Most multistate companies currently apportion their taxable business income among the various jurisdictions by utilizing some variation of the 3 factor apportionment method. This division of income based upon a percentage of Sales, Wages and Property using a variety of weighting formulas in individual states is another example of an overly complicated mechanism that can easily be streamlined by utilizing a more simple approach. Additionally, a significant amount of successful state tax planning also currently takes advantage of the disparate treatment that results from having 50 states attempt to apportion income using their own unique formulas and weightings of factors. Naturally this only results in tax savings for business at the detriment to state coffers. Only a very few states currently make use of a single sales factor for apportioning income.
I am recommending the use of a single sales factor to apportion business income. With the exception of businesses in certain industries such as mining, transportation, etc. which will need to make use of extraction or mileage percentages (however, even these can use a single relevant factor as befits the industry), the majority of companies can best and most fairly be taxed by each jurisdiction by the single sales factor. Applying a uniform definition of sales across all states and by use of a throw-back rule for sales made to a non-nexus location, 100% of taxable income will be sourced and taxable somewhere. The simplicity is obvious, but another benefit is that it does not punish a company located within its borders by paying more than its fair share to that particular state. A state that currently uses the wage or property factors is actually providing a non-incentive to business to locate its facilities there.
Here is a prime real world example. A Fortune 500 company based in a high tax Northeast state does business in all 50 states. In its home state it employs approximately 10,000 people, owns a million square foot headquarters building and various warehouse facilities totaling another million square feet within the state. Its resulting in-state apportionment factors are 8% sales; 35% wages; and 20% property. Using the 3-factor method required by the state results in the company's income attributable to the state to be 21% as compared to the 8% that would result from a single sales factor. This is a vast distortion of the company's source of income within the state and actually punishes it for having created a large number of jobs and having invested significant capital within the state. The state already benefits directly from the jobs being located there by taxing the income of the employees working there and the property is also taxed locally and by other means at the state level. The state also benefits from the multiplier effect of having the company's work force generate sales tax and property tax revenue. The state is virtually taxing the company twice on the jobs it has created and the capital it invests within the state by using the wage and property factors to distort the apportionment of income. The state is punishing the key driver of the state's economy, the in-state business. This is a company that could locate in any state since it has no overwhelming business need to be in that particular location.
What is really hurtful is that same state is under-taxing companies doing business there that are located outside of the state. Another company may be making significant sales (profits) from that state but has only minimal physical presence and therefore has little or no wages or property attributable to the state. As a result it pays a relatively small portion of tax compared to the real income derived from within the state. Under this example, from a purely tax oriented viewpoint, why would any business locate its major facilities in that state? The simple answer is, none would and in reality fewer and fewer actually do.
The logic of using anything other than a single sales factor escapes me. A multi-factor apportionment method is overly cumbersome to administer, harmful to in-state businesses, does not contribute to attracting new businesses and creates an environment for businesses to employ strategies to take advantage of variations among the states' different laws to produce income that goes untaxed at the state level. When coupled with a throw back rule for sales made into states where nexus has not been established means that all sources of income (sales) will be accounted for and tax appropriately. The only untaxed income will be that which is joyfully earned in a jurisdiction that just doesn't impose a tax on business income.
Once again, simple is better. Extending this theory to sweep in non-business taxable income will create the "full apportionment" approach and eliminate the complexity of allocation of nonbusiness income. Although there may be legitimate arguments for treating no-business income as allocable versus apportionable, in the big picture scope the end result is a wash. The added level of complexity just doesn't justify the need to continue this separate method for non-business income.
When combined with a simple computation of the taxable base, a simple apportionment method will allow for a streamlined, single form to be utilized for many businesses. This is clearly a win-win result for all parties. The compliance burden for business is reduced while the states benefit from the removal of a hurdle to attracting new business and at the same time reducing its own administrative burdens.
