STATE TAX NEXUS, ALLOCATION/APPORTIONMENT, AND NET OPERATING LOSS ISSUES PRACTICE GUIDES

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STATE TAX NEXUS, ALLOCATION/APPORTIONMENT, AND

NET OPERATING LOSS ISSUES PRACTICE GUIDES



INTRODUCTION


This practice guide was developed by the AICPA State and Local Taxation Technical Resource Panel and related Task
Forces to inform practitioners about

state corporate income and franchise tax issues, such as
nexus, allocation and
apportionment, and state net operating loss (NOL) deductions
. This guide should be considered in connection with the
checklist questions contained in the
AICPA State Corporati
on Income Tax Return Checklist

also included in this
AICPA

Tax
Practice Guides and Checklists

publication package. In addition, practitioners should refer to the
Unique Considerations
for State Business Tax Returns

(also included in this
AICPA

Tax Practic
e Guides and Checklists

publication package) for
common problems and unique tax issues concerning each of the states’ corporate state tax returns.


Below in this practice guide is a state tax nexus checklist that contains a list of the frequently asked qu
estions appearing in
states’ nexus questionnaires. Practitioners should be aware that the weight of interpretation given to specific questions
might vary from state to state. However, the list can serve as a practice tool for practitioners in soliciting
information from
clients and analyzing such information. This guide is intended to be a broad reference tool. It can aid in addressing nexus
,
allocation and apportionment, and state NOL issues. It is not intended to answer the question of whether a spec
ific company
has nexus or certain tax obligations in a particular state. It should be noted that there are different nexus standards for
the
different types of taxes. The laws and policies of each state should be researched for application to each specif
ic taxpayer’s
situation.



STATE TAX NEXUS



The AICPA State and Local Taxation Technical Resource Panel has compiled a number of state nexus questionnaires
and web links to the states' questionnaires, which are available on the AICPA web page at:
www.aicpa.org.



Nexus describes the amount and degree of business activity that must be present before a taxpayer becomes subject to a
state's taxing jurisdiction. For example, if a taxpayer has income tax nexus in a pa
rticular state, it will be required to
file returns and pay tax on income earned in the state. Similarly, if a taxpayer has sales and use tax nexus, it will be
required to collect and remit sales and use taxes on sales made to purchasers in the state. In

general, nexus is created
for income tax purposes if an entity does business in the state, derives income from sources within the state, owns or
leases property in the state, employs personnel engaged in various activities in the state, or has capital or
property in the
state. The nexus standards for state franchise taxes based on net worth or net capital are broader than they are for
income taxes. The mere fact that a company sales representative solicits orders in a state is often sufficient to establi
sh
nexus for net worth tax purposes. This means that companies that might otherwise be exempt from income tax in a
given state may have a franchise tax liability if they do business in that state. Similarly broad nexus standards generally
apply to sales
and use taxes and other non
-
income based taxes.


The amount of activity or connection that is necessary to create nexus is defined by state statute, case law and/or
regulation and, consequently, tends to vary from state to state. However, Constitutional
principles, the U.S. Supreme
Court rulings, state court rulings, and federal law limit all states’ abilities to impose taxes.



Briefly summarized below are: 1) the federal statute governing “protected” activities within a state, 2) relevant issues
from t
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E䵔C) 楮 瑨楳 慲敡K



1.

Public Law 86
-
272 (15 U.S.C. §381)




Nexus for net income tax purposes is not established merely because sales of tan
gible personal property are
solicited within the states. The states are prohibited under Public Law 86
-
272 (P.L. 86
-
272) from imposing a tax
on or measured by net income when an entity’s only connection with the state is the solicitation of orders for sal
es
of 瑡tg楢汥l p敲son慬a prop敲瑹 楦 such ord敲s 慲攠慣捥p瑥t 慮d sh楰p敤 or d敬楶敲敤 from ou瑳楤攠瑨攠s瑡瑥t qh攠
STATE TAX NEXUS




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Virginia Supreme Court in
Commonwealth of Virginia, Department of Taxation v. National Private Truck Council
,
480 S.E.2d 500 (Va. 1997), and
the Massachusetts Supreme Judicial Court in
National Private Truck Council, Inc.
v. Massachusetts Commissioner of Revenue
, 688 N.E.2d 936 (Mass, 1997), ruled that the mere delivery in
company
-
owned trucks, standing alone, does not establish nexus for incom
e tax purposes because of the protection
afforded by P. L. 86
-
272. Other
state revenue departments have advised that deliveries via company
-
owned trucks
are protected by P. L. 86
-
272.
See

Tex. Comptroller of Public Accounts, Hearing No. 36,590 (Jan. 20,

2000); Neb.
Dept. of Rev., Rev. Rul. 24
-
01
-
01, (Feb. 22, 2001); Okla. Tax Comm'n., Decision No. 2005
-
05
-
10
-
22, (May 10,
2005); and Ala. Dept. of Rev., Ala. Reg. 810
-
27
-
1
-
4
-
.19 (Feb. 28, 2006). During 2001, the MTC amended its
Statement of Information Con
cerning Practices of Multistate Tax Commission and Signatory States Under P. L.
86
-
272 by deleting the sentence that identified as an unprotected activity the shipment or delivery of goods into the
state by means of a private or contract carrier.




Under

P. L. 86
-
272, the only immunity accorded is for the solicitation of orders for the sale of tangible personal
property. Thus, the solicitation for the sale of real property, intangible property, or services is not provided
immunity under P. L. 86
-
272 and
may cause a taxpayer to have nexus in a state where such solicitation occurs.




The immunity afforded by P. L. 86
-
272 only applies to taxes on or measured by net income and does not apply to
taxes imposed on any corporation incorporated within the taxin
g state. For example, because the Michigan Single
Business Tax (SBT) was not imposed on or measured by net income, P. L. 86
-
272 was not applicable in
determining nexus for SBT tax purposes.
Guardian Industries Corp v Dep’t of Treasury,
N98 䵩Mh App PSP㬠
499
乗Od P49I
lv app den
444 Mich 943; 512 NW2d 846 (1994), and
Gillette Co v Dep’t of Treasury,
N98 䵩Mh App

303; 497 NW2d 595 (1993),
lv app den
445 Mich 861; 519 NW2d 156 (1994). Nexus for SBT purposes could be
created by merely soliciting sales in Mic
higan for two or more days (
See

Michigan Department of Treasury RAB
1998
-
1 for details regarding nexus for SBT purposes). Note, that as of January 1, 2008, the Michigan Business Tax
(MBT) replaced the SBT. The MBT is comprised of four components: a busin
ess tax, a modified gross receipts
tax, a gross direct premiums tax (specific to insurance companies), and a franchise tax (specific to financial
institutions). Under the MBT, taxpayers, other than insurance companies and financial institutions that meet
the
active solicitation or physical presence standard will be subject to the modified gross receipts component and the
income component of the tax; however, the protections of P. L. 86
-
272 apply to the extent applicable. In addition,
t
he physical presence

nexus standard and active solicitation nexus standard apply in determining whether an
insurance company or financial institution is subject to the MBT gross direct premiums tax or franchise tax,
respectively.

(See Michigan Department of Treasury Revenue
Administrative Bulletin 2008
-
4 (10/21/08)).

The
MBT has been repeal ded. Ef f ect i ve January 1, 2012, t he MBT has been repl aced by t he Corporat e I ncome Tax
( CI T). The CIT i s i mposed on cert ai n t axpayers wi t h busi ness act i vi t y i n Mi chi gan or benef i ci al i nt e
rest i n a f l ow
-
t hrough ent i t y t hat has busi ness act i vi t y i n Mi chi gan unl ess prohi bi t ed by P.L. 86
-
272.
Pl ease not e t hat st art i ng
1/1/2012 t he Mi chi gan Corporat e I ncome Tax ( CI T) wi l l repl ace t he Mi chi gan Busi ness Tax. As such, P.L. 86
-
272
will provide imm
unity in the state of Michigan, subsequent to this date, for income tax purposes.


Similarly, the Ohio Commercial Activities Tax (CAT), which is based on gross receipts and levied for the privilege
of doing business in Ohio, is not subject to P. L. 86
-
272
restrictions.
"Doing business"

means engaging in any
activity, whether legal or illegal, that is conducted for, or results in, gain, profit, or income at any time during the
calendar year. In addition, the tax is levied on persons with substantial nexus
with Ohio.
"Substantial nexus"

is
deemed to exist if a person: owns or uses a part or all of its capital in Ohio; holds a certificate of compliance with
the laws of Ohio authorizing the person to do business in Ohio; has bright
-
line presence in Ohio; or
otherwise has
nexus with Ohio to an extent that the person may be required to remit the CAT under the U.S. Constitution.
"Bright
-
line presence"

in Ohio exists where a person: has at any time during the calendar year property in Ohio
with an aggregate valu
e of at least $50,000; has during the calendar year payroll in Ohio of at least $50,000; has
during the calendar year taxable gross receipts of at least $500,000; has at any time during the calendar year within
Ohio at least 25% of the person's total prope
rty, total payroll, or total gross receipts; or is domiciled in Ohio as an
individual or for corporate, commercial, or other business purposes.




The New Jersey Tax Court held that P. L. 86
-
272 does not protect a vendor against the corporate minimum flat

tax
because the tax is not based on net income.
Home Impressions, Inc. v. Dir., Div. of Taxation
, 21 N.J. Tax 448
STATE TAX NEXUS




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(2004). For years beginning on or after 2001, taxpayers pay the highest of the minimum flat tax, tax on net income,
or the Alternative Mini
mum Assessment (AMA), which is based on New Jersey gross receipts or New Jersey gross
profits. Although of questionable constitutionality, the New Jersey law provides that P. L. 86
-
272 does not apply
to the AMA.
N.J.S.A. 54:10A
-
5a and New Jersey Regulatio
n 18:7
-
18.2.
The AMA sunset for tax periods
beginning after June 30, 2006 for corporations not claiming immunity from the New Jersey net income tax under P.
L. 86
-
272. However, corporations protected under the public law continue to be subject to the AMA

unless they
file consent to jurisdiction of New Jersey to impose and pay the net income tax.
N.J.S.A. 54:10A
-
5a and New
Jersey Regulation 18:7
-
18.2.




Although similar legislation has been unsuccessful in the past, in
2011
, the Business Activity Tax Si
mplification Act
(BATSA) (H.R.
1439
) was introduced as an update or modernization of P. L. 86
-
272. The legislation seeks to,
among other things, prevent the taxation of businesses that have no or minimal presence in a particular state by
establishing a "b
right line" physical presence standard for the imposition of state and local business activity taxes.
Business activity taxes are defined as "any tax in the nature of a net income tax or tax measured by the amount of, or
economic results of, business or r
elated activity conducted in the State."

For more information on the jurisdiction to
tax, refer to State Taxation, by Jerome R. and Walter Hellerstein.



2.

