Daniel Bunn President and CEO at Tax Foundation | Twitter Website
The process of apportionment determines the percentage of a business's profits subject to a jurisdiction's corporate income or other business taxes. In the United States, states use various methods to apportion business profits based on company property, payroll, and sales within their borders.
Traditionally, the three-factor apportionment method evenly weighs property, payroll, and sales. However, many states have moved towards single sales factor apportionment. This approach considers only a company's sales in calculating tax liability, aiming to benefit in-state production while shifting more tax responsibility to out-of-state companies. Courts allow states considerable flexibility in adopting different apportionment methods but require that the tax must relate rationally to companies' activities in the state (external consistency). Additionally, no more than 100 percent of a corporation's income should be taxed if all states adopted the same formula (internal consistency).
There is no universally "correct" approach to corporate apportionment. While payroll and property are closely related to a company's operations in a state, most states include sales as a factor. Currently, 29 states use single sales factor apportionment.
Single sales factor apportionment reduces tax burdens for businesses with most of their property and payroll in-state but few national sales there. Conversely, it increases tax burdens for out-of-state companies with minimal local property or payroll but significant national sales in the state.
Sales of tangible property are typically sourced to the sale destination. The sourcing of service sales is more complex; 26 of 45 corporate income-taxing states emphasize where a service's benefit is received—known as market or benefit sourcing—contrasting with rules focusing on where income-producing activity occurs.
For Tax Year 2020:
- Six states used three-factor apportionment.
- Eight states used a 50% sales factor.
- Three states used more than 50% sales factor.
- Twenty-nine states employed single sales factor.
Certain states offer alternative factors either optionally or for specific industries.
Texas uses single sales factor for its Margin Tax—a gross receipts tax—but other gross receipts taxes do not follow corporate apportionment formulas.
