California's Attempt To Modernize Taxation Laws Faces Setback

California attempted to narrow the scope of the federal preemption on state taxation under PL 86-272, but its efforts have taken a hit as the state’s guidance has been found void.

Nearly two years after California released Technical Advice Memorandum (TAM) 2022-01 and Franchise Tax Board (FTB) Publication 1050 – which provided updated guidance on the state’s application of Public Law 86-272 to internet activities – the California Superior Court for San Francisco County held that the guidance was void.

The intent behind PL 86-272 was to protect interstate commerce by limiting state taxing authority. The interpretation of such limitation has been the subject of much litigation over the last 65 years. In an effort to update the application of PL 86-272 for a 21^st-century economy, the Multistate Tax Commission (MTC) issued a revised “statement of information” in 2021, which added 11 new scenarios to its list of “unprotected activities” where a business operates a website with no other contact in the state.

California was the first state to issue guidance mirroring the revised MTC statement: In February 2022 California issued TAM No. 2022-01 and revised FTB Publication 1050.

The American Catalog Mailers Association (ACMA) took swift action, filing suit against the California FTB in August of the same year on the basis that the FTB-issued guidance was invalid based on the following counts:

• It contradicts the U.S. Constitution and PL 86-272.
• It fails to comply with the Administrative Procedure Act (APA) under California Government Code.
• It runs afoul of the California Code of Civil Procedure.

The ACMA initial summary judgement motion was based on the first count, which the court denied, finding that ACMA did not meet the burden of proof to find that the FTB guidance was facially invalid. In its decision, the court noted that the regulations included in the guidance were  subject to the APA, but it did not rule on this issue as the motion was not brought on this count.

The ACMA quickly filed a second motion for summary judgement based on the second count. And, as it mentioned it might in its earlier decision, the court granted the motion on Dec. 13, 2023, stating that both the TAM and FTB Publication were void as the included regulations were not in compliance with the procedural requirements outlined in the California APA.

The court’s decision appears to be a taxpayer victory, but only on an administrative front. The issue of how PL 86-272 applies to internet activities has yet to be resolved. Whether the FTB continues to fight this battle in the courtroom or start the formal regulatory process to adopt the TAM’s positions is yet to be seen. Regardless, it is likely not the last word on the topic from the state of California – or other states for that matter.

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