New York court upholds internet activities regulations

On April 28, 2025, the New York Supreme Court in Albany County upheld the constitutionality of the internet activities provisions added by the New York State Department of Taxation and Finance to its corporation franchise tax regulations interpreting the scope of Public Law 86-272 (P.L. 86-272), finding they are not preempted by federal law.¹ However, the court invalidated the Department’s attempt to apply the regulations retroactively to tax years beginning in 2015, ruling that such retroactive enforcement prior to their December 2023 publication date violates due process protections.

Background

P.L. 86-272, enacted by Congress in 1959, prohibits states from imposing an income tax on out-of-state corporations if their in-state activities are limited to the mere solicitation of orders for the sale of tangible personal property, with the orders approved and fulfilled from outside the state.² In August 2021, the Multistate Tax Commission (MTC) issued a revised statement of information addressing the application of P.L. 86-272 in the context of the modern economy and internet-based transactions. The MTC’s updated guidance includes examples that effectively narrow the protection afforded by P.L. 86-272 as it relates to internet vendors.³

In December 2023, the Department promulgated comprehensive corporation franchise tax regulations, which it sought to apply retroactively to the state’s major tax reform legislation effective for tax years beginning in 2015.⁴ Aligned with the MTC’s position, the Department’s regulations specify that in order to qualify for protection under P.L. 86-272, “the activities in New York State of employees or representatives, or activities engaged in via the Internet, must be limited to the solicitation of orders for the sale of tangible personal property.”⁵ Protected solicitation activities do not include activities that the corporation would have reason to engage in apart from the solicitation of orders, but chooses to “engage in via the Internet,” including interacting with customers or potential customers through the corporation’s website or computer application. However, the mere presentation of static text or images on a website does not, by itself, create taxability. The New York regulations adopt the MTC’s examples and mirror its conclusions regarding which activities are protected under P.L. 86-272.

In April 2024, the American Catalog Mailers Association (ACMA), an organization of merchants that sell items to customers through catalogs or over the internet,⁶ filed suit in New York Supreme Court against the Department seeking a declaration that the internet activities regulations are invalid as conflicting with and preempted by P.L. 86-272. Specifically, ACMA argued that the internet activities regulations violate the Supremacy Clause of the U.S. Constitution by improperly expanding New York’s authority to impose income taxes on sellers lacking business activities in New York, contrary to federal limitations under P.L. 86-272. ACMA further contended that the Department’s decision to retroactively apply the challenged regulations, promulgated in December 2023, to tax years dating back to 2015, violates its members’ due process rights. As argued by ACMA, a business that relied on the exemptions provided in P.L. 86-272 in organizing its business operations could be stripped of the statute’s protections for nearly nine years without notice. Following ACMA’s motion for summary judgment, the Department filed a cross-motion for summary judgment seeking dismissal of the complaint.

Applicable constitutional and federal provisions

The New York Supreme Court reviewed the relevant constitutional provisions, federal preemption standards, and P.L. 86-272 before ruling on the validity of the internet activities regulations and the constitutionality of their retroactive application. First, the court explained that the U.S. Constitution prohibits states from depriving any person of property without due process of law. Also, the court explained that the Due Process Clause requires a definite link or minimum connection between a state and the person, property, or transaction that it seeks to tax. New York’s due process protections mirror those under the federal Constitution. The court also highlighted that the Commerce Clause, which grants Congress authority over interstate commerce, has long been interpreted to bar states from discriminating against or unduly burdening the interstate flow of goods.

Federal preemption of state laws is based on the U.S. Constitution’s Supremacy Clause. The court explained that the provisions of P.L. 86-272 only preempt state law to the extent there is a direct conflict between federal and state law. Under P.L. 86-272, the federal government established minimum standards that limit states’ ability to impose state income taxes on out-of-state businesses engaged solely in the solicitation of interstate sales.

Internet activities regulations are valid

In granting the Department’s cross-motion for summary judgment on the validity of the internet activities regulations, the court held that such regulations are not preempted by P.L. 86-272, and do not violate the Supremacy Clause of the U.S. Constitution. The court emphasized that the contested regulations do not broadly tax any internet sales, but rather delineate specific online activities that create a substantial nexus between remote sellers and New York. Thus, the regulations do not subject remote sellers that engage in more than solicitation within the state to duplicative or unfair taxation. The court further found that P.L. 86-272 does not bar New York from adopting the internet activities regulations, which were amended in response to the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc.⁷ In that case, the Court held that substantial nexus does not require a physical presence but may be met by economic and virtual contacts. Because P.L. 86-272 does not prohibit a state from identifying and regulating which internet activities constitute more than solicitation of orders, the challenged regulations do not conflict with the exemptions in P.L. 86-272. Finally, the court held that the regulations do not impermissibly expand the exemptions provided by P.L. 86-272, as any internet activity considered ancillary to solicitation remains protected under P.L. 86-272.

No retroactive application

The court granted ACMA’s motion for summary judgment with respect to the retroactive application of the internet activities regulations, holding that such application violates the Due Process Clauses of both the U.S. and New York Constitutions. In evaluating the constitutionality of retroactive tax measures, courts consider: (i) whether the taxpayers are forewarned of a change in the legislation and the reasonableness of relying on old law; (ii) the length of the retroactive period; and (iii) the public purpose for retroactive application.⁸ The court noted that, in April 2022, the Department published draft regulations that included the internet activities regulations, which explicitly provided that “these draft regulations are not yet final and should not be relied upon.” The internet activities regulations, in their final form, were published in December 2023 and made retroactive to January 2015. These final regulations provided, for the first time, that they would be applied retroactively. In its ruling, the court found that ACMA and its members had no forewarning of the retroactive application of the regulations, which exposed them to unexpected New York tax liabilities for years during which their activities were thought to be exempt from taxation. Also, the court determined that the nearly nine-year length of the retroactive period was excessive. Notably, the court pointed out that the Department failed to demonstrate a valid purpose for the retroactive application of the regulations. As a result, the court declared that the retroactive application of the internet activities regulations, as applied to any time period before the December 2023 publication date, violated ACMA’s due process of law.

