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March 1992

U.S. Supreme Court reviews state and local taxation issues.

by O'Connell, Daniel

    Abstract- The US Supreme Court's future decisions involving three cases on real property taxes, sales and use taxes, and corporate income taxes will have major consequences on taxpayers and government agencies, and legislation on the sourcing of local and state revenue. The Nordlinger case on real property taxes involves a dispute of California legislation on real estate taxation as contained in the 1978 Proposition 13 referendum. The Quill Corp sales and use taxes case challenges a previous Supreme Court decision regarding a 'bright line' differentiation between sellers of mail order and other businesses based out-of-state in use taxes collection. The corporate income taxes concerning William Wrigley Jr Co disputes the extent of protection of interstate businesses as stated in Public Law 86-272. The three tax cases are expected to be settled by June 30, 1992.

The U.S. Supreme Court has agreed to bear three cases on fundamental concepts of state and local taxation:

* Real property/taxes--the Nordlinger case;

* Sales and use taxes--the Quill case; and

* Corporate income taxes--the Wrigley case.


The Nordlinger case involves the system of real estate taxation enacted by the voters of California in the Proposition 13 referendum in 1978. Under Proposition 13, which is a part of the State of California constitution, real estate taxes are limited to 1% of the lesser of fair market value or the assessed value of the property on March 1, 1975.

An annual inflation adjustment of no more than 2% is allowed. If there is a change of ownership, the property is reappraised at its fair market value, and the 1% tax rate is imposed on that value.

Strangers are Welcome

This system of taxation is sometimes referred to as the "welcome stranger" doctrine. In Allegheny Pittsburgh Coal Co. v. County Commissioner of Webster County, 488 U.S. 336 (1989), the Supreme Court ruled that a system of assessments based on the most recent purchase prices violated the equal protection clause of the U.S. Constitution. The result of the county assessor's system was assessments of recently sold properties from eigbt to 35 times higber tban those of comparable neighboring properties. The county assessor's practice was to assess property at 50% of purchase price. The court held that such a general adjustment was not constitutionally improper when used as a transitional substitute for the reappraisal of individual properties. To satisfy the equal protection clause, in the court's words, there should be: "Seasonable attainment of a rough equality in tax treatment of similarly situated property owners."

Allegheny-Pittsburgh involved the practices of a county assessor. In a footnote referring to Proposition 13, the court stated: "We need not and do not decide today whether the Webster County assessment method would stand on a different footing if it were the law of a state, generally applied, instead of the aberrational enforcement policy it appears to be." The Nordlinger case directly addresses this issue, since it involves a new homeowner paying substantially more tax than her neighbors who are long-term residents, because of an explicit provision in the California constitution.

The Nordlinger case could have enormous impact throughout the country on those states that do not have an effective system of periodic reappraisal to current market values. In Allegheny-Pittsburgh, the Supreme Court hinted that only a system of real estate taxation that included relatively frequent reassessment of all property could satisfy the equal protection clause. Many jurisdictions do not satisfy this standard.


North Dakota v. Quill Corporation is a direct challenge to precedent established by the Supreme Court in National Bellas Hess Inc. v. 1Illinois Department of Revenue, 386 US 753 (1967). In Bellas Hess, the Supreme Court held that a Missouri corporation that solicited sales in Illinois by mail order catalogs and shipped its goods by common carrier had no obligation to collect the use tax imposed on its customers by Illinois. This "bright line" distinction between mail order sellers and other out-of-state businesses with more substantial connections, including physical presence in a state, has become the operating principle governing the collection of use taxes. The Supreme Court also emphasized the substantial administrative burden of collecting and remitting use taxes to numerous jurisdictions.

The North Dakota Supreme Court's ' decision pointed out that the mail order: industry has grown phenomenally since 1967, when total mail order sales were i only $2.4 billion. Mail order sales for . 1989 had grown to $183.3 billion and represented approximately 15% of total i sales. State taxing authorities have become increasingly concerned about the loss of revenue from uncollected use taxes. North Dakota and many other states have amended the definition of retailers required to collect sales and use taxes to include mail order sellers who systematically solicit within the state. The North Dakota definition of systematic solicitation is three or more separate transmittances of advertisements during a 12-month period.