Physical Presence




Historically, cases brought before the U.S. Supreme Court relating to nexus

involved factual situations in which the
taxpayer had a degree of physical presence in the state seeking to impose its tax. In
Quill Corp. v. North Dakota
,
504 U.S. 298 (1992), the U.S. Supreme Court ruled that the Commerce Clause mandated that, absent ac
tion by the
U.S. Congress to the contrary, a taxpayer must have some physical presence in a state to be subject to collection
responsibility for the state’s use tax (
Quill

at 1914). Although
Quill

deals with use tax, the Court’s discussion of
瑨攠 gen敲慬a
au攠 mro捥ss 慮d Comm敲捥 C污ls攠 捯ns瑩tu瑩tn慬a pr楮捩c汥猠of nexus sh敤s som攠 汩gh琠on th敩e
慰p汩捡瑩ln 瑯 fr慮ch楳e 慮d in捯me 瑡tesK 乥k敲th敬敳sI some s瑡瑥t off楣楡汳 b敬楥v攠瑨慴a瑨e nexus s瑡nd慲d for
楮捯me 瑡t purpos敳eis 愠汯wer 瑨r敳ho汤 瑨an fo
r s慬asLus攠t慸 purpos敳e 慮d thus b敬楥v攠瑨慴aphys楣慬ipr敳en捥 is
no琠r敱u楲敤 b敦or攠慮 楮捯me
J
b慳敤 瑡t 捡n b攠impos敤K fn r散敮琠y敡rsI 愠numb敲 of st慴攠捯ur瑳 h慶攠h敬e 瑨at
Quill

does not apply to income taxes.




The Commerce and Due Process Cl
auses are generally considered to be the primary constitutional limitations on
state taxation. The Commerce Clause provides that “Congress shall have the power to regulate Commerce with
for敩en 乡瑩knsI and among 瑨攠s敶敲慬a s瑡瑥sI 慮d w楴h th攠fnd楡n 瑲
ibes.” The Commerce Clause has been
楮瑥tpr整敤 慳ano琠only 捯nf敲r楮g pow敲 on 瑨e n慴楯n慬agov敲nmen琠瑯 regu污瑥t捯mm敲捥I bu琠慬獯 慳 汩m楴ing the
states’ powers to interfere with commerce.




䅮 an慬ysis of wh整h敲 愠瑡x v楯污瑥猠lh攠Comm敲捥 C污use

involv敳⁡pp汩捡瑩ln of 瑨e four prong 瑥獴 d敬楮敡瑥t in
Complete Auto Transit v. Brady
, 430 U.S. 274 (1977). Under this test, the activities taxed must: (1) have a
substantial nexus with the taxing state; (2) the tax must be fairly apportioned; (3) the

tax must not discriminate
against interstate commerce; and (4) the tax must be related fairly to the services provided by the state.




The Due Process Clause prohibits states from denying any person “life, liberty, or property, without due process of
l
aw.” Due process protects against unfair governmental interference or taking of property. A state whose laws
prov楤攠pro瑥捴楯nI s散ur楴yI and oppor瑵n楴楥i 瑯 楮div楤ualsI prop敲瑹I 慮d busin敳s may 數慣琠愠瑯汬lin th攠form of
瑡t敳e瑯 suppor琠瑨攠gov敲
nment, but not without due process of law. The Due Process Clause requires that “there is
愠m楮ima氠捯nn散瑩tn or nexus b整w敥n 瑨攠in瑥ts瑡瑥t 慣瑩v楴楥s 慮d 瑨攠瑡xing s瑡瑥t and 愠r慴楯n慬a r敬慴楯nsh楰
b整w敥n th攠楮捯m攠慴瑲楢u瑥d 瑯 瑨攠s瑡瑥t and 瑨攠
intrastate values of the enterprise.”
Hunt
-
Wesson, Inc. v.
Franchise Tax Board,
528 U.S. 458, 464 (2000).


The issue of “economic nexus” in the case of service providers and financial organizations with no physical
pr敳敮捥 has no琠y整eb敥n 慤dr敳e敤 by t
h攠售匮ppuprem攠Cour琻⁨owev敲I 愠numb敲 of s瑡t攠捯ur瑳 hav攠ru汥l on the
楳su攠of 散onom楣i n數usK fn 慤d楴楯nI s瑡瑥t 汥lis污lur敳e h慶攠瑡ten 愠mor攠aggressive s瑡t捥 in r散敮琠y敡rs in
STATE TAX NEXUS





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enacting legislation that adopts an economic nexus or factor presenc
e nexus standard.


For example, applicable to tax years beginning on or after January 1, 2010, Connecticut has adopted an economic
nexus standard, which provides a company that engages in active solicitation of
Connecticut

residents and has
significant rec
eipts ($500,000 or more) has nexus with
Connecticut

unless P.L. 86
-
272 protection applies.




The South Carolina Supreme Court, in
Geoffrey, Inc. v. South Carolina Tax Commission
, 313 S.C. 15, 437 S.E.2d
13 (1993), held that a Delaware holding company t
hat owned only intangible property used in South Carolina and
other states was subject to income tax. The court rejected Geoffrey’s claim that it had not purposefully directed its
activities toward South Carolina’s economic forum and held that by licensin
g in瑡tg楢l敳efor us攠楮 th攠s瑡瑥t 慮d
r散敩e楮g in捯me 楮 exch慮g攠for 瑨敩e us攬 䝥dffrey h慤 瑨e minimum 捯nn散t楯n and subs瑡tt楡氠nexus w楴h 卯uth
C慲o汩l愠r敱u楲敤 by th攠au攠mro捥ss C污ls攠慮d th攠Comm敲捥 C污us攠of th攠售匮p Cons瑩瑵瑩tnK fn 慤d楴i
onI
Geoffrey’s receivables were found to have a business situs in South Carolina. The U.S. Supreme Court
subs敱u敮tly d敮楥i 捥r瑩tr慲椠楮
Geoffrey

(510 U.S. 992 (1993)), making the case applicable only in the state of
South Carolina. Many states, howeve
r, have incorporated through statute or regulation the principles of economic
nexus outlined in
Geoffrey

regarding intangibles in the nature of trademarks and trade names.




In another decision that held against the taxpayer, the New Mexico Court of App
eals held that Kmart Properties,
Inc. (KPI) was subject to income, franchise, and gross receipts taxes (
Kmart Properties, Inc. v. Taxation and
Revenue Department,
131 P.3d 27 (2001)). KPI, a Kmart subsidiary, owned trademarks and tradenames and
licensed t
hem to Kmart retail locations doing business in the state. During the investigation, the New Mexico
Taxation and Revenue Department requested and received memoranda explaining how to set up a trademark
company, how to operate it, and the expected state ta
x savings. The trademark company generally operated with
independent substance as a separate company: it moved into a separate building in Michigan; and it employed five
employees who were transferred from Kmart Corporation, including two intellectual pro
perty lawyers and support
staff. There were executed loan documents between Kmart and the trademark company (however, the loan
documents provided for loans up to $500 million, much lower than the outstanding balance).




Following the logic of the depart
ment, the court relied on trademark laws, which provide that trademarks cannot be
separated from goodwill; in essence, a trademark has no value (or would be considered abandoned) unless it is
maintained by an ongoing business. The court compared a company
's goodwill and trademark symbol to Siamese
twins who cannot be separated without death to both. The court also looked at the licensing requirements under
trademark law, which require a licensor to maintain, control, and protect a trademark. It found tha
t there was a
substantive identity between KPI and Kmart based on a direct correlation between Kmart’s use of KPI’s trademarks
楮 乥w 䵥x楣i 瑯 promo瑥 s慬敳 慮d enh慮捥 楴s sa汥l r敶敮ues and 瑨e r敶enu敳e 䭐f r散敩e敳e 慳 roy慬瑩as
E捡汣l污瑥l 慳a愠p敲捥nt
慧攠of 瑨攠乥w 䵥x楣i s慬敳aK f琠fur瑨敲 found 瑨慴a瑨攠rniform a楶楳楯n of fn捯m攠for q慸
Purposes Act’s (UDITPA’s) three
J
factor formula did not fairly represent KPI’s business activity in New Mexico
b散慵s攠楴i only busin敳s 慣瑩t楴y 楮 th攠s瑡瑥tw慳ath
攠汩捥lsing of 楴s 瑲慤em慲ks for us攠瑨敲攮 fn 慤d楴楯nI 瑨攠Court
upheld the gross receipts tax assessment on KPI’s royalty income in New Mexico, finding that payment of the
roy慬a楥猠w慳⁡ 捯nd楴楯n of th攠s慬攠慮d w慳⁴h攠捯ns楤敲慴aon for 瑨攠s慬攠瑯

th攠數瑥n琠th攠s慬攠o捣urr敤 楮 瑨攠s瑡瑥t




䑵r楮g OMMRI 瑨攠乥w 䵥xi捯 卵prem攠Cour琠汥琠s瑡nd w楴hou琠h敡ringI and 慬汯w敤 瑯 b攠f楬敤I 瑨攠Cour琠of
App敡汳 d散楳楯n th慴ain捯me from 汩捥ns楮g 瑲慤em慲ks 瑯 慮 楮
J
s瑡瑥taff楬楡瑥tis subj散琠瑯 捯rpor
慴攠楮捯me 瑡xK
Kmart Corporation (f/k/a Kmart Properties, Inc.) v. Department
, 131 P.3d 22

(2005).




During 2004, the Louisiana Court of Appeal held that the licensing of trademarks creates nexus despite a lack of
physical presence.
Dept of Revenue v.

Gap (Apparel), Inc.,

886 So.2d 459 (2004). During 2005, the New Jersey
appellate level court similarly held that trademark subsidiaries had nexus despite a lack of physical presence. The
ruling was upheld in 2006 by the New Jersey Supreme Court and, in
2007, the U.S. Supreme Court denied the
taxpayer's petition for review.
Lanco, Inc. v Director, Division of Taxation
, 379 N.J. Super. 562 (8/24/05),
aff’d

908 A.Od NTS (O00S)I
cert. denied

551 U.S. 1131

(June 18, 2007). The Oklahoma appellate court reac
hed a similar
conclusion with respect to the physical presence standard in
Geoffrey Inc. v. Tax Commission
, 132 P.3d 632 (2005).
In 2005, t
he U.S. Supreme Court denied a petition by A&F Trademark, Inc. to consider a North Carolina
Court of
STATE TAX NEXUS





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Appeals ruling
that
the physical presence nexus standard established in
Quill

applies only to state sales and use
taxes.
A&F Trademark, Inc. v. Tolson,

605 S.E.2d 187 (2004),
cert. denied

546 U.S. 821

(2005). Although recent
years have seen more state success judiciall
y, state efforts to tax all trademark subsidiaries have been met with
resistance and, thus, this is expected to be an area of continued litigation until it is addressed by the U.S. Supreme
Court.


In a case involving whether the mere issuance of credit car
ds to state residents creates nexus, the court held for the
taxpayer. In
J.C. Penney Nat’l Bank v. Ruth Johnson, Comm’r of Rev., State of Tenn,
N9 匮p. Pd 8PN

(1999), the
Tennessee Court of Appeals reversed a chancery court decision and held that J.C. Pen
ney National Bank did not
have substantial nexus with the state. In so doing, the court rejected as not “constitutionally significant” the
chancery court’s finding that the taxpayer’s 11,000 to 17,000 credit cards in Tennessee constituted a physical
pr敳e
nce. The court also rejected the chancery court’s findings that the unaffiliated retail stores operated by J.C.
Penney National Bank’s parent gave the bank physical presence in Tennessee. The state supreme court denied
p敲miss楯n 瑯 慰p敡氻⁴l攠售匮 卵pr
eme Court denied the state’s
writ of certiorari.
531 U.S. 927 (2000).


