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 Multistate Tax Trends Q&A series for Checkpoint News delivers quick, actionable insights from some of the practitioners our team follows most closely.
This installment features Shail Shah, a BDO Principal who focuses his practice on complex California tax planning and representation. His experience includes working as an attorney at the California Franchise Tax Board (FTB), and he draws on this experience in an attempt to turn audits into potential refund opportunities. Shail is an Executive Committee member of the Tax Section for the California Lawyers Association (CLA). He also assisted the Catalyst team in significant post-Wayfair topic development.
Here Shail and Catalyst’s Rebecca Newton-Clarke discuss emerging issues in SALT practice, including California’s retroactive apportionment law, alternative apportionment strategies, the FTB’s underground P.L. 86-272 stance, state IRC conformity gaps, and how AI is reshaping state tax compliance.
How does your background as tax counsel with the California Franchise Tax Board shape your approach to client advisory work and tax controversies?
California law is very complex, and at times businesses and regulators may have different interpretations of the law. My time on the California Franchise Tax Board (FTB) gave me a foundational understanding of how the agency approaches issues, and what the intention behind any given set of guidance might be.
That experience informs how I approach controversy work. Rather than defaulting to an adversarial posture, I look for opportunities to engage the FTB in a thoughtful, substantive discussion with a resolution in mind. That approach has often produced outcomes where the FTB and the taxpayer both achieved a result they found acceptable. That kind of resolution — one that works for both sides — is more efficient and more durable than protracted litigation.
Income tax apportionment has always been contentious, and California is at the center of a great deal of recent litigation. You’ve been at the forefront of challenging a 2024 California law that redefines “receipts” for apportionment purposes and applies that redefinition retroactively. Could you walk us through the constitutional concerns?
Generally, states have broad discretion to enact tax laws that apply prospectively to taxpayers as long as those laws do not violate the U.S. or state constitutions. Navigating constitutional concerns becomes more complicated when laws are applied retroactively.
California’s SB 167, which enacted Revenue and Taxation Code § 25128.9 [Cal. Rev. & Tax. Cd. § 25128.9], is a perfect example. The legislation came on the heels of a California Office of Tax Appeals (OTA) decision that reached the opposite conclusion from what the bill proposed. The central question in the OTA case was whether all gross receipts — with limited enumerated exceptions — must be included in the sales factor, or whether only a net amount is included. The OTA held that all gross receipts are included, which is how most taxpayers historically interpreted the statute. SB 167 reversed that, providing that only net receipts are included and characterizing the legislation as a clarification of existing law – a position that an independent tax tribunal had just explicitly rejected.
The constitutional concerns arise under the Due Process Clause. When a state retroactively applies a change in law, taxpayers are placed in an untenable position: may have filed and paid taxes to California in accordance with a prevailing interpretation of the gross receipts rules, only to be told that assessment was always wrong and that they are now subject to an assessment and penalties. The U.S. Supreme Court’s decision in Carlton v. U.S., 512 U.S. 26 (1994) establishes the framework for evaluating retroactive tax legislation, and without a clear retroactivity limitation, laws structured like SB 167 face serious constitutional exposure.
A California trial court ruled in March that a large farming operation with significant sales into California but a small physical footprint in the state could use a three-factor sales, property, and payroll factor to apportion its income to California. The court determined that the sales factor alone did not accurately reflect the company’s substantial out-of-state payroll, property, and other income-generating activities, and did not account for the physical realities or constraints of its farming operations. How do you see this ruling affecting California apportionment for multistate agricultural businesses and potentially analogous business operations?
Apportionment disputes always produce winners and losers depending on a company’s particular facts, but it is difficult to dispute that a company’s business activity in any jurisdiction can be fairly measured just by sales into that state, without any regard to where its property and payroll are located.
That said, it’s important to be precise about what the court actually held. The ruling does not establish that every taxpayer is entitled to three factor apportionment. Rather, it stands for the more targeted proposition that taxpayers whose revenue includes a significant amount of labor and physical assets should be able to seek an alternative apportionment formula, provided they can demonstrate through quantifiable evidence that those people and property are integral to the company’s overall business activity.
For agricultural businesses and similarly capital- and labor-intensive operations, this decision opens a meaningful avenue for challenging apportionment outcomes that would otherwise produce a distorted result.
Last fall, Florida filed an original jurisdiction complaint at the Supreme Court challenging California’s exclusion of occasional sales from the sales factor. I’m curious how you assess the merits of Florida’s position as a California practitioner.
There are two distinct issues here. First, whether Florida even has standing to bring this claim against California in an original jurisdictional proceeding. The second is whether California’s substantial and occasional sale rule is itself unconstitutional.
