Inequitable Barriers to Equitable Apportionment: When petitioning for equitable apportionment, taxpayers face motley state-imposed obstacles.

• Date: 01 November 2024
• Author: Friedman, Jeffrey,Lagrossi, Sebastian

Every state that imposes a corporate income tax requires multistate businesses to apportion business income. The states' methods of apportioning income, however, vary considerably and can produce inconsistent results. The United States Supreme Court sanctioned these differences in Moorman Mfg. Co. v. Bair (1) when the Court allowed Iowa to deviate from the commonly used three-factor apportionment formula based on property, payroll, and sales. (2) The Court refused to mandate a specific apportionment formula, although perhaps it should have done so.

A dissenting opinion predicted that the Court's decision would lead to inconsistent state apportionment formulas, a prediction that has proven to be prescient. (3) Apportionment variations come in several forms. States have abandoned the three-factor apportionment formula, which was the benchmark method at issue in Moorman (4) and which comprised the triad of property, payroll, and sales factors. (5) Over time, states have shifted to either a heavily weighted sales factor formula or a single sales factor. (6) Other apportionment models vary in how they define a "receipt" or a "sale" for sales factor purposes, how they situate an in-state sale to determine the numerator of the sales factor, and the availability (or requirement) to apply an equitable apportionment method. It is no wonder that taxpayers are increasingly confronted with inconsistent--and at times unfair--apportionment results.

The United States Supreme Court has noted that a generally applied apportionment method can lead to arbitrary or unfair results as applied to certain taxpayers. (7) Significant unfairness could lead to unconstitutional results. For example, in Hans Rees' Sons, North Carolina's single-factor property apportionment formula resulted in North Carolina taxing between sixty-six and eighty-five percent of the taxpayer's income for the tax period, even though the taxpayer showed that the income attributable to the state did not exceed 21.7 percent for any given year in the tax period. (8) The US Supreme Court determined that North Carolina's formula, as applied to the taxpayer during the tax period, "operated unreasonably and arbitrarily in attributing to North Carolina a percentage of income out of all appropriate proportion to the business transacted by the [taxpayer] in [the] State." (9) Thus, a taxpayer may have a right to equitable apportionment when faced with the results of unfair apportionment. A barrier to equitable apportionment is not only an administrative inconvenience but may also be illegal.

This article focuses on a relatively recent and troubling aspect of apportionment--the requirement to apply beforehand for equitable apportionment as a condition of using an apportionment method that fairly represents the taxpayer's business activities.

Background on Equitable Apportionment

Irrespective of the apportionment formula that a particular state mandates, most states allow or require a "relief valve": an "alternative" or "equitable" apportionment formula that rectifies unfairness that arises from the state's statutory formula. For instance, the Uniform Division of Income for Tax Purposes Act (UDITPA), which forms the basis of several states' apportionment rules, provides an alternative to the standard apportionment formula. (10) Section 18(a) of UDITPA states:

If the allocation and apportionment provisions of this article do not fairly represent the extent of the taxpayer's business activity in this state, the taxpayer may petition for or the tax administrator may require, in respect to all or any part of the taxpayer's business activity, if reasonable:

1. separate accounting;

2. the exclusion of any one or more of the factors;

3. the inclusion of one or more additional factors which will fairly represent the taxpayer's business activity in this state; or

4. the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income. (11)

Limiting the availability of equitable apportionment can lead to significant challenges for taxpayers, in two ways. First, taxpayers must be aware of the requirement or limitation when they consider whether to deviate from the statutory method...