In contrast, during 2005, a West Virginia circuit court reversed the decision of the Office of Tax Appeals and held
that a Delaware bank had nexus solely due to the issuance of credit
cards and the isolated and sporadic use of in
-
state attorney services and state courts. During 2006, the West Virginia Supreme Court affirmed the Circuit Court’s
decision. The U.S. Supreme Court denied the taxpayer’s petition for review in 2007.
Commiss
ioner v. MBNA
America Bank
, No. 04
-
AA
-
157W. Va. Cir. Ct. (6/27/05),
aff’d

S40 匮p.Od OOS (t. s愮 O00S)I
cert. denied

2007
U.S. LEXIS 7868 (June 18, 2007).


The Massachusetts Supreme Judicial Court upheld the imposition of the financial institutions exci
se tax and
corporate excise tax in two cases, despite the fact that the taxpayers involved did not have physical presence in the
state. The U.S. Supreme Court denied certiorari in both matters.
Capital One Bank v. Commissioner of Revenue,

899 N.E.2d 76 (
Mass.

Jan

08, 2009), cert. denied
U.S, No. 08
-
1169 (June 22, 2009);
Geoffrey Inc. v. Commissioner
of Revenue
, Mass.,
899 N.E.2d 87

(Mass.

Jan

08, 2009), cert. denied U
.S., No. 08
-
1207 (June 22, 2009).


Wisconsin legislation enacted in 2009 provides that,

effective for tax years beginning on or after January 1, 2009,
the definition of "doing business" includes an economic nexus standard. Under the expanded definition, companies
engaging in any of the following activities are deemed to be doing business in

Wisconsin and subject to the state
income tax:



regularly selling products or services of any kind to customers in Wisconsin who receive the product or
service in Wisconsin;



regularly soliciting business from potential customers in Wisconsin;



reg
ularly performing services outside of Wisconsin for which the benefits are received in Wisconsin;
regularly engaging in transactions with Wisconsin customers that involve intangible property and result in
receipts flowing to the taxpayer from within Wisco
nsin; or



holding loans secured by real or tangible property located within Wisconsin.


California legislation enacted in 2009 adopts a "factor presence" nexus standard e
ffective for taxable years
beginning on or after January 1, 2011. Specifically, the
legislation provides that the definition of "doing business"
in Cal. Rev. & Tax. Code Sec. 23101 includes any taxpayer whose sales in the state for the taxable year exceed the
lesser of $500,000 or 25% of the taxpayer's total sales. For purposes of deter
mining whether the sales threshold is
exceeded, sales of the taxpayer include sales by an agent or independent contractor of the taxpayer. The legislation
also includes within the definition of "doing business" having real property and tangible personal p
roperty in the
state exceeding $50,000, or 25% of the taxpayer's total real and tangible personal property, or paying compensation
in the state in excess of $50,000, or 25% of the total compensation paid by the taxpayer.


Practitioners with clients licens
ing intangibles or otherwise deriving income where the activities are not protected by
P. L. 86
-
272 in states where the client does not otherwise have a physical presence should review any recent
changes in the applicable state laws and regulations, as wel
l as recent court decisions in this area.






STATE TAX NEXUS





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3.

Solicitation




Under P. L. 86
-
272, an activity is immune from net income taxation if it consists merely of solicitation of sales of
tangible personal property. The term “solicitation” is not defin
敤 by mK iK US
J
OTO㬠;ow敶erI 瑨攠售匮ppuprem攠Court

Wisconsin Dept. of Rev. v. William Wrigley, Jr. Co.
, 505 U.S. 214 (1992) (Wrigley) interpreted this term. In
finding that Wrigley’s activities in Wisconsin exceeded the protection of P. L. 86
J
OTOI 瑨e

Cour琠h敬e 瑨慴a 瑨e
solicitation of orders includes “any explicit verbal request for orders and any speech or conduct that implicitly
invites an order.”




The clear line is the one between those activities that serve no independent business function apa
rt from their
connection to the solicitation of orders, and those that the company would have reason to engage in anyway but
chooses to perform through its in
-
state sales force. The Court affirmed the de minimis principle of P. L. 86
-
272 in
holding that,
to lose the immunity afforded by P. L. 86
-
272, the activity must establish a nontrivial additional
connection with the taxing state. In aggregate, though minimal in comparison to Wrigley’s total solicitation
慣瑩t楴楥s in 瑨攠s瑡瑥t th攠non
J
immun攠慣瑩v楴
楥s 數捥敤敤 th攠d攠minimis s瑡nd慲dK mra捴楴楯n敲s shou汤 捯ns楤敲
wh整h敲 慣瑩ti瑩敳 o瑨敲 th慮 so汩捩瑡瑩ln 慲攠mor攠瑨an d攠m楮im楳 in 愠p慲瑩捵污l s瑡瑥t



4.

Multistate Tax Commission Guidance to the States




The MTC has issued lengthy guidance u
nder P. L. 86
-
272 including a list of activities that it considers protected
under the public law and a list of unprotected activities that will cause sales to lose their protection under the public
law.
A copy of the MTC Statement of Information Concerni
ng Practices of the MTC and Signatory States Under
Public Law 86
-
272 can be found on the MTC’s web page (http://www.mtc.gov/) under the Uniformity tab.


Working together through the MTC, twenty
-
six states issued Nexus Program Bulletin 95
-
1 (1995), targetin
g the
computer direct marketing industry. The bulletin takes the position that, because in
-
state repair services are not
immune from taxation by reason of P. L. 86
-
272, the use of independent contractors or other representatives of a
computer company to p
rovide such repair services creates nexus for the computer company. Although the nature of
the bulletin is informative and educational rather than regulatory, it met much opposition from industry and mixed
reaction from the states. In fact, California re
jected the bulletin as a policy statement. The California State Board of
Equalization (BOE) voted on March 14, 1996 to rescind California’s inclusion on the list of 26 states that have
慤op瑥t jqC Bu汬整楮 VR
J



Through its National Nexus and Multistate
Voluntary Disclosure Programs, the MTC also assists businesses involved
in multistate commerce in voluntarily resolving potential state sales/use and income/franchise tax liabilities where
nexus is the central issue. The program acts as a coordinator thro
ugh which companies may approach 46 member
and non
-
member states which participate in these programs (AL, AK, AZ, AR, CA, CO, CT, DC, FL, GA, HI, ID,
IN, IA, KS, KY, LA, ME, MD, MA, MI, MN, MS, MO, MT, NE, NH, NJ, , NC, ND, OH, OK, OR, RI, SC, SD, TN,
TX,
UT, VT, VA, WA, WV, WI, WY) anonymously and seek resolution of potential liabilities arising from past
activities. It is the strict policy of the MTC and its National Nexus Program that they will not reveal the identity of a
taxpayer to any state that doe
s not accept the voluntary disclosure agreement. Further information on this program
can be found on the MTC’s web page (http://www.mtc.gov/) or by contacting the MTC at 202
J
㔰R
J
PUMMK bxp敲楥i捥
h慳⁳hown 瑨慴a in som攠捡s敳e 瑡tpay敲s may b攠慢汥l瑯 n敧
o瑩慴攠愠b整瑥e 慲r慮gemen琠t楲散瑬y w楴h ind楶楤u慬as瑡瑥s㬠
how敶敲I 瑨攠tim攠and⽯r 捯s琠tf do楮g so may ex捥敤 瑨攠ben敦楴f nego瑩慴tng w楴h 敡捨 楮d楶楤u慬as瑡瑥t



Conclusion


The issue of nexus for income, franchise/net worth, sales/use, and othe
r tax purposes is a complex one and there is a
tremendous degree of inconsistency among the states. The large number of court cases in this area highlights the fact that



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the Due Process and Commerce Clause analysis is largely dependent on the specific fac
ts and circumstances of each case.
Among the state court systems, emerging issues, such as agency nexus, affiliate nexus, and economic nexus, evolve in the
ever
-
changing market place. In addition, the changing landscape of state taxes, including the move

to non
-
traditional, non
-
income based taxes adds additional complexity. This guide is meant as a broad reference tool used to highlight those areas
that individual states have deemed to create nexus within their state for purposes of subjecting an entity
to taxation.




Page 1 of 5




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Page Completed


STATE TAX NEXUS CHECKLIST
-

FREQUENTLY ASKED QUESTIONS

ON STATE NEXUS QUESTIONAIRES







COMMENTS OR





YES

NO

EXPLANATION


1)

If the business a corporation, was it incorporated in this state?



______

______

________________


2)

If the business is not a corporation, was it organized in this state?



______

______

________________


3)

Is the business authorized by the Secre
tary of State to do business
in the state?






______


______


________________


4)

Is the business currently filing any tax returns with the state
(specify type of tax)?




______


______


________________


5)

Has the business previously filed in
come tax returns in the state?



______

______

________________


6)

Does the business have an office, agency, warehouse, or other
business location owned or leased in the state?




______


______


________________


7)

Is the business listed in any telephone directories in the state?



______

______

________________


8)

Does the business maintain a telephone answering service in the
state?




______


______


________________


9)

Does the business perform constr
uction contracts in the state?



______

______

________________

10)

Does the business act as a sub contractor in the state?



______

______

________________

11)

Has the business used the court system in this state for any
reason, even as a defendant?




______


______


________________

12)

Does the business own or lease real property in the state?



______

______

________________

13)

Does the business own or lease tangible personal property located
in the state?




______


______


________________

14
)

Does the business rent or lease tangible personal property to
others who then use the property in the state?





______


______


________________

15)

Does the business license intangible property such as patents,
trademarks, tradenames, etc. for use in
the state?




______


______


________________

16)

Does the business license software for use in the state?



______

______

________________

17)

Has the business ever executed contracts in the state?



______

______

________________

18)

Does the busi
ness have employees or representatives who
perform any of the following activities in the state:










a)

Solicit orders with or without authority to approve?



______

______

________________


b)

Engage in managerial or research activities?



_____
_

______

________________

STATE TAX NEXUS CHECKLIST
-

FREQUENTLY ASKED QUESTIONS

ON STATE NEXUS
QUESTIONAIRES







COMMENTS OR




YES

NO

EXPLANATION




Page 2 of 5




20
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Page Completed



c)

Secure deposits on sales?



______

______

________________


d)

Make collections on regular or delinquent accounts?



______

______

________________


e)

Repossess items or property of the business?



______

______

______
__________


f)

Offer technical assistance and training to purchasers of its
products before or after the sale?




______


______


________________


g)

Repair, service, or replace faulty or damaged goods?



______

______

________________


h)

Install or
assemble its products?



______

______

________________


i)

Inspect the installations of the business products by its
customers or users of its products?




______


______


________________


j)

Pick up or verify destruction or damaged or returned
mercha
ndise from customers or users of the business
products?





______



______



________________


k)

Coordinate delivery of merchandise, whether or not special
promotions are involved?




______


______


________________


l)

Distribute replacement parts?




______

______

________________


m)

Conduct credit investigations or arrange for credit and
financing for purchasers of its products?




______


______


________________


n)

Rectify or assist in rectifying any product, credit, shipping
or similar com
plaint arising from the purchase or use of its
products?





______



______



________________


o)

Service or maintain displays of its products?



