Multistate taxation is a complex area of tax law that affects businesses operating in more than one state. At the core of multistate taxation is the concept of apportionment, a method used to determine how much of a business’s income is taxable in each state where it operates.
What Is Multistate Apportionment?
Apportionment refers to dividing a company’s business income among various states where the company conducts business activities. This income is typically from a company’s regular course of trade or business operations.
Any income generated from the business’s day-to-day activities or from the use of business-related assets and investments is generally apportionable—meaning it is subject to allocation among states. Each state then applies its own apportionment formula to calculate the portion of the company’s income that is attributable—and therefore taxable—to that state.
How States Determine Taxable Income
Each state has the discretion to determine its apportionment method, but the goal is the same: to tax a fair share of the income that’s reasonably related to business activities conducted within that state.
The most common apportionment methods include:
1. Three-Factor Apportionment Formula
Traditionally, states have used a three-factor apportionment formula that gives equal weight to:
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Payroll
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Property
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Sales
Each factor is averaged to determine the state’s share of the company’s income. However, only a handful of states still use this traditional method, including:
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Delaware
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Hawaii
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Rhode Island
2. Single Sales Factor Apportionment
The single sales factor formula considers only the company’s sales activity within the state, disregarding payroll and property. This method has been adopted by many states because it encourages businesses to expand operations without increasing their tax burden. States using this formula include:
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California
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Georgia
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Illinois
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Michigan
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New York
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Pennsylvania
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Texas
3. Enhanced Sales Factor (Weighted Sales)
Some states use a modified three-factor formula that gives extra weight to the sales factor. This approach balances the benefits of both the traditional and single-factor formulas. Examples of states using this weighted formula include:
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Arizona
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Florida
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Massachusetts
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Virginia
Understanding the Impact of Different Formulas
Because states use different apportionment formulas, it’s possible for a business to be taxed on more—or less—than 100% of its total income. This can result in double taxation or under-taxation, depending on how the apportionment is calculated across jurisdictions.
Sample Apportionment Calculations
To better understand how multistate taxation works in practice, refer to the example calculations below (see image). These examples illustrate how different formulas and state rules can significantly affect a company’s tax liability. Notably, Examples 2 and 4 show scenarios where the total taxable income across states adds up to more or less than 100%.
Sample calculations:
Company X is a unitary business. Assume 50% of Company X’s property, 60% of its payroll, and 100% of its sales are in State A. We will also assume that 50% of Company X’s property, 40% of its payroll, and 0% of its sales are in State B.
1. Both State A and B use the traditional three-factor apportionment formula
State A = (50+60+100)/3 = 70% of Company X’s total income will be taxable in State A
State B = (50+40+0)/3 = 30% of Company X’s total income will be taxable in State B
2. State A uses an enhanced three-factor formula (in which sales is given double weight) and State B uses the traditional three-factor apportionment formula
State A = (50+60+(100*2))/4 = 77.5% of Company X’s total income will be taxable in State A
State B = (50+40+0)/3 = 30% of Company X’s total income will be taxable in State B
3. State A uses the single-sales factor apportionment formula and State B uses the single-sales factor apportionment formula.
State A = 100/1 = 100% of Company X’s total income will be taxable in State A
State B = 0/1 = 0% of Company X’s total income will be taxable in State B
4. State A uses traditional three-factor apportionment formula and State B uses the single sales factor apportionment formula
State A = (50+60+100)/3 = 70% of Company X’s total income will be taxable in State A
State B = 0/1 = 0% of Company X’s total income will be taxable in State B
Final Thoughts on Multistate Taxation
It is crucial for taxpayer businesses to work with a CPA firm well-versed in multistate taxation in order to ensure their business is receiving the most accurate advice. This can also be very helpful in providing tax planning guidance to taxpayer businesses looking to minimize their state taxes. Singh and Associates, LLP regularly helps its clients with multistate taxation and is extremely well-experienced in this arena. We have filed returns in nearly every state and are very familiar with apportionment formulas, and its related tax planning opportunities.