The substantial and occasional sales rule, when compounded with single sales factor apportionment, can produce results that rise to the level of unconstitutional distortion. This is precisely why a multi-factor approach has practical merit: if a sales factor exclusionary rule is offset by property and payroll factors, its impact on a taxpayer’s overall apportionment percentage is proportionally reduced. In a single sales factor regime, that same exclusionary rule can produce a disproportionate concentration of income in California with no counterbalancing mechanism.
Hopefully this lawsuit sparks a broader conversation among states about how to properly build relief valves into their apportionment regimes, particularly when multiple compounding factors can drive outsized allocation of income to a single state.
I’m also interested in any insights you might have on how the FTB is approaching P.L. 86-272 following the American Catalog Mailers Association v. Franchise Tax Board case, in which a California court voided published guidance as an “underground regulation.” That guidance essentially announced that the FTB was following the Multistate Tax Commission in asserting that a variety of internet activities breach the solicitation protections of P.L. 86-272. Quite a few state tax agencies are reportedly following the MTC’s approach without formal rule adoption — do you have the sense that the FTB is one of them?
FTB seems to still apply the MTC approach, notwithstanding the court’s ruling that its published guidance constituted an underground regulation. That interpretation is evident throughout the controversy process and, in my view, reflects the FTB’s de facto litigating position — even in the absence of formally adopted guidance.
State conformity to the Internal Revenue Code has become an increasingly fraught issue following last year’s federal changes. From a multistate planning perspective, what are the most significant conformity gaps you’re advising clients to keep an eye on?
The most significant area of focus right now is the varying state conformity to provisions outlined in the One Big Beautiful Bill Act. The mix of rolling conformity, fixed conformity, and selective conformity states creates a complex and sometimes unpredictable landscape, particularly around IRC sections 163(j) and 174, where state treatment diverges.
That complexity, however, also creates planning opportunities. For taxpayers willing to analyze their state-by-state exposure carefully, the conformity patchwork can be navigated strategically — and in some cases, used to their advantage.
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?
The answer that may seem predictable — but is nonetheless accurate — is artificial intelligence. The questions that AI raises for state tax are significant and largely unresolved. For example, many states impose sales tax on certain services. The question becomes whether those same services are taxable when performed by an AI agent. And the analysis grows more complex from there: what about scenarios where an AI agent performs services for another AI agent?
These changes are happening much faster than most state tax regimes can accommodate, which means most states will likely respond reactively. For businesses, the imperative is to get ahead of it now. That starts with a simple operational question: can existing systems even capture AI-driven activity at the transaction level? If not, companies need to begin building that infrastructure before these services are broadly subject to tax.
Aside from the impacts of AI, many tax professionals expect states to continue filling the void left by reduced IRS capacity by increasingly auditing federal tax issues at the state level. Companies need to be prepared to take a two-step approach when a state auditor pursues a federal issue – (1) educate a state auditor on a federal tax concept and (2) rigorously defend the audit.
Related Resources from Checkpoint News, CoCounsel Tax, and Checkpoint
- Checkpoint News subscribers:
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- Multistate Tax Trends: Q&A With SALT Expert Niki Ford on Nexus, Marketplaces, AI, and the Future, by Catalyst’s Rebecca Newton-Clarke
- Multistate Survey: Income Tax Immunity Erodes as States Follow MTC Statement on P.L. 86-272, by Catalyst’s Tom Cornett and Rebecca Newton-Clarke
- CoCounsel Tax Templates:
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- Indicate State’s 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
- Indicate State’s Approach to Economic Nexus for Corporate Net Income Tax Purposes
- To access CoCounsel Tax templates, log in to CoCounsel and click the CoCounsel Templates navigation link in the left panel.
- Checkpoint subscribers can dive deeper into apportionment, P.L. 86-272, and OBBBA conformity, and electronically delivered goods and services, 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 # 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 # 1005, Sales Factor, providing in-depth state-by-state analysis of taxpayers subject to allocation and apportionment, the types of income allocated or apportioned, and each state’s standard apportionment formula, as well as industry-specific rules and alternative apportionment provisions
- 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 # 1003, IRC Conformity, providing in-depth state-by-state analysis of each state’s conformity to the IRC, federal tax concepts, and major federal legislation from TCJA through the CARES Act and OBBBA, including conformity dates, the effect of federal tax elections, and agency guidance
- Catalyst Topic #305, Limitation on Deduction of Business Interest Under IRC 163(j), providing in-depth state-by-state analysis of state conformity to the federal limitation on the deduction of business interest under IRC 163(j), breaking down variations in conformity, such as granular analysis of the state’s approach to changes enacted by TCJA, the CARES Act, and OBBBA
- Catalyst Topic # 403, Bonus Depreciation and Expensing, providing in-depth state-by-state analysis of each state’s conformity to bonus depreciation under IRC 168(k) and 168(n), and expensing under IRC 179, as affected by major federal legislation from TCJA through the CARES Act and OBBBA
- 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
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