court’s decision in Wayfair is limited to sales tax. I would suggest that the decision impacts taxes well beyond the sales tax that was at issue in the case. For decades the physical presence requirement was sacrosanct. Businesses understood that and relied on the consistency of knowing that if they limited their activity to a single state, they would be safe from other states imposing their filing requirements on them.

Everyone knew the importance to businesses of having clarity in the rules surrounding nexus. This clarity was so important that it prompted Congress to enact federal legislation protecting them from the imposition of state income taxes. The law has commonly become known as PL 86-272 and indicates that if a business that sells tangible goods only conducts solicitation activities within a state, that state is without the authority to impose its income tax.

P.L. 86-272 has not been without it challengers. The litany of state tax cases that attempted to challenge the federal law prohibiting the imposition of state income tax is long. It includes the Supreme Court’s decision in Wrigley, which established the “ancillary to the solicitation” and “independent business purpose“ standards of determining when a business has exceeded mere solicitation activity in a state.  The Supreme Court held that P.L. 86-272 extends to the entire sales process and includes activities that are ancillary to solicitation. The Court in Wrigley held that activities are ancillary when they serve no independent business purpose beyond the solicitation.

P.L. 86-272 still remains the standard for when businesses create state income tax nexus. However, we are beginning to see states become more discerning when determining when activities go beyond solicitation. A recent decision by the Maryland Court of Special Appeals in the Blue Buffalo case interpreted the scope of P.L. 86-272 and the decision in Wrigley to determine when out-of-state business activities exceed solicitation. In the Blue Buffalo case, the Court applied a two-pronged test to determine if the taxpayer exceeded the protection of P.L. 86-272. The first prong examined whether the activities were entirely ancillary and the second prong examined if any non-ancillary services were de minimis.

The lower court held that activities such as attending pet-related events in Maryland, encouraging in-store purchase, product training, quality control, reworking displays, and collecting competitive intelligence were not ancillary and had an independent business purpose. The Maryland Court of Special appeals focused on customer relations, product training, and retail services. The Court held that attendance at pet-related community events had no independent business purpose and were protected.  The Court also held that Blue Buffalo’s product trainings were protected because their only purpose was solicitation. However, the Court noted that product trainings designed to educate the customer on how to use the product could be considered independent and cause the protection of P.L. 86-272 to be lost.  Similarly, the Court found services such as quality control to be of an independent nature and also lost the protection of the federal law.

Determining that there were services of an independent business purpose provided, the Court then examined whether these services were de minimis. Taken individually, the services could have been considered de minimis. However, taken as a whole, the services were not de minimis and the Court concluded that Blue Buffalo had nexus and was subject to the corporate income tax.

The Blue Buffalo decision demonstrates that the federal protection afforded by P.L. 86-272 is a relatively low hurdle for businesses to cross and become taxable in another state. While the decision only relates to taxpayers in Maryland, the possibility that other states adopt a similar logic to reviewing in-state business activities to defeat the historical protection provided by the federal law is a reasonable possibility. Businesses that rely on the protection of P.L. 86-272 should revisit their in-state business activities to determine the nature of the services provided and whether they could be deemed to be serving an independent business activity causing the immunity to be lost.


Thomas M. Frascella can be reached at Email or 215.441.4600.


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Thomas M. Frascella

Thomas M. Frascella

Director, Tax Strategies, State & Local Tax Group Leader

State and Local Tax Services Specialist

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