______

______

________________


p)

Accept returned merchandise for customers?



______

______

_________
_______


q)

Sell tangible personal property?



______

______

________________


r)

Make “on the spot” sales of company products?



______

______

________________




m敲form engin敥ring or d敳楧n fun捴楯ns?



______

______

________________




Ch散k
the 楮ven瑯ry of cus瑯m敲sI 慤v楳攠 cus瑯m敲s or
d楳瑲楢u瑯rs 慳 瑯 m楮imum inv敮瑯ry 汥v敬猻 remov攠
obso汥瑥l d慭ag敤 or ou瑤慴敤 goods?





______



______



________________




䡡ed汥l捯mp污ln琠forms and forw慲d 瑯 瑨攠prop敲 汯捡瑩tn
for pro捥ss楮g?

Eff y敳Ⱐprovid攠愠捯py of formK)




______


______


________________

STATE TAX NEXUS CHECKLIST
-

FREQUENTLY ASKED QUESTIONS

ON STATE NEXUS
QUESTIONAIRES







COMMENTS OR




YES

NO

EXPLANATION




Page 3 of 5




20
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Page Completed



v)

Process complaints?



______

______

________________


w)

Investigate, recommend, or appoint potential dealers,
agents, or distributors of the company in the state?




______


__
____


________________


x)

Arrange financing for customers in the state or through
lenders located in the state?




______


______


________________


y)

Conduct training courses, seminars or lectures?



______

______

________________

19)

Does the busine
ss have a standard form of written agreement
with sales representatives? If so, please enclose a copy.




______


______


________________

20)

Does the company provide a warranty or service contract for
products sold to customers in the state?




______


______


________________

21)

Does the business investigate, recommend, or appoint, potential
dealers, agents, or distributors of its products or services in the
state?





______



______



________________

22)

Does the business provide computer program
ming or data
processing services in the state?




______


______


________________

23)

If the business is a member of an af
filiated group of corporations
does the business file:







a)

A consolidated return in the state?



______

______

______________
__


b)

A combined return for a unitary business group in the state?



______

______

________________

24)

Does the business have any affiliates who conduct business in the
state and perform any services for the company in the state?




______


______


___
_____________

25)

Does the business maintain a bank account or other investment in
the state?




______


______


________________

26)

Does the business have display merchandise in leased space in
the state?




______


______


________________

27)

Does
the business contract with a third party that is located in the
state to print and distribute promotional materials to customers
and potential in and outside the state?





______



______



________________

28)

Does the business drop ship orders from the

state?



______

______

________________

29)

Do employees have samples in the state? If yes, then state the
average value thereof.




______


______


________________

STATE TAX NEXUS CHECKLIST
-

FREQUENTLY ASKED QUESTIONS

ON STATE NEXUS
QUESTIONAIRES







COMMENTS OR




YES

NO

EXPLANATION




Page 4 of 5




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30)

Does the business have any goods, property or equipment on loan
in the state? (e.
g., signs, display cases, tools & dies, molds,
patents, etc.)





______



______



________________

31)

Does the business reserve the right of inspection of the customer’s
f慣楬楴楥猠ir produ捴猠慦瑥t d敬楶敲y?




______


______


________________

㌲P

a
o敳e瑨e bus楮ess prov楤攠s慬敳eor s敲v楣攠m慮u慬s 瑯 custom敲sI
d楳瑲楢u瑯rsI or 慧敮ts?




______


______


________________

㌳P

䑯敳e 瑨攠busin敳e 慤v敲瑩t攠in 瑨攠s瑡瑥t ff soI 汩l琠th攠d楦f敲敮t
慤v敲瑩ting m敤楡ius敤K




______


______


_____________
彟_

㌴P

䑯敳e th攠busin敳s do 慮y 汯捡汩穥l 慤v敲瑩ting E捯op敲慴楶攠or
o瑨敲w楳攩 楮 th攠s瑡瑥t




______


______


________________

㌵P

䑯敳e瑨攠busin敳s h慶攠any emp汯y敥s or r数r敳敮瑡瑩tes who use
瑨敩e 楮
J
s瑡瑥thom攠㨠












䅳⁡Abusin敳s 慤d
r敳e?



______

______

________________




qo r散敩e攠bus楮ess 捡汬敲s?



______

______

________________




qo s瑯r攠楮v敮瑯ry?



______

______

________________




qo m慩n瑡tn books⽲散ords?



______

______

________________




qo m慩n瑡tn 捯mpan
y prop敲瑹?



______

______

________________

㌶P

Ar攠 emp汯y敥s r敩mburs敤 for 瑥汥thon攬 f慸 or u瑩汩瑩敳
數p敮ses?



______

______

________________

㌷P

Ar攠hom攠numb敲s 汩l瑥t in 汯捡氠ldv敲瑩tem敮ts of th攠busin敳s?



______

______

________________

㌸P

䑯 emp汯y敥s of th攠捯mpany so汩捩琠lrd敲s for 瑨攠s慬攠of㨠









o敡氠ls瑡瑥t



______

______

________________




卥pv楣敳i



______

______

________________




fn瑡tg楢汥lprop敲瑹?



______

______

________________

㌹P

䑯敳⁴e攠bus楮ess h慶
攠any 捯nsign敤 s瑯捫 of goods 楮 th攠s瑡瑥t



______

______

________________

㐰4

䑯敳⁴e攠bus楮ess op敲慴攠愠mob楬攠s瑯r攠楮 瑨攠s瑡瑥t



______

______

________________

㐱4

aoes the business m慩nta楮 a secur楴i 楮瑥rest⽭or瑧慧e in proper瑹
unt楬 瑨e c
ontra捴 price or 慭ount borrowed has b敥n p慩d㼠




______


______


________________

STATE TAX NEXUS CHECKLIST
-

FREQUENTLY ASKED QUESTIONS

ON STATE NEXUS
QUESTIONAIRES







COMMENTS OR




YES

NO

EXPLANATION




Page 5 of 5




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Page Comp
leted


42)

Does the business have agents or independent contractors selling
products in the state and are they forbidden from selling or
promoting competitors’ services?





_
_____



______



________________

㐳4

䑯敳e 瑨e bus楮ess g楶e 慰prov慬a 瑯 s敲v楣ing d楳瑲楢u瑯rs 慮d
d敡汥ls w楴h楮 th攠 s瑡瑥t wh敲攠 捵s瑯m敲s 捡n hav攠 produ捴猠
s敲v楣敤 or r数慩a敤?





______



______



________________

㐴4

䑯敳⁴ee bus楮ess own an 楮瑥
r敳琠楮 愠p慳s
J
瑨rough en瑩ty th慴ahas
op敲慴楯nsI 捯ndu捴猠cusin敳eI or owns r敡氠lrop敲瑹 in 瑨攠st慴政




______


______


________________

㐵4

Do delivery persons assist with the “set up” or installation of the
business’ products?




______


______


_
_______________

㐶4

Ar攠produ捴猠ch楰p敤 瑯 瑨攠st慴攠楮 r整ern慢汥l捯n瑡tn敲s?



______

______

________________




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185



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STATE TAX ALLOCATION/APPORTIONMENT




INTRODUCTION



Income earned by a multistate corporation is allocated and apportioned among the state
s of operation. In general,
income from other than regularly occurring business operations (
i.e.,

nonbusiness/nonapportionable income) is
allocated using rules specific to the type of income at issue. In contrast, income from regularly occurring business

operations (
i.e.,

business/apportionable income) is generally apportioned using a statutorily
-
mandated apportionment
formula. Allocation and apportionment is viewed as the most effective way to determine the level of income earned in
a state, and superio
r to separate accounting. Under separate accounting, the activities of a corporation within a state
are considered separate and distinct from those outside the state. The corporation attempts to source each item of
revenue and expense to the state where
it was generated. Because it has several major weaknesses, separate
geographical accounting in the state tax area (once the preferable method for determining the income of a corporation)
is now used only in limited instances. Its primary weaknesses are e
ase of manipulation and lack of accuracy.



1.

SPECIFIC ALLOCATION



Specific allocation generally refers to a method by which certain types of income are traced to their source or other
connection with a state and attributed solely to that state. In
those states that distinguish between business and
nonbusiness income, income classified as nonbusiness income is specifically allocated and income classified as
business income is subject to apportionment. A few states have identified certain types of in
come as allocable and the
taxpayers remaining net income is apportioned among the states with which the taxpayer has nexus.



A.

Business v. Nonbusiness Income




The distinction between business and nonbusiness income is significant because, while nonbu
siness income is
allocable to a specific state (typically either the taxpayer’s state of commercial domicile or the situs of the
prop敲瑹)I busin敳s in捯m攠wi汬lb攠subj散琠瑯 慰por瑩tnment 慮d w楬i b攠d楶楤敤 among th攠s瑡瑥猠in wh楣h the
mu汴楳瑡瑥t瑡tpay
敲 do敳⁢us楮敳e b慳敤 on 愠m慴hem慴楣a氠lppor瑩tnmen琠formu污l




qh攠瑨r敥 m慩a m整hods us敤 瑯 d整敲min攠wh整e敲 in捯m攠is busin敳s or nonbus楮ess 慲攺






啮楦orm a楶is楯n of fn捯m攠䙯r q慸 murpos敳e A捴c E啄rqmA) 䑥a楮楴楯ns of Bus楮敳s 慮d 乯nbus楮ess
fn捯m攻





䵵汴楳瑡瑥tq慸 Commiss楯n E䵔C) r敧u污瑩lns Ewhen 慤op瑥t by 愠s瑡瑥t㬠;nd





啮楴敤 却慴敳 puprem攠Cour琠t慳敳K


䑵攠瑯
愠污捫 of uniformity among th攠s瑡瑥t慰por瑩tnm敮t prov楳楯nsI th攠sp散if楣i污ws of 敡捨 jur楳d楣瑩in in
qu敳瑩on shou汤 b攠捯nsul瑥tK




1)

UDITPA Definitions of Business and Nonbusiness Income





Under UDITPA, business income is defined as income that

arises from transactions and activities in the
regular course of the taxpayer’s trade or business and includes income from tangible and intangible
prop敲瑹 楦 瑨攠慣quis楴楯nI m慮慧emen琬t 慮d d楳pos楴楯n of 瑨攠prop敲瑹 捯ns瑩tu瑥t 楮瑥gr慬ap慲瑳 of 瑨e

xpayer’s regular trade or business operations. UDITPA §1(a). UDITPA defines nonbusiness income as
慬氠楮捯m攠
other than

business income. UDITPA §1(e).





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186



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AICPA, Inc.

STATE TAX ALLOCATION/APPORTIONMENT






Many states interpret the UDITPA definition of business inc
ome as incorporating two tests for
determining whether income is business income. The tests are referred to as the “transactional test” and
the “functional test.” Most states take the position that if income is classified as business income under
either

test, the income will be classified as business income. However, the courts of several states have
interpreted the UDITPA language as requiring that both tests be satisfied in order to classify income as
business income.





a.

