What is State Income Tax Sourcing?
State Income Tax Sourcing refers to a state’s tax rules for assigning business income and receipts from sales to the jurisdiction that is entitled to tax the income. In this article, we’ll examine how state sourcing requirements impact revenue in the states where a company is doing business.
Sourcing rules are fairly straightforward for companies with business activities that are limited to a single state. For a company doing business in multiple states (remember – ‘doing business’ is not limited to physical presence in a state) sourcing rules can become a bit trickier. For a multistate company, states provide a formula for calculating the percent of taxable revenue attributable to a given state. This formula is apportionment. Apportionment is the process of assigning to a particular state that portion of a multistate corporation’s income that the state may tax.
Types of Apportionment
While apportionment formulas vary from state to state, most states adhere to one of the following protocols:
- Single Sales Factor Apportionment which is calculated as the ratio of a company’s in-state sales to overall sales.
- Three Sales Factor Apportionment which is calculated as an equally weighted ratio of a company’s in-state payroll, property, and sales divided by three.
- Double-Weighted Sales Factor Apportionment which is calculated similarly to the three-sales factor apportionment formula, but with sales given a different weight (normally double) that of payroll and property.
Additional complexities tend to occur within the application of these rules. For instance, Massachusetts applies different apportionment formulas depending on the industry of a company. Other factors that affect apportionment allocations relate to the type of product or service offered. As well as if the sale pertains to tangible or intangible sales.
What Does This Mean for Your Company?
It is important to know the state income tax sourcing rules of the states your company is conducting business. First, depending on the application of a state’s income tax sourcing rule, your business might be liable to pay corporate income tax on a percentage of its revenue which was not generated in the state imposing the tax. A company’s failure to understand these rules could make the company liable for not only taxes but penalties and interest.
Second, being familiar with these rules allows a company to strategize on structuring business operations in a more advantageous manner. For example, a multi-state company may choose to maintain majority of its property within states utilizing a single sales factor apportionment formula. Allowing a company to avoid the extra tax liability that occurs with state apportionment rules. These rules that take into account a company’s property when calculating the amount of revenue taxable by the state.
As discussed above, state income tax sourcing is a complicated area with myriad nuances. The good news is with proper expertise, there are ways in which businesses can navigate.
References:
https://taxfoundation.org/tax-basics/apportionment/
