Was the 1999 NC William Lee Act amendment that gave tax credits to electronic shopping and mail-order houses (but not brick-and-mortar retailers, and not businesses with consolidated operations) constitutional?

Plain-English summary

In 1999 the NC General Assembly considered amending the William S. Lee Quality Jobs and Business Expansion Act (Article 3A of Chapter 105 of the General Statutes) to extend its tax credits to electronic shopping and mail-order retailers. The amendment would have given these mail-order businesses William Lee Act tax preferences. Brick-and-mortar retailers accepting walk-in customers would not qualify. And, more curiously, mail-order operations would qualify only if they kept inventory or distribution centers physically separated from sales staff; centralized operations would not.

Representative Bill Owens asked Senior Deputy AG Reginald Watkins and Special Deputy AG George Boylan to evaluate the constitutional risks.

The opinion identified two potential equal-protection vulnerabilities:

1. Mail-order vs. brick-and-mortar. Mostly defensible. NC equal-protection analysis of economic regulation uses a "rational basis" test (Village Publishing Corp.; White v. Pate; Four County Membership Corp.). A classification survives if it bears a rational relationship to a conceivable legitimate purpose. The justification offered to the AG was that mail-order sales bring new money into NC (because the buyers are out-of-state customers who would not otherwise have purchased from NC), creating a multiplier effect aligned with the Lee Act's economic-development purpose. Brick-and-mortar retailers, the argument went, merely compete with each other for in-state spending. The AG accepted this as a plausible rational basis but emphasized the legislative record needed to develop the rationale clearly so courts would not have to invent it.

2. Consolidated vs. separated operations. Constitutionally suspect. The AG could not identify any legitimate state objective served by penalizing efficient consolidation of inventory and sales staff. Without a rational basis, this distinction would fail equal-protection review. The opinion recommended eliminating it from the bill.

The opinion also warned that if the amendment were ultimately struck down, the remedy would likely be retroactive under Harper v. Virginia Department of Taxation. Courts could invalidate the whole scheme, order refunds to denied businesses, or expand eligibility to include all retailers. Either way the state's fisc and the bill's revenue projections were exposed.

The opinion separately addressed whether the legislature would be locked into the amendment under Bailey v. State. The AG concluded Bailey did not apply because the William Lee Act was already scheduled for automatic repeal, eliminating the reliance interests that drove Bailey. The legislature could later narrow or repeal the amendment without violating the contract-clause concerns Bailey raised in the state-pension-tax context.

Currency note

This opinion was issued in 1999. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

The William S. Lee Act was repealed and replaced by successor economic-development tax-credit programs (Article 3A's credits sunset; later programs adopted different qualification criteria). The specific mail-order amendment analyzed here, and its constitutional fate, would need to be researched in the legislative and litigation record of the years immediately following 1999. The underlying constitutional analysis (rational basis review of economic classifications; Harper retroactivity; Bailey contract-clause framework) remains current NC equal-protection doctrine but specific outcomes turn on later case law.

Common questions

Q: What is "rational basis" review?
A: The most deferential level of constitutional scrutiny. A classification is upheld if it bears a rational relationship to any conceivable legitimate state purpose. Economic regulations almost always survive rational-basis review, but "almost always" is not "always," as the opinion's caution about the consolidated/separated distinction illustrates.

Q: Why is mail-order vs. brick-and-mortar defensible?
A: Because mail-order sales pull money from out-of-state buyers into NC sellers, while brick-and-mortar retailers mostly redistribute in-state spending. The William Lee Act's purpose is economic expansion, so favoring activity that brings in new money has a rational connection to the statutory purpose.

Q: Why is consolidated vs. separated operations suspect?
A: Because there is no obvious economic-development reason to penalize a mail-order business that keeps inventory and sales staff in one efficient location. The AG could not articulate any rationale, even on the deferential rational-basis standard.

Q: What was the Bailey concern?
A: Bailey v. State (1998) held that the legislature could not retroactively tax pension benefits that state and local government employees had been promised would be tax-exempt. The decision rested on reliance interests and contract-clause principles. Counsel may have worried that creating a tax-credit class would similarly lock in the legislature. The AG concluded no, because the Lee Act had a built-in sunset, so reliance interests could not vest indefinitely.

Q: What is "retroactive" remediation?
A: Under Harper v. Virginia Department of Taxation, when a tax law is struck down on constitutional grounds, the remedy generally reaches back, not just forward. The state may have to refund unconstitutional taxes already paid (or fail to collect on time-barred refund claims). For tax credits, the parallel issue is whether courts will retroactively make the credit available to similarly situated taxpayers who were denied it.

Q: What was the practical legislative advice?
A: Develop a clear legislative record on the new-money/multiplier rationale for the mail-order/brick-and-mortar distinction so courts do not have to invent the rationale on judicial review. Drop the consolidated/separated distinction, which lacks any defensible justification.

Background and statutory framework

The William S. Lee Quality Jobs and Business Expansion Act (Article 3A of Chapter 105) provided a structured set of tax credits for businesses creating jobs, investing in equipment, or investing in central-administrative offices in NC. The Lee Act used tiered county designations and credit amounts, with extra incentives for distressed areas.

