State discretionary authority and alternative apportionment.

• Author: Klahsen, Rick

Every state taxing authority has some measure of discretion to determine a taxpayer's income under alternative methods if the taxing authority believes the taxpayer's income, as determined under the state's tax code, does not fairly represent the extent of the taxpayer's activity in the state. A state taxing authority can generally allow or require a taxpayer to:

* Use separate accounting in lieu of formulary apportionment;

* Exclude any one or more of the standard apportionment factors;

* Include one or more additional apportionment factors; or

* Use any other method to effectuate an equitable allocation and apportionment of the taxpayer's income (see Uniform Division of Income for Tax Purposes Act [dollars]18).

With state tax revenues falling, states have ramped up enforcement measures in an effort to ensure that taxpayers comply with state tax laws and remit the full amount of tax they owe. Many states are actually hiring more tax auditors even as they lay off government employees in other positions. As a result, state audit activity has both increased in frequency and become more aggressive in nature.

State taxing authorities have shown a growing predilection to use their discretionary power in their favor as they have become increasingly desperate for revenue. Several recent cases highlight this unsettling trend.

Bell South

In BellSouth Advertising & Publishing Corp. v. Chumley, No. M2008-01929-COA-R3-CV (Tenn. Ct. App. 8/26/09), the Tennessee Court of Appeals upheld the commissioner of revenue's exercise of discretionary authority to vary the statutory apportionment formula based on the cost of performance methodology and to instead require the use of a market-based sales factor.

The taxpayer used the all-or-nothing cost of performance approach as set forth in Tennessee Code Ann. Section 67-4-2012(i). As a result, the taxpayer computed a relatively small sales factor for Tennessee franchise and excise tax purposes because a greater proportion of its costs of performance were outside Tennessee. The commissioner recalculated the taxpayer's income using a market sourcing approach, which resulted in an increased sales factor and an increased tax liability. The case did not reveal whether the commissioner conversely would offer a taxpayer relief if the all-or-nothing cost of performance approach resulted in a significantly higher sales factor than under a market approach.

This decision unfortunately highlights Tennessee's broad authority...