Quill is a Delaware corporation with offices and warehouse in Illinois, Calffornia, and Georgia Quill sells office supplies, stationery, and equipment, offering over 9,500 different products ranging from paper clips to computers, with annual sales in excess of $200 million.

Quill solicits business through its numerous catalogs and flyers, advertisements in nationally distributed "card packs," advertisements in national periodicals and trade journals, and telephone solicitation of current customers. Of the more than 200,000 orders that Quill receives monthly, approximately one-half are by telephone. The remaining are received by mail, fax, telex, and by direct computer contact.

24 Tons of Mail

Quill's annual sales to nearly 3,500 active North Dakota customers are just under $1 million. By sales volume, it is the sixth largest seller of office supplies in North Dakota. Each year, Quill mails over 60 different catalogs and flyers to its North Dakota customers. This amounts to more than 230,000 separate pieces of mail, weighing over 24 tons, sent into the state annually by Quill.

The basic fact pattern in Quill is the same as in Bel/as Hess. The North Dakota Supreme Court acknowledged that it was not following the precedent established by the U.S. Supreme Court and put forth persuasive arguments why the Bellas Hess principle should be overturned: "Quill in effect asks us to accept the notion that the U.S. Supreme Court will abandon its common sense and experience at the courthouse door and ignore the tremendous social, economic, commercial, and legal innovations since 1967, and blindly apply an obsolescent precedent."

First, the North Dakota Supreme Court noted that the U.S. Supreme Court had established a four-part test to determine the constitutionality of a tax under the interstate commerce clause. In its discussion in Complete Auto Transit v. Brady, 430 u.s. 274 (1977), the court held that a tax does not violate the commerce clause if:

1. It is applied to an activity with sub - stantial nexus within the taxing state;

2. It is fairly apportioned;

3. It does not discriminate against inter - state commerce; and

4. It is fairly related to the services pro - vided by the state. Quill had based its defense on only the first prong of the Complete Auto test and maintained that it did not have a physical presence and, therefore, it had no substantial nexus in North Dakota. The North Dakota Supreme Court held that Quill had established a "ubiquitous presence" in the state because it had 3,500 active customers generating $1 million in sales who received 230,000 pieces of mail annually. It also had a "help line" for consumers. Quill leased computer software that permitted customers to have access to Quill's computer for direct orders by their own computers. Quill had availed itself of modern technology to engage in extensive, continuous and intentional solicitation of the North Dakota market.

North Dakota's Position

The North Dakota court relied on the U.S. Supreme Court's holding in the area of personal jurisdiction of out-of-state defendants in state courts under the due process clause. In Burger King v. Rudszewicz, 471 U.S. 462 (1985), the Supreme Court stated:

"It is an inescapable fact of modern commercial life that a substantial amount of business is transacted solely by mail and wire communications across state lines, thus obviating the need for physical presence within a state in which business is conducted. So long as a commercial actor's efforts are 'purposefully directed' toward residents of another state, we have consistently rejected the notion that an absence of physical contacts can defeat personal jurisdiction there."

It also emphasized the U.S. Supreme Court's holding that an Illinois telecommunication excise tax was constitutional because it was a "realistic legislative solution to technology of the presentday telecommunications industry." Goldberg v. Sweet, 488 U.S. 252 (1989).

The North Dakota court then applied the test of Complete Auto. It stated that modern technology gave the mail order business a presence and, therefore, nexus in the state. The second and third prongs of the test were not issues in this case. Finally, the cost of disposing of the discarded catalogs and other remnants of 230,000 pieces of mail was a benefit provided to Quill. Accordingly, the use tax collection responsibility imposed on Quill satisfied the test of Complete Auto and was constitutional.