Transactional Test






U
nder the transactional test, income is considered business income if it arises from “transactions and
activities in the regular course of the taxpayer’s trade or business.” The focus is on the
type of
transaction

giving rise to the income, and how the tra
nsaction relates to the taxpayer’s regular trade
or bus楮敳sK










bxamp汥㨠 qh攠 s慬攠 of 愠 fa捴cry by 愠 manuf慣tur敲 norm慬ay wou汤 b攠 捯ns楤敲敤 unusu慬a
數瑲慯rd楮慲yI 慮d o捣urring ou瑳楤攠th攠norm慬a捯urs攠of busin敳eK qh攠g慩a on such a s慬攠wou

b攠捯ns楤敲敤 nonbusin敳s 楮com攠und敲 瑨攠瑲慮s慣瑩tn慬a瑥s琮t





b.

Functional Test






Under the functional test, income is considered business income if the acquisition, management, and
disposition of the asset that generates the income constitu
te integral parts of the taxpayer’s regular
瑲慤攠or bus楮敳s op敲慴楯nsK qh攠fun捴楯na氠瑥獴 focuses on 瑨攠
relationship

between the asset
giving rise to the taxable income and the business itself.






Example: Gain or loss on the sale of a factory by

a manufacturer likely would be considered
business income under the functional test because the factory would have been acquired and used in
the taxpayer’s regular trade or business.


A汴hough many s瑡瑥猠慰por瑩tn busin敳e in捯m攠慮d 慬汯c慴攠nonbus楮es
s in捯m攠using prov楳楯ns
捯mp慲慢汥l 瑯 啄rqmAI no琠慬氠s瑡瑥猠fo汬lw th楳 pr慣瑩捥t 卯m攠s瑡瑥s sp散if楣慬iy 慬ao捡瑥t only
敮um敲慴敤 types of 楮捯me E
e.g.
, interest, dividends, rents, royalties), and others apportion all
income except that on which the
state is prohibited under the U.S. Constitution from imposing tax.
For example, Illinois law defines business income as all income treated as apportionable business
income under the U.S. Constitution

but allows taxpayers to make a binding election to trea
t all
income as apportionable business income
. Massachusetts does not define business income, but
generally defines nonbusiness income as income, under the U.S. Constitution, that can only be taxed
in the taxpayer's state of commercial domicile. North Ca
rolina does not classify income as
business/nonbusiness, but rather as apportionable/allocable income. Apportionable income is
defined as all income apportionable under the U.S. Constitution. Kansas adopts the
business/nonbusiness income distinction, but

allows taxpayers to make a binding election to treat all
income as apportionable business income.




2)

Multistate Tax Commission Regulations





Under the MTC regulations which interpret UDITPA, there is a presumption in favor of classifying
income as
business income. According to the MTC regulations, “an item of income is nonbusiness
income only if it does not meet the definitional requirements for being classified as business income.”
䵔C o敧K §f嘮NKE愩K qh攠fo汬lwing 慲攠數amp汥猠lf business in捯m
攠und敲 瑨攠䵔C oegu污瑩lnsW







Rents received from property “used” in or “incidental [to]” the taxpayer’s trade or business and
楮捬ud慢汥l楮 瑨攠prop敲ty f慣torK







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20
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†††† †††††††
STATE TAX ALLOCATION/APPORTIONMENT


Gains and losses
from dispositions of real or personal property if the property was used in the

taxpayer’s trade or business or was otherwise included in the property factor.







In瑥t敳琬eif 瑨e 楮瑡tg楢汥lgener慴楮g th攠in瑥t敳e 楳 us敤 or aros攠from 瑨e 瑲慤攠or bus
iness or wh敲攠
瑨攠purpos攠for 慣qu楲ing and ho汤楮g 瑨攠in瑡ng楢汥l楳 an 楮t敧r慬a func瑩tn慬a or op敲慴楶攠捯mponent
of 瑨攠瑲慤攠or bus楮敳s op敲a瑩tns, or o瑨敲wis攠m慴敲楡ily 捯n瑲楢u瑥猠瑯 瑨攠produ捴楯n of busin敳s
楮捯m攠of 瑨攠瑲慤攠or bus楮ess op
敲慴楯ns.







Dividends, if the stock arose out of or was acquired in the regular course of the taxpayer’s trade or
busin敳e op敲慴楯ns or wh敲攠瑨攠慣qu楲楮g 慮d ho汤楮g of 瑨攠s瑯ck 楳 慮 楮瑥tr慬a fun捴楯n慬a or
op敲慴楶攠捯mpon敮琠of 瑨e tr慤攠or bu
s楮敳s op敲慴楯nsI or o瑨敲wis攠m慴敲楡汬y 捯n瑲楢u瑥猠瑯 the
produ捴楯n of busin敳s 楮捯me of 瑨攠瑲慤攠or bus楮敳s op敲慴楯nsK







P慴敮琠慮d 捯pyr楧h琠roy慬瑩as 慲攠bus楮敳s 楮捯m攠if 瑨攠p慴敮琠or 捯pyrigh琠慲os攠out of or w慳
捲敡瑥t 楮 th攠regu污l

course of the taxpayer’s trade or business operations or where the acquiring and
ho汤楮g of th攠p慴敮t or 捯pyr楧ht 楳 慮 楮瑥tr慬a func瑩tn慬I or op敲慴楶攠捯mpon敮琠of th攠瑲慤攠or
busin敳e op敲慴楯nsI or o瑨敲wis攠m慴敲楡汬y 捯n瑲楢u瑥猠瑯 瑨攠produ捴c
on of business in捯me of the
瑲慤攠or bus楮ess op敲慴楯nsK




3)


The United States Supreme Court




In addition to the rules under UDITPA and the MTC regulations, the U.S. Supreme Court has adopted
another test to determine whether income is subject to
apportionment.





In
Allied
-
Signal, Inc. v. Director, Division of Taxation
, 504 U.S. 768 (1992), the Court held that only
income from the taxpayer’s unitary business is apportionable income. If the taxpayer’s activities and
prop敲瑩敳 慲攠p慲琠of 愠unit
慲y busin敳sI in捯me from such a捴楶楴y or prop敲瑹 楳 捯ns楤敲敤 瑯 b攠d敲楶敤
from the regular course of the taxpayer’s trade or business and is deemed to be apportionable income.
Income that is unrelated to the taxpayer’s unitary business is considered

瑯 b攠楮捯m攠subj散琠瑯 慬汯捡瑩tnK





However, while affirming the unitary test for determining whether income is apportionable, the Court held
that this test is not the exclusive means of meeting the constitutional requirements for apportioning
incom
e.





The Court introduced the operational versus investment function test. Under this test, a transaction or
activity may create apportionable income if it serves an operational, rather than an investment, function.
By way of example, the Court point
ed out that interest earned by a corporation on short
-
term bank
deposits used as working capital may be apportionable even though the bank and the corporation are not
engaged in a unitary business. Likewise, income received from stock of a company held by

a corporation
to ensure a steady supply of raw materials for the corporation’s production process would presumably
constitute apportionable income even if the supplier was not part of the taxpayer’s unitary business.
卩mi污llyI in捯m攠from s瑯捫 楮vestme
n瑳 th慴a捯ns瑩tu瑥tint敲im us敳eof 楤汥lfunds 慣cumu污瑥l for futur攠
busin敳e op敲慴楯ns wou汤 慰p慲敮瑬y 捯ns瑩tu瑥t慰por瑩tn慢汥l楮捯m攮





Additionally, as in
ASARCO v. Idaho State Tax Comm’n
I 4R8 售匮p P0T (N98O)I 瑨攠Cour琠 r敪散瑥t 愠
“business purp
ose” test, stating that the mere fact that an intangible asset was acquired pursuant to a long
J
瑥tm 捯rpor慴攠s瑲慴敧y of 慣qu楳i瑩tns and d楳pos楴楯ns do敳eno琠捯nv敲琠慮 o瑨敲wis攠p慳aiv攠楮v敳tment
楮瑯 慮 op敲慴楯n慬afun捴楯nK





The United States Su
preme Court revisited the operational test issue in 2008, when it vacated the decision
of the Illinois Appellate Court in

MeadWestvaco Corp. v. Illinois Dept. of Revenue
, No. 06
-
1413 (U.S.
Apr. 15, 2008), and remanded the case back to that court for furth
er consideration. The case involved the
question of whether it was constitutionally permissible for Illinois to apportion Mead Corporation’s gain
from th攠s慬攠of 慳s整猠ef i數is⽎數楳K qh攠s瑡瑥t慰p敬污瑥ecour琠t慤 捯n捬ud敤 瑨慴a䵥慤 慮d iexis⽎Lx楳

r攠no琠un楴慲yI y整 瑨a琠s瑡瑥 捯ur琠h敬e th慴a慰por瑩tnment was p敲miss楢汥lb慳敤 on 愠find楮g th慴ath敲e
was an “operational purpose” for Mead to own Lexis/Nexis.







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The U.S. Supreme Court reasoned that the state appe
llate court, having found no unitary relationship, erred
in considering whether Lexis/Nexis served an “operational purpose” in Mead’s business. In addition, the
Cour琠s瑡瑥t 瑨慴a
r敦敲en捥s 瑯 ?oper慴楯n慬a fun捴楯n? 楮
Container Corp.

and
Allied
-
Signal

we
re not
intended to modify the unitary business principle by adding a new ground for apportionment. The concept
of operational function "simply recognizes that an asset can be a part of a taxpayer's unitary business even
if what we may term a 'unitary rela
tionship' does not exist between the 'payor and payee.'" The Court made
note of the banking example used in
Allied
-
Signal,

as well as the futures contracts at issue in the
Corn
Products

case. "In each case, the 'payor' was not a unitary part of the taxpa
yer's business, but the relevant
asset was." The conclusion that the asset served an operational function "was merely instrumental to the
constitutionally relevant conclusion that the
asset

was a unitary part of the business being conducted in the
taxing
state[.]" The Court went on to say that where the asset in question is another business, "we have
described the 'hallmarks' of a unitary relationship as functional integration, centralized management, and
economies of scale." While the trial court found
all of these hallmarks lacking, the appellate court made no
such determination, instead relying on "its operational function test."


The Supreme Court remanded the case to determine whether the taxpayer and Lexis/Nexis constituted a
unitary business and

invited the lower court to conduct a unitary analysis. The Illinois Appellate Court
subsequently remanded the case further to the circuit court "for the limited purpose of conducting a hearing
as to the issue of the apportionment of intangibles based on
the State's contacts with the capital asset rather
than the taxpayer." This was an alternative argument raised by the state in its reply brief to the Court and at
oral arguments, but was not ruled on by the Court.







B.

