Skip to main content

California Judge Moots State’s “Invalid Underground Regulation” on P.L. 86-272

California Superior Court Judge Ethan P. Schulman has granted a motion for summary judgment on behalf of the American Catalog Mailers Association (ACMA) voiding the state’s February 2022 Technical Advice Memorandum (TAM) regarding P.L. 86-272, or the Interstate Income Act. While this does not constitute a ruling on the merits, other states should take note that they cannot expect a judicial rubber stamp on what constitutes a significant departure from past guidance on what activities create taxable nexus for corporate income tax purposes in a state.

In August of 2021, the Multistate Tax Commission (MTC) released a statement of information advising states to adjust how they interpret P.L. 86-272. P.L. 86-272 prohibits states from imposing corporate income tax nexus on out-of-state businesses solely on the basis of selling goods into that state. 

Though states have steadily worked to erode the protections afforded by this law over the years, the MTC’s guidance would effectively represent the final nail in the coffin. Examples of activities that would not be protected by P.L. 86-272 under the MTC’s guidance include:

  • Offering customer service through email or chat accessed from the business’s website

  • Offering remote repairs or automatic software updates

  • Enabling prospective hires to apply for open jobs through the website

  • Contracting with marketplace facilitators that store inventory in the state

  • Placing digital “cookies” on a customer’s computer 

  • Selling digital goods, such as streaming music

Taken together, these comprise a list of activities that nearly every business with a modern website performs in some capacity. 

California became the first state to implement this position in February 2022, though it did so through a TAM rather than going through the formal process for promulgating new regulations. It was soon challenged by the ACMA on both procedural (for changing the state’s approach to P.L. 86-272 through a TAM rather than a formal regulation) and legal (for imposing corporate income tax nexus in cases not permitted by P.L. 86-272) grounds.

Judge Schulman chose not to rule on the legal question, but ruled in favor of ACMA on the procedural question. Nevertheless, Judge Schulman effectively rejected the premise that the TAM was merely an acknowledgement of the existing application of P.L. 86-272, stating instead that the TAM represented an “invalid underground regulation.” 

While California can still appeal the procedural ruling, the legal question remains unsettled. It remains an important question, as New York has recently announced that it will soon finalize its regulation implementing the MTC guidance

Nevertheless, taxpayers can take heart that courts do not appear inclined to allow states to pass off a major regulatory change as a mere technical update.