Commentary

This decision breaks ground in its consideration of the validity of a state’s regulations that implement the MTC’s revised statement interpreting P.L. 86-272 as it applies to the modern economy and internet transactions. The MTC’s revised statement has been controversial because it tends to substantially narrow P.L. 86-272 protection for merchants conducting business over the internet. In response, several other states have taken action to adopt the MTC’s revised statement in some form.⁹ California was the first state to address the revised statement by issuing administrative guidance in 2022. ACMA filed litigation in California and successfully argued that the guidance was void as “underground” regulations because the Franchise Tax Board failed to comply with the requirements of the California Administrative Procedure Act (APA).¹⁰ The facts in the instant New York litigation differ from the California case because New York adopted the MTC’s guidance in formally promulgated regulations. The New York Supreme Court’s approval of the internet activities regulations may encourage other states to promulgate regulations adopting the MTC’s revised statement on P.L. 86-272.

The court’s ruling striking down the retroactive application of the regulations prior to their December 2023 publication is also noteworthy. As discussed above, the Department sought to retroactively apply the regulations to nearly nine years in the past, and the original intent of the regulations in question was to address New York corporate franchise tax reforms, not the adoption of interpretive changes to P.L. 86-272. This decision may serve as persuasive authority for future challenges to the retroactive application of other provisions in the extensively revised New York corporation franchise regulations.

This is not the first time that this court has considered the retroactive application of the New York tax reform regulations. In Paychex, Inc. v. Department of Taxation and Finance, the court held that applying the regulations back to 2015 did not violate Paychex’s right to due process.¹¹ Paychex involved the retroactive application of apportionment regulations concerning the exclusion of reimbursements received for professional employer organization (PEO) services. Although these decisions may seem to conflict at first glance, the facts in the two cases do differ somewhat. In Paychex, the court noted that the taxpayer was forewarned of the amendment of the regulations as early as 2017.¹² In contrast, ACMA did not have notice of the regulatory changes that would impact its members until April 2022. It is very likely that both holdings in the instant case will be appealed, and future decisions will be issued by higher courts that could ultimately set forth a more consistent standard regarding the extent to which the New York regulations may have retroactive reach.

P.L. 86-272, which has not been amended by the federal government since its original enactment in 1959, may be subject to amendment this year. The House Judiciary Committee has included language in its budget reconciliation proposal that would expand the protection provided by P.L. 86-272.¹³ Specifically, the proposed legislation would redefine “solicitation of orders” to encompass business activities that serve an independently valuable business function apart from the solicitation of orders. The fact that a state court has approved a state’s adoption of the MTC’s revised statement may increase the likelihood of the enactment of federal legislation to broaden the protection provided by P.L. 86-272. Taxpayers relying on the protections offered by P.L. 86-272, especially those with limited physical presence in certain states, would be well advised to monitor the proposed federal legislation that would amend P.L. 86-272 as well as further state developments that impact the interpretation of current P.L. 86-272.

1 American Catalog Mailers Association v. Department of Taxation and Finance, New York Supreme Court, Albany County, No. 903320-24, April 28, 2025.
2 15 U.S.C. §§ 381-384.
3 Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272, Multistate Tax Commission, revised Aug. 4, 2021. Generally, when a business interacts with a customer via the business’s website or app, it is engaged in “business activity” within the customer’s state that exceeds P.L. 86-272 protection. In contrast, if the website merely presents static text or photos, there is no engagement or facilitation within the customer’s state.
4 For a discussion of the regulations, see GT SALT Alert: “New York finalizes corporation franchise tax reform regulations.”
5 FN.Y. COMP. CODES R. & REGS. tit. 20, § 1-2.10. Emphasis added by court.
6 The ACMA members currently have no property or payroll in New York and conduct no business activities within the physical boundaries of the state.
7 585 U.S. 162 (2018).
8 AmerisourceBergen Drug Corp. v. New York State Department of Public Health, 227 A.D.3d 1286 (3rd Dept. 2024), appeal dismissed, 42 N.Y.3d 1023 (2024).
9 The Massachusetts Department of Revenue currently is considering the promulgation of regulations that adopt the MTC’s revised statement. New Jersey previously released administrative guidance following the MTC’s revised statement and has proposed rules that would be consistent with the MTC’s statement.
10 American Catalog Mailers Association v. Franchise Tax Board, California Superior Court, San Francisco County, No. CGC-22-601363, Dec. 13, 2023. For further information, see GT SALT Alert: ”California court invalidates FTB’s P.L. 86-272 guidance.”
11 New York Supreme Court, Albany County, No. 904047-24, Dec. 18, 2024. For a discussion of this decision, see GT SALT Summary: “New York court rejects challenge of retroactive tax regulations.”
12 In Paychex, the Department had issued multiple proposed drafts of the regulations and Paychex had submitted written comments concerning the draft regulations. Also, Paychex and the Department negotiated a settlement for the tax periods of June 1, 2014, through May 31, 2019. As explained by the court, the closing agreement encompassed a large portion of the retroactive period.
13 H.R. 427, introduced Jan. 15, 2025, and added to House Judiciary Committee’s budget reconciliation proposal.