Business/nonbusiness income distinction subject to challenge.

• Author: Eisenstadt, Amy

A multistate corporation may be required to pay income tax in all the states in which it does business, but the U.S. Constitution prohibits states from taxing income not connected, at least in part, by activities within the state. Therefore, a corporation generally is allowed to apportion its income among the states in which it operates. The Uniform Division of Income for Tax Purposes Act (UDITPA) was designed to provide a uniform system for a multistate taxpayer to divide income among the states in which it is subject to income tax. Many states have incorporated UDITPA provisions or similar provisions into their statutes or regulations.

Under the UDITPA, business income may be apportioned among all the states in which the taxpayer operates. Nonbusiness income, which generally constitutes all income other than business income, is allocable to a single state, often the state of the taxpayer's commercial domicile. Section 1 of the UDITPA 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."

Traditionally, business income has been interpreted to include income arising from sales of property used in the taxpayer's business; see, e.g., MultiState Tax Commission Regulations, Reg. IV.1.(A). However, a number of courts have recently held that gain from extraordinary sales of assets may not be apportionable business income.

Pennsylvania

Laurel Pipe Line Co. v. Commonwealth of Pennsylvania, 642 A.2d 472 (Pa. 1994), involved gain derived from the sale of a pipeline that had been nonoperational for three years prior to the sale. Immediately after the sale, the board of directors declared a dividend equal to the entire after-tax net proceeds from the sale. The Pennsylvania Supreme Court used both the transactional test and the functional test to hold that gain from the sale was nonbusiness income. The court concluded that the statute required that, for income to be treated as business income, the property's disposition must be an integral part of the taxpayer's regular business. Since the gain was not invested to generate income for the company, the court rejected the state's contention that the sale was necessary to maintain the business's financial security. Thus, the court...