New York Appellate Court Upholds Income Tax Rule for Out-of-State Online Sellers

A New York appellate court has upheld a state regulation that expands corporate income tax obligations to out-of-state e-commerce businesses based on their online activities, a decision that could have significant implications for online sellers nationwide. The ruling affirms a lower court decision in a lawsuit brought by the American Catalog Mailers Association (ACMA), which argued that New York’s rule is preempted by a 1959 federal law. This decision marks a pivotal moment in the ongoing battle between states seeking to capture tax revenue from the digital economy and federal laws designed for a pre-internet era. For small and mid-sized companies selling online, the ruling is a significant warning that their digital presence in a state could trigger complex new tax filings, even without a single employee or warehouse there. The case centers on the interpretation of Public Law 86-272, a federal statute enacted by Congress in 1959. This law prohibits states from imposing a net income tax on out-of-state businesses whose only activity within that state is the “solicitation of orders” for tangible personal property. For decades, this law provided a clear shield for companies that sent salespeople into a state or mailed catalogs, as long as orders were approved and fulfilled from outside the state. However, the rise of e-commerce has blurred the lines of what constitutes “solicitation.” Following guidance issued by the Multistate Tax Commission (MTC) in 2021, New York’s Department of Taxation and Finance finalized regulations in December 2023 that narrowly interpret the protections of P.L. 86-272. Under New York’s rule, certain common internet-based activities are considered to go beyond mere solicitation, thereby creating an income tax nexus for the remote seller. The Wayfair Supreme Court decision in 2018 opened the floodgates for states to impose sales tax based on economic activity, and now we are seeing states like New York aggressively apply the same logic to income tax. This ruling serves as a clear signal that the traditional definition of physical presence is becoming irrelevant for income tax purposes as well. Many online businesses that were previously protected by P.L. 86-272 may now find themselves with unexpected filing requirements not just in New York, but in other states that follow its lead. According to the New York regulations, non-protected activities that can create income tax liability for an out-of-state business include providing post-sale assistance through an online chat feature, placing tracking cookies on a customer's device to gather data for non-advertising purposes, or even allowing New York residents to apply for non-sales positions through a website. These are standard practices for many modern e-commerce companies. The ACMA, a trade group representing remote sellers, filed suit in New York Supreme Court in April 2024, arguing that these regulations effectively nullify the federal protections of P.L. 86-272 and violate the Supremacy Clause of the U.S. Constitution. While the trial court sided with the state on the validity of the regulations, it did hand the ACMA a partial victory by striking down the state’s attempt to apply the rule retroactively to 2015. The court ruled that the regulations could only be applied to business activities taking place on or after December 27, 2023, the date the final rule was published. The recent appellate court decision upholds the entirety of that trial court ruling, solidifying the state’s position. The court found that the internet activities specified in the rule are not equivalent to simple solicitation and therefore are not protected by the federal law. The distinction between “solicitation” and “business activity” is now incredibly nuanced. Does having a live chat feature on your website mean you now have to file a New York corporate income tax return? According to this ruling, the answer is likely yes. This creates a significant compliance burden that requires careful analysis of a company's entire digital footprint. This is precisely the kind of complex, multi-state issue where our tax preparation and compliance services become critical. We help clients navigate these evolving rules to ensure they remain compliant without overpaying. Businesses facing this uncertainty should contact C&S Finance Group LLC at csfinancegroup.com to assess their specific exposure. While the ruling is a major victory for the New York Department of Taxation & Finance, legal experts suggest this is unlikely to be the final word on the matter. The decision could encourage other states that have adopted the MTC’s guidance to more aggressively enforce their own rules, potentially leading to a patchwork of different interpretations and further litigation across the country. The outcome reinforces a trend that began with the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc., which allowed states to require sales tax collection from remote sellers based on economic nexus rather than physical presence. Looking ahead, the ACMA may seek to appeal the decision to New York’s highest court, the Court of Appeals. Meanwhile, the U.S. House Judiciary Committee has previously proposed an amendment to P.L. 86-272 to clarify its application in the digital age, though legislative action remains uncertain. For now, out-of-state businesses with customers in New York must immediately review their online activities to determine if they have newly established an income tax filing obligation in the state.