The distinction between business and nonbusiness income.

• Author: Huizenga, David L.
• Position: State taxation

Should income from a unique, extraordinary or unusual transaction be apportioned and taxable among the states? It seems the nationwide trend is to identify these special transactions, yet the question of business vs. non-business income still remains.

Business vs. Nonbusiness Income

A multistate corporation generally will allocate and apportion its net income among the states in which it is doing business or subject to the income/franchise tax. The majority of states distinguish business income from nonbusiness income when determining whether income should be apportioned or allocated. Some states do not distinguish between business and non-business income and are considered "full apportionment" states.

Business income is generally apportioned (applying a formula apportionment) among the states in which the corporation is doing business; nonbusiness income is allocated to a single taxing state. States have often adopted their own definitions of business and nonbusiness income; this classification varies. Different approaches in deciding whether an item of income is allocable (nonbusiness) or apportionable (business) include:

* Uniform Division of Income for Tax Purposes Act (UDITPA);

* Type of income; and

* Unitary business.

Many states have adopted the definition under UDITPA, which defines business income as income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income from tangible and intangible property if the acquisition, management and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations.

This definition contains two independent tests. The transaction test addresses whether the transaction or activity that gave rise to the income in question occurred in the regular course of a taxpayer's trade or business. The functional test is based on the functional integration of the income-producing property and the taxpayer's unitary business operations. If either test is met, the income is apportionable business income.

Although each state can follow either a functional or income-type approach, the unitary business approach (which focuses on the relationship between the taxpayer and the entity) may be applied as an additional or alternative test.

Presumption That Income Is Apportionable

Multistate Tax Commission regulations state that, in essence, all income arising from the conduct of trade or business operations of a taxpayer...