Multistate tax practice is always evolving. The Catalyst state team stays on top of trends, frequently consulting with SALT practitioners on the front lines and incorporating their insights, along with our in-depth analysis, into Checkpoint Catalyst topics that integrate into CoCounsel Tax. This new Multistate Tax Trends Q&A series for Checkpoint News delivers quick, actionable insights from some of these practitioners.
The first installment features Niki Ford, a partner with Baker McKenzie who represents multinational and domestic corporations, LLCs, partnerships, and individuals in income tax and sales tax controversies and planning. As a former Catalyst editor, Niki enhanced many Catalyst topics.
Here Niki and Catalyst’s Rebecca Newton-Clarke discuss emerging issues in SALT practice, including nexus, P.L. 86-272, marketplaces, deference, and more.
States like California, Massachusetts, New York, and New Jersey have adopted portions of the MTC’s 2021 revised statement on internet activities. Our multistate survey confirmed that some tax agencies are following the MTC’s approach without official rule adoption. From your perspective as a practitioner advising clients, what are the two or three most common internet activities that businesses don’t realize states might consider to breach P.L. 86-272 immunity?
While I continue to have concerns about the MTC’s revised statement and whether it comports with the statutory language of P.L. 86-272, I agree that businesses should be aware that states are continuing to follow this position and protect themselves to the extent possible. From an awareness perspective, I would say that the internet activities that do not relate to selling are those that cause the most surprise to clients evaluating their P.L. 86-272 position.
For example, collecting job applications or providing customer support chatbots on a company’s website are activities that many businesses don’t think about being a potential break of P.L. 86-272.
I’m also careful to let clients know that even if their activities aren’t protected under P.L. 86-272, if those activities don’t independently create nexus in the state (and they don’t otherwise have nexus), there’s no tax obligation. While states continue to blur the two, nexus and P.L. 86-272 are two separate concepts, and nexus must always be satisfied as a prerequisite to the imposition of any state or local tax.
AI is transforming the workplace, and state taxes are shifting quickly. Last year Maryland, Texas, and Washington (state) extended their sales taxes to various automated services, and many other jurisdictions are considering sales tax expansion or even pondering or enacting new gross receipts or excise taxes. How are you advising clients on these issues?
This is one of the biggest areas of concern for many of our clients, particularly those who use technology to deliver services that were historically not subject to sales tax. Service providers who never really had to think about sales tax are now finding themselves in a place where sales tax can become very material simply because they’ve modernized their services to be delivered using technology or automation.
At a high level, we are advising clients to think of sales tax at this time as an ever-evolving area, because what is nontaxable this month may very well be taxable 6 months from now. At an offering-specific level, we are advising clients to take a close look at things like their customer terms and statements of work to determine whether each offering should be characterized as the sale of software or the sale of a nontaxable service.
Are there any major but lesser-known sales tax risks for marketplace facilitators?
There are a couple that come to mind. The first relates to the tax base. Most marketplace facilitators recognize that state marketplace facilitator laws shifted the tax remittance burden from the direct seller to the marketplace. However, facilitators also need to look at the statutory tax base language to determine whether their own fees or commissions earned on the transaction are included in that tax base. We’ve seen states — most notably Texas — assert that a marketplace facilitator’s commissions are separately subject to sales tax as fees from taxable data processing services.
The second is the potential retroactive application of a state’s marketplace facilitator requirements to periods before the law came into effect. We’ve seen a couple court decisions, the Amazon case in South Carolina and the StubHub case in Wisconsin, in which marketplaces were held liable for sales taxes before the marketplace law came into effect in those states, on the grounds that the marketplaces met the definition of a retailer or a person engaged in the business of selling even before the adoption of the state’s marketplace facilitator law.
How should businesses involved in cryptocurrency transactions — whether as exchanges, wallet providers, or merchants accepting crypto — think about nexus for both income tax and sales tax purposes, especially given the difficulty of sourcing these transactions?