The 1999 amendment under review would have added electronic shopping and mail-order houses as qualifying businesses, subject to two filters: (a) the business had to use electronic or mail-order channels (excluding walk-in retail); (b) inventory or distribution centers had to be separated from sales staff (excluding consolidated operations).

The constitutional questions:

• Commerce clause: The opinion clears the amendment of commerce-clause infirmities, noting that the Lee Act benefits are available to all entities regardless of domicile or residency.
• Equal protection (state and federal): Reviewed under rational basis for economic regulation. The mail-order/brick-and-mortar distinction has a plausible justification (new-money multiplier). The consolidated/separated distinction lacks any.
• Contract clause / reliance / Bailey: Not implicated because the Lee Act had a scheduled sunset.

The opinion is candid about uncertainty: "we cannot predict with any certainty how [NC courts] would rule." But it provides specific actionable advice on which distinctions to keep and which to drop. That is the most useful thing a legislative-advisory opinion can do.

Citations

• N.C. Gen. Stat. § 105-129.2 (William Lee Act tax credit definitions)
• N.C. Gen. Stat. ch. 105, art. 3A (William S. Lee Quality Jobs and Business Expansion Act generally)
• In re Assessment of Taxes Against Village Publishing Corp., 312 N.C. 211, 222 (1984) (rational basis standard for economic-regulation equal-protection challenges)
• White v. Pate, 308 N.C. 759, 766-67 (1983) (rational relationship to a conceivable legitimate purpose)
• Four County Membership Corp. v. Powers, 96 N.C. App. 417, 424 (1989) (classification founded on rational basis will be upheld)
• Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993) (retroactivity of tax-invalidation remedies)
• Bailey v. State, 348 N.C. 130 (1998) (state-pension-tax contract-clause reliance)
• Smith v. State, 349 N.C. 332 (1998) (companion to Bailey)

Source

• Landing page: https://ncdoj.gov/opinions/tax-preferences-for-electronic-shopping-and-mail-order-houses/

Original opinion text

Best-effort transcription from a fragmented Sofya extract. Minor errors may remain — the linked landing page is authoritative.

[The first portion of the body extract is truncated. Opening citation includes a "N.C. 608, 617 (1977)" reference that the extract did not fully resolve.]

The test for whether an economic regulation withstands equal protection scrutiny is the "rational basis standard." In re Assessment of Taxes Against Village Publishing Corp., 312 N.C. 211, 222 (1984). An act provides equal protection if its classification "bears a rational relationship to a conceivable legitimate purpose." White v. Pate, 308 N.C. 759, 766-67 (1983). As long as a classification is not arbitrary or capricious, but rather founded upon a rational basis, the distinction will be upheld by the Court." Four County Membership Corp. v. Powers, 96 N.C. App. 417, 424 (1989).

The amendment appears free of commerce clause infirmities. Nothing we have examined in materials provided suggests the legislation would impermissibly favor local interests at the expense of interstate commerce. While the William Lee Act itself provides favorable tax attributes for business activity conducted within North Carolina, these benefits are available to all entities regardless of domicile or residency. In any event, the general constitutionality of Article 3A, enacted several years ago, is beyond the scope of this review.

Two aspects of the amendment might invite equal protection challenges by retailers not qualifying for benefits. The rationale for the legislation's award of tax preferences to businesses selling via electronic media, but denial of benefits to main street vendors accepting walk-in customers, will need to be developed. As possible justification for this distinction, the reviewed materials suggest that mail order sales pull new money into a jurisdiction with a multiplier effect promoting business expansion and growth, thus furthering objectives of the William Lee Act. In contrast, we understand that traditional vendors merely compete with [each other for in-state spending].

The Honorable Bill Owens
June 23, 1999
Page 3

Candidly, since North Carolina courts have not yet addressed the validity in the tax area of either rationale, we cannot predict with any certainty how they would rule upon these issues. Nevertheless, as noted, they traditionally accord considerable deference to the lines set by the legislature in economic regulations.

Of greater concern to us is the further distinction drawn between establishments with separate distribution centers, and those with centralized operations. From the materials presented to us, we have been unable to identify a legitimate governmental objective served by a tax scheme which penalizes entities which consolidate their business activities, but rewards those which separate inventory or distribution centers from sales staff. Absent a rational basis, the distinction would not pass constitutional muster, and we suggest its elimination.

If the amendment were declared unconstitutional for any reason, the ruling likely would be retroactive. Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993). In fashioning appropriate relief, the court might invalidate the entire scheme, order refunds to businesses which had not qualified for the credit or expand the class eligible to receive credits from merely mail order businesses to all retailers. Bailey v. State, 348 N.C. 130 (1998); Smith v. State, 349 N.C. 332 (1998).

You also inquire whether the legislature might be precluded later from narrowing or repealing the amendment, as occurred in Bailey. We do not believe Bailey implicates the amendment from this perspective. Bailey addressed distinctive features of employer-employee contract law, and rested upon unique reliance factors. In distinction, the William Lee Act is already scheduled for automatic repeal in the future, eliminating the reliance interests which so animated the Bailey decision.

We hope you find the foregoing helpful.

Sincerely,

Reginald L. Watkins
Senior Deputy Attorney General

George W. Boylan
Special Deputy Attorney General

GWB:jmc