The single sales factor - a new trend?

• Author: Esstman, Donald L.

When a company steps beyond the borders of its home state and into another state with sufficient contacts ("nexus") to be subject to tax in that state, the problem arises in determining the amount of income attributable to that state. A common method of determining the amount of attributable income is a three-factor apportionment formula consisting of sales, property and payroll. Although apportionment formulas vary by industry and by state, the most commonly used factor is the three-factor formula prescribed by the Uniform Division of Income for Tax Purposes Act (UDITPA). Under this formula, the average of three equally weighted ratios consisting of property, payroll and sales in the state versus total property, payroll and sales is used to determine the taxable base in each state.

Twenty-three of the 48 states imposing an income or franchise tax on corporations have modified the UDITPA formula to double-weight the sales factor. Use of the double-weighted sales factor tends to include a larger percentage of an out-of-state company's income in the taxing state; the company's sales activity is weighted more heavily than its payroll or property activity. If a company is domiciled in such a state, double-weighting sales generally provides tax relief, since the company's higher in-state cost of payroll and property receives less weight than the lower out-of-state cost of payroll and property.

As states seek new sources of revenue, consideration has been given by many to adopting a single-sales factor formula. Three states currently use a single-sales factor formula: Iowa, Nebraska and Texas. Missouri offers the option of using a single-sales factor or three-factor formula. Michigan recently considered legislation to switch to a single-sales factor apportionment formula. Massachusetts passed legislation to switch to a single-sales factor formula over a four-year phase-in period.

Whether this is a fair and equitable method of apportionment is a subject of much debate. In General Motors v. District of Columbia, 380 US 553 (1962), the Supreme Court criticized the use of single-sales factor apportionment formulas without ruling on its constitutionality:

The great majority of States imposing corporate income taxes apportion the total income of a corporation by application of a three-factor formula which gives equal weight to the geographical distribution of plant, payroll, and sales. The use of an apportionment formula based wholly on the sales...