Opportunities with non-business income and state apportionment.

• Author: Zambrano, Jose M.

In the absence of a standardized system for state apportionment formulas, tax savings opportunities may arise from excluding nonbusiness income from state apportionment. By performing a careful analysis of business and nonbusiness income, it may be possible to achieve a sales apportionment factor that is less than 100%. In essence, advisers could remove the portion related to nonbusiness income from taxation, thus creating so-called nowhere income. However, the throwback rule, if applicable, may negate this opportunity. Tax practitioners could potentially take advantage of this situation by performing a more in-depth analysis of sales by state.

The body of work that dictates state apportionment formulas for many states is known as the Uniform Division of Income for Tax Purposes Act (UDITPA). It was created in 1957 as an effort to produce congruence among states when dealing with state apportionment. One of its highlights was creating a framework for defining business and nonbusiness income. In general, business income means "income arising from transactions and activity in the regular course of the taxpayer's trade or business" (UDITPA [section] l(a)); it is subject to apportionment and divided among all filing states. Nonbusiness income is categorized as "all income other than business income" (UDITPA [section]l(e)); it is allocated to the taxpayer's state of domicile or where the property resides (UDITPA [section][section]4-8). Many nonconforming states have developed parallel definitions regarding business activities for their apportionment systems.

The principal purpose of the apportionment formula is to approximate the corporation's taxable income attributable to that state. The most frequently used apportionment formula is a three-factor formula that encompasses sales, property, and payroll and weights each of these factors equally. Some states have developed apportionment formulas that weight the factors differently--for example, using a double-weighted sales factor or a single sales factor. At the core of a practitioner's analysis of a taxpayer's allocation of income is the comparison among states that conform to UDITPA and thus define receipts as either business or nonbusiness versus states that have their own definition of receipts.

First, taxpayers in UDITPA-conforming states will need to carefully examine their receipts and determine the portions that relate to...