A New York appellate court recently issued an important decision in a case challenging the state’s revised P.L. 86-272 regulation, affirming the lower court’s ruling that 20 N.Y.C.R.R. §1-2.10 is not facially preempted by P.L. 86-272 and cannot be applied before its promulgation date. The appellate court also disagreed with the plaintiff’s argument that Congress could not have intended P.L. 86-272 to address internet-based taxation activity because the statute predates the digital economy. 1
Preemption
In analyzing the preemption issue, the Appellate Division of the New York Supreme Court began with the basic statutory framework: New York generally imposes franchise tax on foreign corporations doing business in the state, but P.L. 86-272 limits that taxing authority. The law protects a seller of tangible personal property from a state’s net income tax if its only in-state activity is the solicitation of orders, with approval and fulfillment occurring from outside the state.
The court recognized that Congress enacted P.L. 86-272 to provide clarity2 and establish a minimum standard3 for when states cannot tax interstate sellers but noted that application of the statute has never been entirely mechanical. Over time, judicial interpretation has expanded the statute’s protection to cover activities that are entirely ancillary to solicitation or are only de minimis non-solicitation activities.4 Thus, the court concluded that New York’s regulation does not on its face conflict with federal law.
A critical aspect of the decision is that the court characterized the plaintiff’s challenge to the text of the regulation as a purely facial one. The court found that the only issue before it was “whether the regulation, as written, stands as an obstacle to the accomplishment and execution of Congress’s objectives in enacting P.L. 86-272.”5 In other words, applied questions — including whether a particular taxpayer’s actual internet activities fall inside or outside the statute’s immunity — were not before the court. That distinction materially shaped the outcome.
The court rejected the plaintiff’s argument that the regulation created a separate, geographically unlimited category of internet activity that exposed out-of-state businesses to tax without regard to whether the activity actually occurred in New York. It emphasized that the regulation must be read as a whole and that its text expressly and repeatedly limit its scope to activities “in New York State.”
Importantly, the appellate court did not adopt the trial court’s broader reliance on Wayfair or equate virtual contacts for sales tax nexus purposes with in-state business activity for P.L. 86-272 purposes. Instead, it accepted at face value the regulation’s premise that internet activity can occur both inside and outside a state, and it confined its review to whether the regulation’s text was legally defective.
The court acknowledged the practical concern underlying the plaintiff’s challenge: If a corporation selling into New York cannot isolate which of its internet-based activities occur in the state, the regulation could create exposure based on internet activity more generally — activity that might or might not have a sufficiently demonstrable connection to the state. But the court held that this concern goes to administration and application, not facial validity.
Retroactive Application and Technological Advances
The lower court granted the plaintiff’s motion for summary judgment on the issue of retroactivity, and the appellate court affirmed. The court agreed that the retroactive application of 20 N.Y.C.R.R. §1-2.10 to 2015 violated due process and limited its application to its promulgation date of December 2023. The appellate court affirmed that decision.
The appellate court also rejected the plaintiff’s argument that Congress could not have intended P.L. 86-272 to address internet activity because the statute predates the digital economy. According to the court, the federal law is framed in functional terms, requiring analysis of the nature and purpose of the business activity, not merely the medium through which it is conducted. On that basis, the court found that New York’s detailed examples of internet-based conduct actually further Congress’s original objective of clarity by giving taxpayers more concrete guidance on which online activities the state tax authorities view as protected solicitation, ancillary conduct, or unprotected business activity.
At the same time, the court was careful to stop short of endorsing the tax authorities’ line-drawing in every respect. It clarified that it was not deciding whether the regulation draws the correct line between protected internet solicitation and unprotected business activity, nor whether particular online functions are truly ancillary or de minimis in all cases.
BDO Insights
Because the plaintiff is a trade association, it was limited to making a facial challenge to the P.L. 86-272 regulations because it did not have facts that would allow an as-applied challenge.
The lower court ruled on two issues: (1) the validity of New York’s regulation on P.L. 86-272 and (2) New York’s ability to retroactively apply the final regulation to 2015. The appellate court affirmed the lower court, which means the P.L. 86-272 portion of 20 N.Y.C.R.R. §1-2.10 cannot be applied to years before its promulgation date of December 2023.
While the decision is a clear win for New York on the facial preemption issue, it also leaves open the possibility of future as-applied challenges by taxpayers whose specific facts may demonstrate that the state’s enforcement goes beyond the protections afforded by P.L. 86-272. At the same time, the ruling provides taxpayers with meaningful protection against the state’s attempt to apply its interpretation to prior tax years without fair notice.
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1 American Catalog Mailers Association v. Department of Taxation and Finance, No. CV-25-0865 (N.Y. App. Div. 2026).
2 Heublein, Inc. v South Carolina Tax Comm'n, 409 U.S. 275, 280, 93 S. Ct. 483, 34 L. Ed. 2d 472 (1972).
3 Matter of Disney Enters., Inc. v Tax Appeals Trib. of State of N.Y., 10 NY3d at 404.
4 Most notably under Wisconsin Dept. of Revenue v William Wrigley, Jr., Co., 505 U.S. 214, 232 (1992).
5 Original emphasis.