Allocation of Nonbusiness Inco
me




Once income has been classified as nonbusiness, the next step is to determine to which state it should be
allocated. Generally, nonbusiness income is sourced to the state in which the property is located (for tangible
assets) or to the taxpayer’s c
omm敲捩慬cdom楣楬攠Efor in瑡tg楢汥l慳a整猩e




1)

Commercial Domicile





Depending on the taxpayer, the identification of a taxpayer’s state of commercial domicile can be a very
simp汥 pro捥ssI or 愠mor攠捯mp汥l pro捥ssK rnd敲 啄rq偁m§NEb)I 捯mm敲捩慬c
dom楣i汥 楳 defin敤 慳athe
“principal place from which the trade or business of the taxpayer is directed or managed.” The criteria
瑨慴a慲攠typ楣慬iy us敤 瑯 d整敲min攠瑨攠捯mm敲捩慬cdom楣楬i of 愠瑡tpay敲 楮c汵d攺











Site of board of directors’
m敥瑩tgs;






Lo捡瑩tn of s瑯捫ho汤敲 m敥瑩ngs;






Lo捡瑩tn and r敳楤敮捥 of th攠off楣敲s㬠;nd






Lo捡瑩tn of 捯rpor慴攠r散ords 慮d b慮k 慣捯unts, 整挮








In Pr楶慴攠L整瑥t Ru汩ng (r敤慣瑥t v敲s楯n) 04
-
004 (9⼱3/2004), 瑨攠Louis楡n愠䑥D慲tm敮
琠of R敶enue
數p污楮敤 th慴a瑨敲攠楳 no br楧ht
-
line test to determine a corporation’s commercial domicile, but that each
corporation’s actual commercial practices as a whole must be examined to decide where business is
d楲散瑥t 慮d m慮ag敤K fn
Kevin Assoc
iates., LLC v. Crawford
, 865 So.2d 34 (2004), the Louisiana
Supreme Court held that a Delaware trademark holding company had Louisiana commercial domicile and,
thus, was subject to income/franchise tax because the taxpayer functioned and was substantially
managed
in Louisiana through its parent company and numerous board of director actions occurred in the state.







3.

FORMULARY APPORTIONMENT




As indicated above, income from regularly occurring operations (
i.e.,

business/apportionable income) is
app
ortioned using a statutorily
-
mandated formula. However, according to the U.S. Supreme Court, the
Constitution requires that formulary apportionment be applied only to the income of a unitary business. As the







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Court
states, “[t]he linchpin of apportionability in the field of state taxation is the unitary business principle.”
Mobil Oil Corp. v. Commissioner of Taxes
, 445 U.S. 425 (1980).



A.

Unitary Business




A number of requirements for determining the scope of
a unitary business have developed. In addition to
Supreme Court decisions addressing unitary business principles, the following tests devised at the state level
have gained widespread applicability: (1) the three unities test, (2) the contribution and dep
endency test, and (3)
the factors of profitability test. There may also be “unitary” implication for a single corporate entity in addition
to “unitary” implications in relation to a unitary group of affiliated corporations.


䑵攠瑯 瑨攠污lk of uniform楴y
in 瑨is 慲敡I sp散楦楣is瑡瑥t污w shou汤 b攠捯nsu汴敤K








1)

Three Unities Test





The three unities approach was developed in the California case
Butler Brothers v. McColgan
, 111 P.2d
334, 341 (1941)
aff’d,

PNR 售匮p R0N (N94O)I 慮d prov楤敳eth慴a a
nalytically, “the unitary nature of a
busin敳e is d敦in楴敬y es瑡t汩lh敤 by th攠pr敳敮捥 of th攠fol汯wing 捩c捵ms瑡n捥s㨠EN) unity of own敲sh楰;
EO) un楴y of op敲慴楯n 慳a ev楤敮捥d by 捥n瑲慬a purch慳angI 慤v敲瑩s楮gI 慣捯un瑩ngI and managem敮t
d楶楳楯ns㬠;
nd (3) unity of use in its central executive force and general system of operation.”





啮楴y of own敲sh楰 r敦敲s 瑯 愠捯mmon own敲sh楰 s瑲u捴cre of 愠bus楮敳s 慮d 楴i 慦f楬楡瑥sK A汴hough the
r敳e汵瑩tn of 瑨is 瑥s琠d数敮ds in 污lg攠p慲琠on 瑨e p慲瑩捵
lar provisions of each state’s law, as a general
ru汥l 瑨敲攠mus琠b攠gr敡瑥t 瑨an RM p敲捥n琠s瑯捫 own敲sh楰 b敦or攠愠group of busin敳ees s慴楳fy th攠un楴y
of own敲sh楰 r敱u楲emen琮





啮楴y of op敲慴楯n 楳 ev楤敮捥d by 捥n瑲慬楺敤 suppor琠tun捴cons su捨

as㨠











Corpor慴攠慣捯un瑩tg;






Leg慬a






P敲sonn敬e






Pur捨慳ang㬠






Adv敲瑩ting㬠






卥汬楮g㬠;nd






R敳敡e捨 and d敶敬epmen琬tor o瑨敲 汩l攠d数慲tm敮瑳.







啮楴y of us攠 楳 慰p慲敮瑬y shown by 愠 捥n瑲慬a e散u瑩ve for
捥 慮d 愠 g敮敲慬 sys瑥m of op敲慴楯ns.
A汴hough un楴y of us攠慰p敡rs 瑯 r敱u楲攠數散u瑩t攠d楲散瑩tn 瑯 慣h楥i攠捯rpor慴攠go慬猬a楴⁩i no琠捬敡r 慳a瑯
wh慴a數瑥t琠ton瑲o氠mus琠t攠e敲捩獥c by 瑨攠捥n瑲慬ae散u瑩v攠for捥.





A汴hough 楴iis h慲d 瑯 d楦f敲e
n瑩慴攠b整w敥n 瑨攠un楴y of op敲慴楯n 慮d un楴y of us攠瑥tts, on攠C慬aforn楡
d散楳楯n,
Chase Brass & Copper Co. v. Franchise Tax Board
, 10 Cal. App. 3d 496 (1970), attempted to
reconcile the two tests. According to the decision, the unity of operation tes
t refers to the personnel of an
organization who furnish auxiliary and advisory services and do not directly participate in production.
The unity of use test refers to the personnel who are directly responsible for manufacturing and
assembling functions i
n the various stages of production.




2)

Contribution and Dependency Test





The contribution and dependency approach was set forth in
Edison California Stores v. McColgan
, 183
P.2d 16 (1947). The California Supreme Court stated that where “the opera
瑩tn of 瑨e por瑩tn of 瑨攠
busin敳e don攠wi瑨楮 th攠s瑡瑥t楳 d数敮d敮琠tpon or 捯n瑲楢ut敳⁴e 瑨攠op敲慴楯n of 瑨攠busin敳s w楴hou琠the
state, the operations are unitary,” 183 P.2d at 24
J
ORK









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This test is the one m
ost widely used in determining whether a unitary business exists. Although it does
not suffer from the narrow scope of the three unities test, its breadth is also the test’s primary weakness
b散慵s攠of 楴s 楮慢楬ity 瑯 楤敮瑩晹 wh楣i 敬emen瑳 慲攠import慮
琠楮 making 愠uni瑡ty d整敲min慴楯nK





ff any 敬em敮t of op敲慴楯n慬 楮瑥td数敮d敮捥I howev敲 insubs瑡n瑩慬t w敲攠suff楣楥n琠瑯 捲敡瑥t愠un楴慲y
busin敳eI th敮 慰p慲敮瑬y 慮y 捯mmonly 捯n瑲o汬敤 bus楮ess敳 wou汤 捯nst楴i瑥t愠un楴慲y busin敳s E攮gKI
due

瑯 捯mmon 慣捯un瑩ng and r数or瑩tg sys瑥msI 捯mmon off楣敲sI 慮d 捯mmon insur慮捥 p污ls) und敲
瑨楳 瑥獴K qhusI for 瑨e un楴慲y bus楮ess 捯n捥p琠瑯 h慶攠any m敡ningI some w敩ght 慰p慲敮瑬y must be
g楶en 瑯 瑨攠subs瑡tt楡汩iy of th攠楮瑥td数敮den捥K




3
)

Multistate Tax Commission Guidance





The MTC has issued guidance on whether the activities of a taxpayer are to be regarded as a single trade
or business or separate trades or businesses and, although the regulations speak of the operations of one
tax
payer, many states have chosen to apply the rules across legal entities.





According to MTC Reg. §IV.1.(b), any of the following factors creates a strong presumption that the
activities of the taxpayer constitute a unitary business:







卡m攠typ攠of

business;






却数s 楮 愠v敲瑩捡氠pro捥ss㬠;nd






却牯ng 捥n瑲慬楺ad managemen琮t




4)

Factors of Profitability Test





In
Mobil Oil Corp. v. Vermont Tax Commissioner
, 445 U.S. 425 (1980), the U.S. Supreme Court held that
the income of a multist
ate business can be apportioned if its intra
-
state and out
-
of
-
state activities come
from a part of a unitary business. In
Mobil
, the Court set out the following factors, which have become
the basis of determining whether a business is unitary:







䙵n
捴楯n慬ain瑥gr慴楯n;






C敮瑲慬楺a瑩tn of man慧ement㬠;nd






E捯nom楥猠if s捡汥l



B.


Apportionment Formulas




Under formulary apportionment, there is no attempt to trace items of income to the state in which the income
was generated. Rather, a
formula is used to arrive at an adequate approximation. Formulary apportionment
divides a multistate corporation’s tax base among the states in which it does business by applying a fraction
r数r敳敮瑩tg th攠r慴楯 of 楮
J
st慴攠f慣瑯rs 瑯 瑯瑡氠f慣瑯rsK 䙯r
mu污ly 慰por瑩tnmen琠mer敬y 慰proxim慴敳a the
amoun琠of in捯m攠of 愠busin敳s 瑨慴a shou汤 b攠慴瑲楢u瑥d 瑯 愠par瑩捵污l s瑡瑥t 䑩vid楮g th攠in捯m攠of a
corporation by the use of a statutory formula provides a rough approximation of the corporation’s income
th慴ais
reasonably attributable to the corporation’s operations in the state.




qh攠f慣琠瑨慴a愠捯rpor慴楯n has s慬敳ain o瑨敲 s瑡瑥猠do敳enot 慵瑯m慴楣a汬y m敡n 瑨攠捯rpor慴楯n h慳ath攠r楧h琠瑯
慬汯捡瑥t慮d 慰por瑩tn 楴i 楮捯m攮 䵯s琠s瑡瑥猠do no琠p敲m
楴 愠捯rpor慴楯n 瑯 慬汯捡瑥tor appor瑩tn 楴i 楮捯m攠瑯
o瑨敲 s瑡瑥猠un汥ls th攠捯rpor慴楯n 楳 瑡x慢汥lin 慮oth敲 s瑡t攮 卯m攠s瑡瑥s r敱u楲攠th慴ath攠捯rpor慴楯n 慣瑵慬ay
f楬攠an in捯m攠瑡x r整urn wi瑨 慴 汥慳l on攠oth敲 s瑡瑥 b敦or攠瑨e 捯rpor慴楯n h慳a t
he r楧h琠瑯 慬汯捡瑥t and
慰por瑩tn 楴i 楮捯m攮




qh攠me瑨od 瑨a琠pr敶楯usly 睡猠mos琠fr敱uen瑬y us敤 瑯 慰por瑩tn bus楮ess in捯m攠瑯 愠p慲瑩捵污l s瑡瑥twas an
敶敮ly
J
w敩gh瑥tI 瑨r敥
J
f慣瑯r formu污lth慴a捯mp慲敳eth攠r慴楯 of in
J
s瑡瑥t 瑯 ov敲慬氠prop敲tyI

payro汬Ⱐand s慬as
Eor r散敩e瑳)K qh攠瑲敮d ov敲 瑨攠p慳琠aev敲慬ay敡rs h慳⁢敥n for 瑨攠s瑡瑥s 瑯 慳aign mor攠睥楧h琠瑯 瑨攠s慬as







Page
191



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factor than the other two factors (i.e., double weight the sales factor) or use a f
ormula with less than three factors
(i.e., two
-
factor or single
-
factor sales formulas). In addition, some states provide different formulas depending
upon the taxpayer’s industry.