Sourcing really is the key here. While most states haven’t directly addressed how cryptocurrency income or gains should be sourced, looking to the states general sourcing rules—in particular, whether those sourcing rules generally depend on the location where the taxpayer is performing its service or the location of the customer—can give the business a reasonable starting point.
Businesses, particularly those involved in an intermediate step in the cryptocurrency creation or sale process, should also be careful to consider whether the state has any guidance on look-through or “customer’s customer” sourcing. We’ve seen states become increasingly aggressive on this point in an attempt to source some piece of a transaction to that state’s market.
In your experience, has the changed deference environment affected how state tax agencies approach settlement negotiations in tax controversies?
Yes, primarily because including a deference argument in a petition inherently strengthens the taxpayer’s position. Reminding the agency that a reviewing court or tribunal is not required to defer to that agency’s position gives the taxpayer a leg up and they can come at settlement negotiations from a stronger position. The key is framing it in a way that isn’t overly academic and instead taking a practical approach that the auditors can work with.
Looking ahead three years, what do you think will be the most significant developments in state tax, and how should businesses and their advisors prepare?
I think we are only beginning to see the way that AI will be addressed by state taxing agencies, both from a sales tax and an income tax perspective. This brings to mind the way that states reacted to the concept of software as a service, with dividing lines being drawn between states that tax SaaS as tangible personal property or an otherwise taxable service and other states continuing to treat SaaS as a nontaxable service — and there are still some states without clear guidance on this front.
Generative and agentic AI have the potential to be even more diverse and varied than software as a service products, and I think we will see states continuing to struggle with how to classify these products for both sales and income tax purposes, particularly when some AI products will look more like traditional software (e.g., an automated technology product) and others will look more like a service provider (e.g., a chatbot that offers business consulting and advice).
Related Resources from Checkpoint News, CoCounsel Tax, and Checkpoint
- Checkpoint News subscribers:
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- Retroactive Online Marketplace Liability Emerges as Major Sales Tax Risk, by Catalyst’s Rob Galloway
- Multistate Survey: Income Tax Immunity Erodes as States Follow MTC Statement on P.L. 86-272, by Catalyst’s Rebecca Newton-Clarke and Tom Cornett
- CoCounsel Tax Templates:
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- Evaluate Sales Tax Nexus Risk of Remote Employee in State
- Indicate Sales Tax Economic Nexus Threshold and Composition
- Indicate State’s Approach to Economic Nexus for Corporate Net Income Tax Purposes
- Indicate Approach to P.L. 86-272 and Internet Activities
- Determine Corporate Income Tax Sourcing Rules for Receipts from Digital and Electronically Delivered Goods and Services
- Checkpoint subscribers can dive deeper into nexus, electronically delivered goods and services, sourcing, and deference, with:
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- Nexus Assistant Charts: covering nuances of economic nexus, physical presence nexus, P.L. 86-272, and threshold computation
- Catalyst Topic # 1002: Corporate Tax Nexus, providing in-depth state-by-state analysis of corporate income tax economic nexus and P.L. 86-272 policies, as well as background context and insights
- Catalyst Topic # 1050: Sales and Use Tax Nexus, providing in-depth state-by-state analysis of remote seller, marketplace, and threshold computation policies, as well as background context and insights
- Catalyst Topic # 1051: Sales and Use Tax: Electronically Delivered Goods and Services, providing in-depth state-by-state analysis of electronically delivered goods and services, including SaaS and AI offerings, as well as bundled transactions, sourcing, threshold computation, and marketplace intermediary platforms such as online travel companies, meal-delivery platforms, and more
- Catalyst Topic # 1010: Corporate Tax: Electronically Delivered Goods and Services, providing in-depth state-by-state analysis of nexus and sourcing issues related to electronically delivered goods and services, including cryptoassets
- Catalyst Topic # 1007, Sales Factor, providing in-depth state-by-state analysis of the sales factor for corporate income tax apportionment, including rules for sourcing receipts to a specific state jurisdiction
- Catalyst Topic# 1001, State Taxation: Basic Principles, Federal and Other Limits on State Taxation—Subtopic 1001: 1009, Judicial Deference to Administrative Agencies’ Interpretations of Law
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