Moving to Uniform Apportionment Rules — Formal vs. Informal Approaches
If uniformity in state income taxation is the best way to avoid over-taxation of state income, why has it been so difficult to achieve?
July 30, 2009
For decades, Congress, the states, businesses and the organization that drafts uniform laws, have engaged in efforts to generate uniform apportionment laws among the states that impose an income tax on multistate businesses. Despite these efforts, uniform apportionment laws among all states have never been achieved. While a few efforts did generate uniform laws, not all states adopted them or did not adopt them in complete model form. When apportionment rules vary from state to state, businesses run the risk that more than 100 percent of their income will be taxed among the states. That risk, along with the added compliance costs of dealing with non-uniform apportionment rules, should cause businesses to be demanding uniformity, but that is not the case.
This article provides a brief overview to the origination of the Uniform Division of Income for Tax Purposes Act (UDITPA), what happened to a recent UDITPA revision committee, why uniformity seems elusive, how recent law changes may actually lead to greater uniformity and what lies ahead.
Apportionment and Uniformity Efforts
When a business operates in more than one state, there is a need to determine how much of its income should be subject to tax in each state in which it is doing business. A separate accounting system can be used to measure the income and expenses attributable to activity in each state. Alternatively, total business income can be apportioned among the states in which the entity does business. Because of inherent inaccuracies and challenges of separate accounting, apportionment is the preferred approach.
In 1957, the National Conference of Commissioners on Uniform State Laws (NCCUSL) drafted the Uniform Division of Income for Tax Purposes Act (UDITPA (PDF)). It was last amended in 1966. UDITPA provides rules on apportionment and allocation of multistate business income among states. However, not all states adopted it.
Areas of Growing Non-Uniformity
Section 9 of UDITPA has become a provision most states no longer want to conform to. This section calls for apportionment using equally weighted sales, property and payroll factors, Over the past 20 years, many states have moved to placing a greater weight on the sales factor. Generally, this change was made for economic development purposes to encourage more businesses to locate their payroll and property in the state and sell to customers outside of the state.
Another growing area of non-uniformity and movement away from UDITPA involves the rules for determining which state sales are sourced to for purposes of calculating the numerator of the sales factor in each state in which the business is taxable. UDITPA provides a different sourcing treatment for sales of tangible personal property versus sales of services and intangibles. With growth in sales of services and intangibles since 1957, many states changed their sourcing rule to have all sales sourced similarly. More specifically, Section 17 of UDITPA provides that sales of services and intangibles are sourced to the state in which the income-producing activity occurs. That is likely to be the origin state (where the business has most of its property and payroll). In contrast, Section 16 sources sales of tangible personal property to the destination state. Despite the fact that several states have changed their laws to source all types of sales similarly, uniformity has not been the result because not all states have changed their rules and those that have did not necessarily use the same language or approach.
The 2008-2009 Effort to Modify UDITPA
In 2008, NCCUSL formed a committee to consider possible revisions to UDITPA. Based on sales sourcing changes in some states and the reasons for such changes, it seemed appropriate to modernize a few provisions in UDITPA. However, the committee's work was not limited to the sourcing provision.
From the start, the committee received comments in support of its efforts (mostly from state governments), as well as in opposition (mostly from businesses). The chief reason for opposition was that it was unlikely that states would adopt the revised uniform rules because uniformity was not desired by state officials. A January 2008 letter from the Council on State Taxation (COST), a business group noted: "elected state policymakers have little or no interest in uniformity in the area of corporate income tax apportionment" (COST, letter of January 2008 (PDF)). In contrast, in September 2008, the Utah State Tax Commission sent a letter of support for the rewrite noting the importance of uniform apportionment "for efficient and fair administration of state taxes" (Utah, September 2008 (PDF)).
After a few meetings and continued protests, in June 2009, the revision committee voted to terminate the project (letter of June 2009 (PDF)).
The Elusiveness of Uniformity
As noted earlier, there has never been uniformity of apportionment rules. Not all states adopted UDITPA and some adopted it with modifications. A 1982 report by the General Accountability (GAO) Office, Key Issues Affecting State Taxation of Multijurisdictional Corporate Income Need Resolving (GAO/GGD-82-38) (PDF) provides helpful background to understanding the history of non-uniformity. Some interesting points made in this report include:
Only "Congress appears capable of striking the needed balance between States' authority to tax and Federal authority over interstate commerce and international tax policy."
Since this GAO report was released, uniformity declined further. For the past 10 years to 15 years, states have become increasingly competitive in their efforts to attract businesses. One economic development technique has been to modify the apportionment framework to result in a low factor for the state. Increasing the weighting of the sales factor has been a favored approach and many states changed to double-weighting the sales factor. Today, more states are going further and only using a sales factor. This approach sends a message to businesses to locate property and payroll in the state and sell outside of the state to achieve a low apportionment rate in the state.
To further reduce the numerator of the sales factor, many states changed the sourcing of sales of services and intangibles from the origin state to the destination state. Some states also repealed or modified their throwback rule.
Despite continued failure of formal approaches for reaching uniformity of apportionment rules, competition for businesses may end up moving states to uniformity. As more states move to a single sales factor and sourcing all sales to the destination state, there will be greater uniformity than we have seen in recent years.
However, the economic development rationale driving states towards uniformity can create new problems. When (if) all states use a single sales factor and source all sales to the destination state, states will need to find some other incentive to keep and attract businesses, such as lower rates, more tax credits or even repeal of the corporate income tax (see Moving State Tax Systems Into the 21st Century).
This informal approach to uniformity is not ideal due to the time involved, likely drafting differences among the states and risks to the efficacy of the state income tax. The recent UDITPA rewrite project is a reminder that the only workable formal approach to uniformity is for Congress to act. With no clear plea from businesses or state governments for Congress to act, we'll likely need to wait and see what the informal approach produces.
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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San Josť State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA's Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.