䝥d敲慬ayI 楮 d整敲min楮g the 慰por瑩tnmen琠formu污l th攠sum of 瑨攠fa
捴crs is div楤敤 by no mor攠瑨an the
numb敲 of 慰p汩捡l汥lf慣瑯rsK qh敲敦or攬 楦 on攠or mor攠of th攠f慣瑯rs 楳 no琠pr敳en琠for 瑨攠瑯瑡氠op敲慴楯ns of a
捯rpor慴楯n E椮iKI 瑨攠denomin慴ar of 瑨e f慣瑯r 楳 穥ro)I 瑨e 慶敲慧e 慰por瑩tnmen琠typ楣慬ay is d整e
rm楮敤 by
d楶楤楮g th攠sum of th攠f慣瑯rs by 瑨攠numb敲 of th攠f慣瑯rs pr敳敮琮t 䙯r 數amp汥l for 愠st慴攠瑨慴ah慳⁡dop瑥t 慮
敶敮ly
J
w敩gh瑥tI 瑨r敥
J
f慣瑯r formu污l if 瑨攠s慬敳Ⱐprop敲瑹I or p慹ro汬lf慣瑯r 楳 no琠pr敳敮琬t瑨攠慰por瑩tnm敮t
formu污l楳 d整e
rm楮敤 by d楶id楮g th攠sum of 瑨攠rem慩ning two f慣瑯rs by twoK




啄rqmA prov楤敳 for the use of an 敱u慬ay
J
w敩gh瑥tI 瑨r敥
J
f慣瑯r formu污 b慳敤 on prop敲tyI payro汬Ⱐand s慬敳a
瑯 慰por瑩tn busin敳e⽡Lpor瑩tn慢汥l 楮捯m攮 佶敲 瑩m攬 s瑡瑥t hav攠mov敤 awa
y from an 敱u慬ay
J
w敩eh瑥t
formu污l瑯 r敬y on an 慰por瑩tnmen琠formu污lmor攠h敡v楬y
J
w敩gh瑥t 瑯w慲d 瑨攠s慬敳afa捴crK fn g敮敲慬a wh敲e
瑨攠s瑡tu瑯ry formu污 do敳ot f慩aly ref汥捴 愠瑡xpay敲Ds 汥ve氠lf busin敳s op敲慴楯ns in th攠s瑡瑥t th攠瑡xpay敲 may
r敱u敳琠er 瑨e 瑡t 慧ency may r敱u楲攠瑨攠use of an 慬瑥an慴av攠formu污l fn g敮敲慬a th攠慬瑥rn慴楶e formu污 慬汯ws
瑨攠use of s数慲慴攠慣捯unt楮gI th攠ex捬us楯n of any one or mor攠of 瑨e f慣瑯rsI th攠in捬cs楯n of one or more
慤d楴楯n慬af慣瑯rs wh楣i w楬i

f慩aly r数r敳敮琠瑨e 瑡tpay敲❳ busin敳s 慣瑩v楴y in this s瑡瑥I or 瑨攠emp汯ym敮琠of
慮y oth敲 m整hod 瑯 敦f散tu慴a 慮 敱u楴慢汥l慬汯捡瑩tn or 慰por瑩tnmen琠tf th攠瑡tpay敲❳⁩D捯m攮




fn gen敲慬a 愠瑡tpay敲 f楲s琠tsc敲瑡楮s th攠in捯m攠th慴ais 瑯 b攠a
ppor瑩tn敤I 慮d 瑨敮 mu汴楰l楥猠瑨is amoun琠ty the
慲楴im整楣e氠lv敲ag攠of thr敥 r慴楯s㨠










-
s瑡瑥tprop敲瑹 瑯 瑯瑡氠property㬠






-
s瑡瑥tpayro汬⁴l 瑯瑡氠payro汬㬠慮d






-
s瑡瑥ts慬as 瑯 瑯瑡氠s慬敳⸠




1)

Property Factor





In genera
l, the property factor consists of the taxpayer’s real and tangible personal property owned or
rented and used during the tax period in the regular course of the taxpayer’s trade or business. Intangible
prop敲瑹 楳 no琠usu慬ay 楮c汵d敤 楮 瑨攠prop敲瑹 f慣
瑯rK Add楴楯n慬lyI only prop敲瑹 us敤 瑯 produ捥
busin敳e or 慰por瑩tn慢汥l 楮捯m攬 no琠prop敲瑹 瑨慴a produ捥s nonbus楮ess in捯m攬 楳 楮捬cd敤 楮 瑨e
prop敲瑹 f慣瑯rK mrop敲瑹 own敤 typ楣慬iy is v慬a敤 慴ai瑳 av敲慧攠Eb敧楮ning of y敡r 慮d end of y敡r) 捯
s琮
o敮瑥t prop敲瑹 usu慬ay 楳 v慬u敤 慴a敩eh琠瑩m敳⁩es 慮nu慬ar敮瑡氮




2)

Payroll Factor





In general, the payroll factor consists of compensation paid by the taxpayer in the regular course of its
trade or business during the tax period. Compensa
tion consists of:











T慸慢汥lwag敳;






卡污S楥猻






Comm楳s楯ns㬠;nd






䅮y o瑨敲 form of remun敲a瑩tn p慩a 瑯 emp汯y敥s for p敲son慬a s敲v楣敳Ⱐ (but do敳e no琠 in捬cde
amoun瑳 p慩a 瑯 楮d数敮d敮琠ton瑲慣瑯rs).






卯m攠s瑡瑥s 數捬ud攠of
ficers’ compensation from the payroll factor.





3)

Sales Factor






In general, the sales factor consists of all gross receipts from transactions and activities in the regular
course of the taxpayer’s trade or business. The sales factor normally incl
ud敳Ⱐbu琠is no琠汩m楴敤 瑯I the
fo汬lw楮g㨠











䝲oss s慬敳
汥ls r整erns and 慬汯wan捥s);






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STATE TAX ALLOCATION/APPORTIONMENT







䙥敳⁡nd 捯mmiss楯ns r散敩eed from 瑨攠p敲forman捥 of s敲v楣敳㬠






R敮ts 慮d 汥慳攠payments r散敩e敤 from re
n瑩ng r敡氠lr 瑡tgib汥lprop敲瑹㬠






Pro捥eds from 瑨攠d楳posi瑩tn of o瑨敲 瑡tg楢汥l慮d in瑡tg楢l攠慳a整猻 and






Roy慬瑩as and o瑨敲 paymen瑳 r散敩e敤 from 瑨攠s慬攬 慳signmen琬tor 汩捥nsing of in瑡ngib汥lp敲son慬a
prop敲瑹 such 慳⁰慴敮瑳 and 捯py
rights.





a.

Sales of Tangible Personal Property






Generally, sales of tangible personal property are included in the numerator of the sales factor of the
state of destination. The destination is the state to which the property is delivered or ship
ped.
Property typically is deemed to be delivered or shipped to a purchaser within the state if the recipient
is located in the state, even if the property is ordered from outside the state.






To prevent sales from escaping inclusion in any state’s
s慬敳a f慣瑯r num敲慴arI many s瑡瑥猠h慶e
adopted the “throwback” rule. Under this rule, sales of tangible personal property sourced to a state
wh敲攠瑨攠瑡tpay敲 楳 no琠瑡t慢汥l E
e.g.
, because its activities are protected under P. L. 86
-
272) are
“thrown ba
ck” to the numerator of the state from which the goods were shipped.






䵅Ⱐ
k
g 慮d ts

adopted a “throw
J
out” rule, which excludes sales to non
J
nexus jur楳d楣瑩ons from 瑨e
d敮omin慴ar
of 瑨e s慬as f慣torK 乊
’s rule, which is repealed for privilege perio
ds beginning on or
慦瑥t
T⼱L
OMNMI 慰p汩敳 瑯 慬氠瑹pes of s慬敳ain捬ud敤 楮 th攠s瑡瑥❳ts慬as f慣瑯r㬠wh楬攠
ME’s and
t
s
’s
ru汥
s

慰pl
y only

瑯 s慬敳aof 瑡ng楢汥lp敲son慬aprop敲瑹K
qh攠乊

瑨row
J
ou琠ru汥lwas uph敬d 慳af慣楡汬y
捯ns瑩tu瑩tn慬ain
䝥n敲慬abngin
敳eCoK fn挮 vK 䑩v楳楯n of q慸慴楯n
; 䑯捫整 乯K MMUUMT
J
OMMSI E乊 q慸
C琮t
P⼱TL
OMMU)K
qh攠乊
䑩ais楯n of q慸慴楯n has 楳su敤
愠no瑩捥t d楳cuss楮g 愠乊

puprem攠Court
d散楳楯nI th楲汰oo氠偲mp敲
瑩ts fn挮 vK 䑩a散瑯r 乊

䑩a楳楯n of q慸慴a
onI 丮gK 匮p琮t 䑫琮t 乯K

A
J
ORI
T⼲U⼲MNNI 慦f楲mingI 慳a mod楦楥iI 瑨攠 f慣楡氠 捯ns瑩瑵t楯n慬楴y of 瑨攠 Corpor慴楯n Busin敳s q慸
“throw
J
out rule” (which was repealed, effective
T⼱L
OMNM)K fn 慣捯rd慮捥 wi瑨 th攠Cour琧t ru汩lg 楮
th楲汰oo氠mroper瑩敳I 瑨攠䑩a楳楯n h慳a r敶is敤 楴i 慵
d楴i po汩捹 捯n捥rn楮g 瑨攠慰p汩l慴楯n of 瑨e
瑨row
J
ou琠ru汥l瑯 r散敩e瑳 assign敤 瑯 k
s
I t
夬 慮d pa
K B散慵s攠th敳攠thr敥 s瑡瑥猠do no琠impos攠a
捯rpor慴攠楮捯m攠瑡x or 愠sim楬慲 bus楮ess 慣t楶ity 瑡xI th攠䑩v楳楯n w楬氠no琠throw ou琠r散敩e瑳
慳aign敤 瑯 the
s攠s瑡瑥猻t for r散敩e瑳 慳ai
gn敤 瑯 s瑡瑥猠oth敲 瑨慮 k嘬 t夬 慮d 卄
I howev敲I 瑨e
th楲汰oo氠d散楳楯n w楬氠no琠r敳e汴lin 愠捨ang攠瑯 瑨攠䑩v楳楯nDs throw
J
ou琠po汩ly and 楴i 慰p汩捡瑩lnK
E
乯瑩捥t 乊

卵pr敭攠 Court 䑥a楳楯n in th楲汰ool

mrop敲瑩敳 fn挮 vK 䑩a
散瑯rI 乊k 䑩a楳楯n of
q慸慴楯nI VL
T⼲MNNK)









b.

Sales of Other Than Tangible Personal Property






Many states provide that receipts that come from sources other than from sales of tangible personal
property are included in the sales numerator of

the state where the greatest proportion of the income
-
producing activity takes place, which is measured by costs of performance. UDITPA Section 17
provides that sales, other than sales of tangible personal property, are in this state if:


(1)

The income
-
prod
ucing activity is performed in this state; or

(2)

The income
-
producing activity is performed both in and outside of this state, and a greater
proportion of the income
-
producing activity is performed in this state than in any other state based
on costs of perfo
rmance.






