SALT Corner: Developments in State Income Tax Apportionment
In state tax, one of the biggest issues for multistate businesses is apportionment of income. States’ starting point for income tax generally flows from the federal income tax returns. While simple enough for individuals, determining what portion of income is taxable to each state for a national business proves more difficult. That is especially true given each state has its own rules and guidance about how to apportion income—including special rules for specific industries (i.e., transportation, broadcasting).
Going back to 1957, states adopted a three-factor formula: multiply apportionable income by the portion of sales, payroll, and property in the state relative to the national totals of each. Since that time, most states have moved to a single sales factor for determining apportionment. That one size fits all formula often raises issues. Because underlying any apportionment formula is its constitutional underpinnings: it must fairly represent a business’s activities in the state.[1] In other words, if the formula results in a distortion that allows a state to tax income not fairly representative of the businesses’ activities in the state, it will be unconstitutional.
Demonstrating distortion and getting approval for an alternative formula that deviates from the state’s standard one can be a challenge. Since the U.S. Supreme Court signed off on the constitutionality of the single sales factor, successful court challenges to apportionment formulas are rare.[2] A few recent cases signal the opportunities to consider alternatives to single sales factor apportionment, particularly when the taxpayer can provide evidence of distortion.
California, like most states, uses a single sales factor formula. The taxpayer, Smithfield, argued that it was an “agricultural business,” which by law, uses a three-factor formula (property, payroll, and sales). In the alternative, Smithfield argued for alternative apportionment because the single sales factor did not fairly represent its activities in the state. The court ruled for Smithfield on both arguments. First, the court said that Smithfield was an agricultural business, based on its activities. California had taken the position that Smithfield was not an agricultural company based only on the products it sold—which were processed food. Second, and more universally applicable: the court said that the single sales factor was distortive because Smithfield presented evidence that only 1% of its business activities occurred in California, but the single sales factor resulted in apportioning 6.6% of its income to California. That disparity (600%) justifies using an alternative—three factor apportionment formula. Smithfield Packaged Meats Corp. v. Franchise Tax Board, No. 21STCV39637 (Los Angeles Cnty. Super. Ct. Feb. 26, 2026). Note California recently appealed this decision, so the final outcome is still pending.
On the other side of the coin: in Nebraska, the court struck down the Department of Revenue’s forced alternative apportionment on Apple’s repatriated 2017 income. The 2017 TCJA had a provision for the one-time inclusion of 965 income, which the court recognized required special apportionment provisions, because the significant income for one year would not fairly represent Apple’s activities in Nebraska. Although the court rejected the Department’s proposed formula, it also rejected Apple’s formula, and ordered the Department to come up with a new plan. The case nonetheless shows that taxpayers can successfully challenge states’ apportionment formulas. Apple, Inc. v. Nebraska Department of Revenue, No. 24-3186 (Lancaster Cnty. Dist. Ct., July 15, 2026).
All states have a process for taxpayers to apply to the state taxing authority for alternative apportionment. Grants of alternative apportionment are generally rare, but outside of court, the processes are generally confidential. These court cases demonstrate that the rationale for applying alternative apportionment can be successful. The cases also highlight the evidence and legal considerations a taxpayer should consider when making such applications.
Footnotes:
[1] The U.S. Supreme Court has established a four-prong test for determining whether a tax violates the Dormant Commerce Clause. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).
[2[ Moorman Manufacturing Co. v. Bair, 437 U.S. 267 (1978).
Authored by Alla Raykin
Picture Credit: “Tax” by 401(K) 2013 is licensed under CC BY-SA 2.0.
Asbury Gardner Tax Counsel, is an Atlanta law firm representing clients in complex civil and criminal tax litigation and federal, international, and state tax litigation and tax controversies. Asbury Gardner represents corporations, partnerships, business owners and high net worth individuals. The tax attorneys at Asbury Gardner are routinely recognized by Best Lawyers in America, Super Lawyers, Chambers USA, and the Legal 500 as tax experts.
