States have the right to tax corporations doing business within their jurisdictions, but, pursuant to a federal law enacted in 1959, are prohibited from taxing net income of a corporation where its in-state activities are limited to the solicitation of orders for tangible personal property that are accepted outside the state and fulfilled by delivery from outside the state. This federal law – known as Public Law (P.L.) 86-272 – allows companies to send sales representatives into a state without incurring state income tax liability.
The law has not been modified since its enactment, and some states have devised strategies to work around this federal preemption in age of the modern, internet-based economy. P.L. 86-272 remains in effect notwithstanding a 2018 U.S. Supreme Court decision holding that remote sellers must collect sales tax in the state where their products are delivered. That decision only addressed sales tax obligations, and P.L. 86-272 only preempts states from imposing an income tax on out-of-state sellers.
In 2015, New York amended its franchise tax law and began a project to update regulations. The state’s Department of Taxation & Finance (DT&F) clarified that foreign corporations are not exempt from franchise tax if they provide regular post-sale customer support via email or online chats. Under New York regulations, placing cookies on customers’ devices to collect data for business purposes may also negate the exemption (20 NYCRR 1.210(a)). Example 11 of the regulation clarifies that “cookies” used solely to retain items in a shopping cart or to store credit card information for future transactions do not constitute activity beyond mere solicitation – and therefore are not protected by P.L. 86-272.
In April 2024, the American Catalog Mailers Association, a trade group, challenged the validity of the regulation, arguing that federal preemption bars New York’s regulation and that its retroactive application to 2015 violates due process. On motions for summary judgment, the trial court held that the federal law did not preempt the DT&F regulation but denied summary judgment on the retroactivity issue. The New York State Appellate Division, Third Department, affirmed.
The court denied the plaintiff’s request for a declaration that federal law bars the regulation, stating that whether the DT&F can comply with Public Law 86-272’s in-state activity requirement depends on specific facts, not merely the regulation’s text. As such, the issue requires a factual hearing based on a particular taxpayer’s activities.
The opinion does not address whether the regulation violates the federal Internet Tax Freedom Act, which prohibits state taxes that discriminate against electronic commerce. The Internet Tax Freedom Act prevents taxes on electronic commerce from being treated differently than transactions placed by phone or via mail. For instance, when a buyer reaches out to a call center by telephone, that action falls under the protection of P.L. 86-272. By contrast, under New York regulations, an online chat may not receive the same protection.
The Appellate Division issued a unanimous decision. Under New York procedure, the taxpayer may seek permission to appeal to New York’s Court of Appeals or may seek to appeal based on federal preemption, which could be considered a constitutional issue that requires review by the Court of Appeals. The question of retroactive application remains pending at the trial court stage.
Because the DT&F regulation stems from a Multistate Tax Commission proposal, other states may adopt similar approaches to collecting revenue from out-of-state corporations.
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