Under this rule, most sales are attributed entirely to a single state if the income
-
producing activity is
performed within and without that state, but the greater proportion of the income
-
producing activity is
performed in that state based
on costs of performance (all
-
or
-
nothing rule). Although many states
employ this all
-
or
-
nothing method, several states require that the receipts be attributed to the state in
the proportion of the costs of performance incurred in that state to the total co
sts of performance.












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STATE TAX ALLOCATION/APPORTIONMENT


The term “income
J
producing activity” applies to each separate item of income and means transactions
慮d 慣瑩t楴楥i d楲散瑬y engaged 楮 by th攠瑡xpay敲 in th攠r敧u污l 捯urs攠of 楴s 瑲慤攠or bu
sin敳s for the
ultimate purpose of obtaining gains or profits. “Activity” does not include the transactions and
慣瑩t楴楥s p敲form敤 on b敨慬f of 愠瑡tpay敲 E攮gKI 慮 ind数敮d敮琠ton瑲慣瑯r)K






The term “costs of performance” means direct costs deter
min敤 楮 愠mann敲 捯nsis瑥t琠w楴h gen敲慬ay
慣捥p瑥t 慣捯un瑩tg pr楮c楰汥猠楮 慣捯rd慮捥 wi瑨 慣捥p瑥d 捯nd楴楯ns or pr慣瑩捥猠楮 th攠瑲慤攠or
busin敳e of 瑨攠 瑡tpay敲K Cos瑳 of p敲forman捥 typ楣慬ay do no琠 楮捬cd攠 paymen瑳 m慤攠 瑯
楮d数敮d敮琠捯n瑲慣瑯rs

for s敲v楣敳i p敲form敤 on beh慬a of 瑨攠捯rpor慴楯nI 慮d 瑡ting 慵thor楴楥s
d楦f敲 on wh慴a捯sts 慲攠r敬敶an琠瑯 瑨攠inqu楲yK






fn
General Motors Corp. v. Dep't of Taxation,

268 Va. 289, 602 S.E.2d. 123 (2004), the Virginia
Supreme Court held that the

taxpayer could include third
-
party costs in calculating the “cost of
performance” ratio for sales factor purposes, which was in opposition to an existing apportionment
r敧u污l楯nK qh攠Cour琠數p污楮敤 瑨慴a noth楮g 楮 th攠s瑡tu瑯ry 污lgu慧攠suppor瑥t 瑨攠r
敧u污瑩ln
汩m楴楮g 捯s瑳 of p敲form慮捥 瑯 d楲散琠捯s瑳 or 慬汯w敤 瑨e d数慲瑭en琠瑯 數捬ud攠捯sts p敲form敤 by
愠瑨楲d
J
p慲tyK






fn i敧慬 ou汩ng #OMMS
J
MO E䵡y PI OMMS)I 瑨攠C慬aforn楡 䙔B 數p污楮s how 瑯 慳sign r散敩e瑳 d敲楶敤
from s慬敳 of o瑨敲 than

瑡ngib汥lp敲son慬aprop敲瑹 when a 瑡tpay敲 memb敲 of a 捯mbin敤 r数or瑩tg
group pays ano瑨敲 group memb敲 瑯 p敲form 慣瑩v楴楥s r敬e瑥t 瑯 瑨攠s慬攮






䑵攠瑯 瑨攠敦f散ts of 捯mb楮ed r数or瑩tg when th攠捯n瑲慣tor 慮d 瑨攠sub捯n瑲慣瑯r 慲攠楮 愠un楴慲

r敬慴楯nsh楰 慮d 慲攠 memb敲s of 瑨攠 sam攠 捯mb楮敤 r数or瑩tg groupI 瑨攠 慣瑩v楴楥i of 瑨e
sub捯n瑲慣瑯r 楮 p敲forman捥 of 瑨攠捯n瑲慣琠wi汬lb攠捯ns楤敲敤 楮捯me
J
produ捩ng 慣瑩v楴楥猠
directly

engaged in by the contractor for purposes of the sales factor in

order to more accurately assign the
receipt to the place where the services were performed.






Due to the
difficult and ambiguous nature of the "income
-
producing activity" standard and the all
-
or
-
nothing rule, several states have changed their laws to
provide for “market
J
sourcing” of sales of other
瑨慮 瑡tg楢汥lp敲son慬aprop敲瑹K 啮d敲 th楳 慰pro慣hI s慬敳aof s敲v楣is 慲攠楮c汵d敤 楮 the num敲慴ar
b慳敤 on 瑨e 汯捡瑩tn of th攠pur捨as敲 of th攠s敲v楣isK

䙯r 數amp汥l for 瑡x慢汥l y敡rs end楮g on or
慦t
敲 䑥aemb敲 PNI OMMUI s慬敳aof s敲v楣敳 慲攠捯ns楤敲敤 慮 f汬lno楳 sa汥猠if th攠b敮ef楴iof th攠s敲v楣i
慲攠 r散敩e敤 楮 f汬lno楳K
卩m楬慲lyIfor 瑡x慢汥l y敡rs beg楮n楮g on or af瑥t g慮u慲y NI OMNN for
瑡tpay敲s 敬散瑩ng s慬敳
J
f慣瑯r on汹 慰por瑩tnmen琬t s慬a
s from s敲v楣敳i 慲攠捯ns楤敲敤 愠C慬楦ornia
s慬攠瑯 瑨攠ex瑥t琠瑨慴ath攠pur捨慳敲 r散敩e敤 b敮ef楴i of 瑨攠s敲v楣敳i in C慬aforn楡i xC慬a o敶K C q慸K
CdK
§
ORNPSEb)EN)Kz






mr慣瑩瑩on敲s shou汤 r敶楥w th攠 sp散if楣i s瑡瑥t 污ws and r敧u污瑩tns 瑯 d整敲m楮攠 t
h攠 慰propr楡瑥i
sour捩cg for s慬敳f o瑨敲 than 瑡tg楢汥lp敲son慬aprop敲瑹K





c.

Unitary/Combined Issues






States that require unitary business groups to file on a combined reporting basis determine the sales
factor for the group under either the
Jo
yce

or
Finnigan

approach, named for the cases in which the
positions arose.


In
Appeal of Joyce, Inc.,
California viewed only the sales of group members, which on a stand
-
alone
basis had nexus with California, as properly included in the numerator of the

group’s sales factor.
Appeal of Joyce, Inc
., Cal. St. Bd. of Equal, 1966. Under the
Joyce

approach, when a group of
companies is conducting a unitary business, only the in
-
state sales of the members that themselves
have nexus with the state are included

in computing the numerator of the sales factor. The sales of all
of the members are included in the denominator of the sales factor.


In
Finnigan Corp
., the California State Board of Equalization took a contrary approach and ruled that
the sales throwbac
k rule was to be applied on a unitary group basis, rather than on a legal entity basis.
Thus, if any member of a unitary group has nexus in another state, the sales in the states generated by



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20
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AICPA, Inc.

that member will not be thrown back to California.
Appeal of F
innigan Corp
., 88

卂b

〲M

A EC慬a
却慴攠BdK bqu慬a g慮K O4I NVVM)K


Under the
Finnigan

approach, when a group of companies is conducting a unitary business and at
least one member has nexus with the state, the in
-
state sales of all members of the unitary

group
(regardless of whether the members themselves have nexus with the state) are included in the
numerator of the sales factor. The sales of all of the members are included in the denominator of the
sales factor. States may follow either approach via
statute, regulation, case law, or policy.












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STATE NET OPERATING LOSS (NOL) DEDUCTIONS


Most states permit a deduction for NOLs. While some states explicitly adopt the federal NOL deduction by using line 30 of
federal Form 1120 (taxable income af
ter the NOL deduction and special deductions), without modification, as the starting
point for computing state taxable income, others use line 30 as the starting point of the state tax calculation, but add back

the
federal NOL deduction and provide a speci
fic computation for the state NOL deduction. Still other states begin the tax
calculation with line 28 of the federal return (taxable income before NOL deduction and special deductions) and provide
their own set of rules for determining the state
-
level NO
L deduction.


The most common variation in determining state NOLs involves the determination of the period of carryback and
carryforward. Many states do not follow the federal rules under IRC §172. Several states limit the carryforward period,
and many

states do not allow NOL carrybacks at all. Note that federal and state NOLs carryover periods may be different if
the taxpayer was not doing business in the state in each loss year, or if the NOL arose in a year in which the taxpayer's
activities were in
sufficient to create a filing obligation.


Regardless of conformity with line 28 or 30 of the federal tax return, state NOLs and the amount of carryback or carryover
allowed may differ from the federal amount as a result of state adjustments (modifications
), the application of
apportionment factors, lack of nexus in the loss year, and the segregation of business and nonbusiness income (
i.e.
,
allocation of nonbusiness income and the apportionment of business income).


Some states require that the NOL be carr
ied over from the loss year after allocation and apportionment (i.e., post
-
apportionment). These states provide that the NOL deduction should be applied to the carryover year after allocation and
apportionment. This permits only the loss attributable to
that state to be carried over and applied against income from that
state.


In determining the amount of NOLs in states that compute NOLs on a post
-
apportionment basis, a state may use the
apportionment factor in the loss year or the apportionment factor i
n the year the loss is utilized. Other states, however,
allow the NOL computation to be made before apportionment and permit the deduction to be applied in the carryover year
before apportionment.


A few states permit an affiliated group of corporations t
o file a consolidated state return rather than file separate returns for
each affiliated corporation if the requirements of the Internal Revenue Code and state law are satisfied. Even if consolidat
ed
returns are filed at both the federal and state levels,

the calculation of the NOL deduction for federal and state purposes may
differ markedly. Some states, even in the context of a consolidated filing, may require NOLs to be tracked on a separate
company basis.


Some states add their own restrictions on the

use of NOLs generated in separate return filing years. A number of states do
not permit consolidated returns, and hence require affiliated group members filing a consolidated federal return to compute
their state NOL deductions on a separate company basi
s.


States that provide for combined reporting by unitary business groups may differ as to how the NOL computation is to be
made. If a state allows or requires a member of an affiliated group filing a consolidated federal return to file on a separa
te
comp
any basis, the NOL generally is computed as if the member filed on a separate company basis for federal income tax
purposes. Thus, the NOLs available for state purposes may differ from those reported on the federal consolidated returns.


Note that each st
ate’s definition of consolidated versus combined reporting should be reviewed prior to preparing any state
tax returns. Also note that states vary in their treatment of NOL carryovers after corporate reorganizations, acquisitions,
or
liquidations. Accord
ingly, specific state laws should be consulted when addressing state NOL issues.


A few states



including CA and IL
--

are implementing periods of time where NOL usage is limited or completely
prohibited.

New NH

state rules regarding NOL usage, please c
onsult individual state NOL rules when using carryforwards
or carrybacks.




Some states also require an NOL modification when an NOL is being utilized. In general, this entails looking back at the
year when the original NOL was created, and analyzing the

addition and subtraction modifications from that year. If
there
is
a net addition modification from that year, and the entire NOL is being used, the net addition modification needs to be added

back in the
year of NOL usage. Many people interpret an NOL modification to mean that an NOL needs to
be
added back,
which is not correct. Please consult individual state instructions if an NOL modification is required.