California PL 86-272 Rules for Internet Businesses

Public Law 86-272 is a 1959 federal statute that limits states from imposing a net income tax on businesses whose activities are confined to soliciting orders for tangible personal property. For this protection to apply, orders must be sent outside the state for approval, and the goods must be shipped from an out-of-state location. This article examines how California interprets this law for contemporary business practices, particularly those conducted over the internet.

Core Protections of Public Law 86-272

The protection of Public Law 86-272 hinges on the definition of “solicitation of orders,” which includes conduct ancillary to the primary request for a purchase. The law’s protections are limited to the sale of tangible personal property, meaning physical goods. Sales of services, real estate, or intangible property like digital downloads are not covered.

Certain activities are considered part of soliciting orders and are therefore protected. Sales representatives can carry product samples and promotional materials for display without triggering tax liability. They are also permitted to use a personal vehicle for business travel and can be provided with lists of potential customers.

Actions that facilitate the communication of an order are also protected. A salesperson can pass along customer inquiries or complaints to their company’s home office without jeopardizing tax protection. As long as an employee’s functions are limited to encouraging a customer to place an order that will be approved and fulfilled elsewhere, the business remains protected.

Activities Exceeding Federal Protection

The safe harbor from Public Law 86-272 is narrow, and many business activities fall outside its protections, creating “nexus” and subjecting a business to state income tax. Maintaining a physical presence, such as an office, warehouse, or any other place of business within the state, exceeds protection. Owning or leasing real estate for business purposes is a clear indication of activities beyond mere solicitation.

Engaging in post-sale activities within the state also removes federal protection. This includes performing repairs, providing maintenance, installation services, or offering in-person customer support. These actions are separate from soliciting orders and establish a more significant connection to the state.

Financial transactions and inventory management within a state also disqualify a business from protection. Collecting payments or formally accepting customer orders within the state are unprotected activities. Similarly, holding inventory in a local warehouse, using a consignment arrangement, or storing products with a third-party logistics provider in the state for fulfillment goes beyond soliciting orders.

California’s Modern Interpretation and Internet Activities

California’s Franchise Tax Board (FTB) has provided specific guidance on how Public Law 86-272 applies to the digital age, through its Technical Advice Memorandum (TAM) 2022-01. The FTB’s position is that when a business interacts with a customer through its website or app, it is engaging in business activity within the customer’s state. This interpretation significantly narrows the safe harbor for online sellers.

A central focus of the FTB’s guidance is on post-sale support provided through a company’s website. Offering live chat or email support that assists California customers with using a product after it has been delivered is considered an unprotected activity. Similarly, providing remote repairs or upgrades by transmitting code to a customer’s device is not protected.

The FTB also scrutinizes the use of internet cookies. Those that gather customer data for purposes beyond soliciting an order can forfeit protection. For instance, placing cookies on a California customer’s computer to track data that will be used to develop new products is deemed an unprotected business activity.

Other online activities that California has identified as exceeding federal protection include soliciting applications for branded credit cards through the company website. Employing a remote worker in California who performs duties other than sales solicitation, such as business management or accounting, will also break the company’s protection.

In contrast, a website that only provides static information, such as a frequently asked questions (FAQ) page, may still fall within protected activities. While TAM 2022-01 was invalidated by a California court on procedural grounds in late 2023, the FTB’s underlying interpretation remains its active position.

Tax Implications of Establishing Nexus in California

Once a business’s activities in California exceed the protections of Public Law 86-272, it is considered to have established income tax nexus. The primary consequence is the requirement to file a California corporate income or franchise tax return. This obligation exists even if the company ultimately owes no tax.

California determines the amount of a company’s total income subject to its tax through apportionment. The state uses a single-sales factor formula, meaning the portion of a company’s income taxable by California is based on the percentage of its total sales made to customers within the state.

For businesses that were unaware of their filing obligation, the consequences can be substantial. The FTB can assess taxes for prior years in which the company had nexus. In addition to the back taxes owed, the state will impose penalties for failure to file and failure to pay, along with accrued interest on the entire outstanding balance.