Apportionment

Apportionment is the division of a whole among several parties by a stated rule, rather than by tracing each part back to an owner. In state income tax the word names one particular division: a business taxable in more than one state splits its apportionable income, the income that is not assigned whole to a single state, among the states that may tax it, and each state taxes a measured share of that income fixed by a formula instead of the whole. The word carries other senses, the congressional apportionment of seats in the U.S. House of Representatives among the states most visibly, but inside a CPA firm it means the state income tax division.

Apportionment Versus Allocation

These are two halves of one operation, and they are not interchangeable. The Multistate Tax Commission’s model Compact Article IV, which carries the Uniform Division of Income for Tax Purposes Act (UDITPA) as revised in 2015, requires a taxpayer with income from business activity taxable both within and without a state to allocate and apportion its net income, with financial organizations, public utilities and the rendering of purely personal services by an individual set outside that rule (MTC model Compact Article IV, section 2).

Apportionment carries the income from the regular course of the trade or business. Apportionable income is all income that is apportionable under the Constitution of the United States and is not allocated under the laws of the state, including income arising from transactions and activity in the regular course of the taxpayer’s trade or business, and income arising from tangible and intangible property if the acquisition, management, employment, development or disposition of the property is or was related to the operation of that trade or business. Non-apportionable income is all income other than apportionable income (sections 1(a)(i) and 1(e)).

Allocation hands the rest over whole. Rents and royalties from real or tangible personal property, capital gains, interest, dividends and patent or copyright royalties, to the extent they are non-apportionable, are allocated under paragraphs 5 through 8 rather than spread by formula (section 4). Interest and dividends are allocable to the state of the taxpayer’s commercial domicile (section 7), which is the principal place from which the trade or business is directed or managed (section 1(b)).

The Apportionment Formula

All apportionable income is apportioned to a state by multiplying that income by a fraction, and the model leaves the weighting of the fraction to each state, recommending a numerator of the property factor plus the payroll factor plus two times the receipts factor over a denominator of four (section 9). The same facts therefore produce different percentages in different states.

Each factor has the same shape, the in-state amount over the everywhere amount. The property factor uses the average value of real and tangible personal property owned or rented and used in the state, over the same measure everywhere (section 10). The payroll factor uses compensation paid in the state over compensation paid everywhere (section 13), and compensation is wages, salaries, commissions and any other form of remuneration paid to employees for personal services (section 1(c)). The receipts factor uses receipts in the state over receipts everywhere (section 15).

Where a receipt counts is the part that moves. Receipts from the sale of tangible personal property are in a state if the property is delivered or shipped to a purchaser other than the United States Government within that state, regardless of the f.o.b. point (the shipping term naming where the seller’s delivery obligation ends) or other conditions of the sale (section 16(a)). Every other receipt is in the state where the taxpayer’s market for the sale is, and for a service that is the state to which the service is delivered (section 17(a)(3)).

Say a client is taxable in several states, and in one of them the three factors come out as follows.

Apportionable income                                1,000,000

Property factor    in state over everywhere              0.10
Payroll factor     in state over everywhere              0.20
Receipts factor    in state over everywhere              0.30

Recommended weighting  (0.10 + 0.20 + 2 x 0.30) / 4     0.225
Apportioned to the state  1,000,000 x 0.225           225,000

Equal weighting        (0.10 + 0.20 + 0.30) / 3         0.200
Apportioned to the state  1,000,000 x 0.200           200,000

Receipts only          (0.30)                           0.300
Apportioned to the state  1,000,000 x 0.300           300,000

The percentage applies to a base, not to the tax, so the state runs its own rate over its own share of net income as that state defines it. Where the provisions do not fairly represent the extent of a taxpayer’s business activity in a state, the taxpayer may petition for, or the tax administrator may require, separate accounting, the exclusion or the inclusion of factors, or another method that reaches an equitable result (section 18(a)).

Whether a State May Reach the Income at All

A formula only matters where the state has the power to tax. Congress removed that power in one narrow case: no state may impose a net income tax on the income derived within the state by any person from interstate commerce where the only business activities in the state are the solicitation of orders for sales of tangible personal property, sent outside the state for approval or rejection and, if approved, filled by shipment or delivery from a point outside the state (15 U.S.C. 381(a), enacted as Public Law 86-272).

Three limits sit on the face of that immunity. It does not apply to a corporation incorporated under the laws of the state, or to an individual domiciled in or a resident of the state (15 U.S.C. 381(b)). It reaches solicitation for sales of tangible personal property only, so soliciting sales of services is not protected activity. And it stops a net income tax, defined as any tax imposed on, or measured by, net income (15 U.S.C. 383), which leaves a tax measured on some other base untouched.

How far the immunity actually reaches turns on what solicitation of orders means, and the definitions in the section reach only independent contractor and representative (15 U.S.C. 381(d)). The Supreme Court drew the line between activities entirely ancillary to requests for purchases, those that serve no independent business function apart from their connection to the soliciting of orders, and activities the company would have reason to engage in anyway but chooses to allocate to its in-state sales force. Only the first kind is covered. An activity outside that line still leaves the immunity intact if it is de minimis, which turns on whether the activity establishes a nontrivial additional connection with the taxing state (Wisconsin Dept. of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992)).

The immunity then feeds back into the formula. A taxpayer is taxable in another state where it is subject to that state’s net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business or a corporate stock tax, or where that state merely has jurisdiction to subject it to a net income tax regardless of whether the state in fact does (section 3). Receipts from tangible personal property shipped from a place of storage in a state then count in that state where the taxpayer is not taxable in the purchaser’s state (section 16(b)). Protection in the destination state can therefore push the sale back into the origin state’s numerator.

What Apportionment Is Not

Prorating divides a single amount in proportion to a measured share such as days or units, and that separation is worked through from the other side in prorated.

Common Questions

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