It is extremely difficult to predict the reaction of the U.S. Supreme Court to this very persuasive argument. In 1977, the court upheld the State of California in requiring the National Geographic Society to collect use taxes on its mail order sales. National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977). National Geographic, however, had offices in California for its advertising activities. Justice Brennan based the finding of nexus on this activity. His decision explicitly stated that: "Our affirmance of the California Supreme Court is not to be understood as implying agreement with that court's 'slightest presence' standard of constitutional nexus." The determination of nexus in that decision supported the precedent established in Bellas Hess. With the change in the makeup of the Supreme Court, it is almost impossible to predict future decisions. State taxing authorities, mail order businesses, and consumers could be significantly affected by the ultimate result in Quill.


In Wisconsin Department of Revenue v. William Wrigley Jr. Co., the court will determine the limits of the protection provided by Public Law 86-272, which is codified at 15 U.S.C. Sec. 381.

In 1959, Congress passed Public Law 86-272, which limits the ability of states to impose their income taxes on interstate business. No state may impose an income tax on a foreign corporation or a nonresident individual if such a taxpayer restricts its activity within the state as follows:

1. Activity within the state consists only of orders for sales of tangible personal property;

2. All orders are sent outside the state for approval or rejection;

3. If approved, orders are filled by shipment or delivery from a point outside the state.

Public Law 86-272 did not resolve all of the questions in this area because it did not define the term solicitation. There has been extensive litigation on this issue. Some state courts have interpreted solicitation broadly, while others have viewed it very narrowly. A resolution of these differences can only come from the U.S. Supreme Court.

Wrigley has been involved in litigation on this issue in three states. It has been successful in the state courts in North Dakota, New York, and Wisconsin. In the Matter of the Petition of William Wrigley Jr. Company, State Commission, March 11, 1987, Wrigley showed that it was entitled to a refund for the New York State franchise taxes that it paid from 1975 to 1980. On virtually identical facts, it has successfully resisted the Wisconsin Department of Revenue's attempt to impose the state corporate income tax. It has won at the administrative level and in three court challenges including a victory at the Wisconsin Supreme Court. The Wisconsin Department of Revenue refused to throw in the towel, however, and filed a petition for certiorari with the U.S. Supreme Court which has agreed to hear the case.

The U.S. Supreme Court has previously heard only one case on this issue. Heublein v. South Carolina Tax Commission, 409 U.S. 275 (1972). This case involved a taxpayer that was required to maintain a local representative in South Carolina to comply with state liquor regulations. This representative called on local retail customers. By law, all shipment of liquor into the state had to be sent to this local representative for transshipment to local retailers. The Supreme Court held that this function of controlling liquor shipments was not protected by Public Law 86-272 since it was more than solicitation. This function also meant that the taxpayer did not satisfy the requirement that all orders be filled by shipment or delivery from a point outside the state. As a result, the court held that Heublein was subject to South Carolina's corporate income tax.

Three Definitions of Solicitation

Most of the action on Public Law 86-272 has taken place in state courts. In Chattanooga Glass Company v. Strickland, 244 Ga. 602 (1979), the Supreme Court of Georgia noted that three definitions of solicitation had developed in the cases on Public Law 86-272. The three alternative

The New Jersey Supreme Court's decision in Clairol v. Kingsley, 57 N.J. 199 (1970), is an example of the first definition. Clairol sold products to salon wholesalers and had "detail people" having a "technical background" call on beauty salons.

The New Jersey Supreme Court concluded that Clairol was subject to tax based on all of the facts and circumstances. It did not specify which particular act made Clairol taxable. Subsequent court decisions have hinted that the activity of technicians was the straw that broke the camel's back. State taxing authorities took advantage of the ambiguity of the Clairol decision. They asserted that any of Clairol's activities made a corporation subject to tax.

Activities That Follow Don't Count

The second interpretation of Public Law 86-272 is that solicitation includes only those activities leading to the placement of orders and should not include activities that follow as a natural result of the transaction. A good example of this definition of solicitation is Miles Laboratories, Inc. v. Department of Revenue, 274 Or. 395 (1976).

The Wisconsin Supreme Court relied on two pro-taxpayer cases in holding that Wrigley was not subject to tax-- United States Tobacco Co. v. Commonwealth, 478 Pa. 125 (1979), and Gillette Co. v. New York State Tax Commission, 45 N.Y. 2d 846 (1978).

