Proposed amendments to article IV of the Multistate Tax Compact.

• Author: Peart, Jason

The Multistate Tax Commission is considering significant changes to the rules that govern how multistate businesses are taxed (see Multistate Tax Commission, Multistate Tax Compact Article IV Recommended Amendments (May 3, 2012), available at tinyurl.com/9xbhk93). The goal of the proposed amendments is to modernize the model law so it conforms to shifting tax policy preferences and changes in the world economy.

The current framework for multistate taxation assigns the total taxable income of a multistate corporation among the various states in which it does business. This framework, proposed initially in the Uniform Division of Income for Tax Purposes Act (UDITPA), has been codified by the commission in Article IV of the Multistate Tax Compact. In an effort to keep this system uniform and up to date, the commission has identified five provisions in need of review. It referred the five provisions to its Uniformity Committee, which worked with a drafting group to compose amendments to those key areas. The proposed amendments are discussed further below.

Change How States Decide Which Income Is Apportioned or Allocated

Currently, items that qualify as "business income" are apportioned using a three-factor formula that considers the percentage of property, payroll, and sales a multistate corporation has within a state. "Nonbusiness income" is allocated to the state in which the property is located. The first amendment would change this distinction in two ways. It replaces "business income" in Article IV(1)(a) with a more expansively defined "apportionable income." It also replaces "nonbusiness income" in Article IV(1)(e) with the more limited "nonapportionable income." The purpose of this change is twofold. First, the expanded definition of "apportionable income" signals the committee's intent to include gains from the liquidation of a unitary business. This includes a liquidation characterized under Sec. 338(h)(10) as a deemed sale of assets, without regard to how the gains are used.

Second, the expanded definition brings more clarity to the type of activities that fall under the functional test. Under both the existing rules and the proposed rules, income subject to apportionment (currently called "business income") includes transactional income and functional income. The definition of transactional income would be unchanged, but "functional income" would be defined differently. Functional income is currently described as "income from...