Courts continue to shape the boundaries of state corporate income taxation, particularly in disputes involving P.L. 86-272 – which restricts states’ authority to impose income tax on certain interstate sellers – receipts sourcing, and the classification of business income.
This blog post is based on a panel discussion held at the 2026 COST Annual Meeting in San Antonio examining state income tax decisions and their potential effect on corporate filing positions and future tax controversies.
Courts Revisit the Scope of P.L. 86-272
In a recent decision, the Massachusetts Appellate Tax Board (ATB), found that the state’s “Finnigan” apportionment rule violated the Supremacy Clause and P.L. 86-272. Specifically, the decision turned on two issues. First, whether the state could impose a tax on other combined group members that was related to the activities of a P.L. 86-272-protected entity. Second, whether P.L. 86-272 applies to each taxpayer in the group, or to the activities of the entire combined group.
On the first question, the ATB held that the “income” earned by a protected person is exempt from tax under the text of P.L. 86-272, regardless of whom the tax is imposed on. On the second, the ATB looked at the meaning of “person” in P.L. 86-272, and found that Congress intended the term to mean specific persons, not a unitary or combined group. Thus, even if some group members did not meet the criteria of P.L. 86-272, the income of those that did was exempt from taxation in the state.
In State Tax Assessor v. Fifth Generation, Inc., the Maine Supreme Judicial Court examined a state-mandated liquor distribution arrangement. Maine required an out-of-state supplier to hold products in a bailment warehouse and retain title until the state bureau purchased them. The court concluded that these activities established nexus and were not ancillary to the solicitation of orders. It therefore denied P.L. 86-272 protection and sustained the penalties imposed. The court noted that the state had a valid interest in regulating sales of liquor in the state, and the regulatory requirements were not established solely to defeat P.L. 86-272 protection.
In American Catalog Mailers Association v. Department of Taxation and Finance, a New York court upheld a regulation permitting the state to consider internet activities, including cookies and digital customer support, when evaluating P.L. 86-272 protection. Although the court upheld the regulation against a facial challenge, it left open questions about how the regulation would apply to particular taxpayers and online functions.
Documentation in Refund Claims
In Jones Apparel Group/Nine West Holdings v. Harris, the Ohio Supreme Court rejected the tax commissioner’s position that the destination of merchandise had to be established exclusively through records available at the time of sale. The court concluded that subsequently obtained evidence of ultimate receipt could be considered. The taxpayer nevertheless failed to secure a refund because it could not adequately quantify the merchandise shipped outside Ohio during the relevant tax years. General testimony and a sample drawn from a period outside the refund claim were insufficient to substantiate the amount. The case illustrates that a taxpayer may establish the correct sourcing methodology but still lose a refund claim if transaction-level records do not support the requested adjustment.
Irregular Disposition of Business Asset Generated Non-Business Income
In Hudson v. U.S. Beef Corp., the Arkansas Supreme Court held that income from the sale of restaurant franchises was nonbusiness income under the state law then in effect. Although the taxpayer regularly acquired and managed franchise assets, it had not previously sold a franchise. The disposition was therefore not an integral part of its regular business under the applicable statutory test, and the income was allocable to the taxpayer’s state of domicile. The decision highlights the relevance of the governing statutory language, the frequency of comparable transactions, and the role that acquisition, management and disposition play in the regular business.
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