U.S. Tobacco's only activity in Pennsylvania was its 10 "missionary" representatives. The representatives were furnished with cars that they used to visit independent wholesalers to inform them about company promotions. Their duties were apparently planned to stay within the limits of Public Law 86-272.

The Pennsylvania Supreme Court held that U.S. Tobacco was immune from state taxation. The court stated that solicitation included any activity closely related to the eventual sale of a product. The court considered that all of U.S. Tobacco's contacts with pennsylvania definitions of solicitation are:

1. The specific act of asking a customer to purchase one's product;

2. Any act that leads to the purchase of one's product as opposed to acts that follow from the purchases; and,

3. Any act that leads to or follows from the purchase as long as the act is incidental to the purchase. were "inextricably" related to tion. It held that the occasional "acts of courtesy" to satisfy or accommodate customers did not go beyond solicitation.

Finally, the court in U.S. Tobacco forthrightly addressed the issue of furnishing cars to salesmen. It stated that use of the cars was insignificant and that Congress could hardly have intended that a salesmen had to walk to his customers. In Gillette, the taxpayer manufactured and sold personal care products in every state. In 1969, Gillette closed its sales offices in New York. It continued to employ between 50 and 70 sales representatives in New York to call on direct and indirect customers. "Indirect accounts" included independent retailers who bought Gillette products from direct account wholesalers and chain retailers supplied by a central purchasing organization which dealt directly with Gillette. The State Tax Commission called this activitv "merchandising" and said that it was not solicitation because it was a post-sale activitv.

The court held that the salesmen's advice to indirect accounts on displaying Gillette products was clearly solicitation because its purpose was to induce the purchase of the taxpayer's products. It stated that:

"Making the evanescent distinctions

which would be necessary to justfiy

the imposition of the tax upon the

petitioner herein would, if indulged

in by the several states, tend to

'Balkanize the American economy,

a result which it was Congress' pur - pose to prevent."

Back to Wrigley--the Case at Hand

The Wisconsin Department of Revenue attempted to tax Wrigley because of the following activities which the department believed were in excess of solicitation:

* Replacement of stale gum;

* Maintaining product displays both as to location design and content;

* Direct sale of gum by use of "agency stock checks;"

* Maintaining offices in homes;

* Conducting regular and periodic training seminars in Wisconsin;

* Recommending hiring, firing, and raises of sales representatives in Wisconsin by a regional manager;

* Involvement in credit transactions by a regional manager;

* Training and supervising sales representatives by a regional sales manager;

* Rental of storage space in Madison, Wisconsin for a former salesman's car; and

* The purchase of non-incidental advertising in Wisconsin.

The Wisconsin Supreme Court held that all of these activities were inextricably bound up with solicitation or so minor as to be de minimis. The court also emphasized the activities that Wrigley did not conduct in Wisconsin, such as maintaining a warehouse or a stock of goods. In its conclusion, it echoed the words of Gillette.

"We would hardly expect Wrigley to cross the state line any time it must engage in activities incidental to placing an order for gum. This would surely be a burden on interstate commerce and would tend to 'balkanize the American economy,' a result which it was Congress' purpose to prevent."

Most practitioners will reflexively agree with the well-written state court decisions in Gilleue, U.S. Tobacco, and Wrigley. The determination shown by the Wisconsin Department of Revenue in challenging Wrigleyl however, indicates that the taxing authorities not only are not giving up, but hope that they can win once-an&for-all with a grand slam home run in the U.S. Supreme Court. Its decision could shape not only the state taxation of corporations but also the way American business markets its products for generations to come.


Nordlinger, Quill, and Wrigley, will be heard during the current term of the U.S. Supreme Court which concludes on June 30, 1992. These cases are so important that practitioners can expect extensive coverage in the business and popular press as well as in professional accounting and tax publications.

Copyright 1992, Daniel O'Connell.

Daniel O'Connell, CPA, practices in Upper Montclair, New Jersey. He has served on the State Taxation Committee of the New Jersey Society of CPAs and is now a member of the Interstate Taxation Committee of NYSSCPA. He has contributed to the state tax column in The CPA Journal and has made numerous presentations on state and local taxation issues

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