Skip to main content
Closely Held Businesses

Multi-State Taxation

By April 25, 2015No Comments

Most large corporations do business in more than one state and, as a result, are typically subject to the corporate income tax in multiple states. However, each state faces two important limits on how much of these corporations’ profits it can tax.

  1. If a corporation does not conduct a minimal amount of business in a specific state, that state is not allowed to tax the corporation at all. Corporations that have sufficient contact in a state to be taxable are said to have “nexus” with that state.
  2. Each state in which a corporation has nexus must develop rules for dividing the corporation’s profits into an in-state portion and an out-of-state portion.  Then, the state can only tax the in-state portion.  This process is referred to as “apportionment” which is explained in further detail below.

Apportionment & Allocation

According to the Uniform Division of Income for Tax Purposes Act (R&TC §§25120–25141), all taxpayer income is divided into business income — which is apportioned among the states where the business operates — or nonbusiness income — which is allocated to a particular source state.


The Uniform Division of Income for Tax Purposes Act (UDITPA) recommends an apportionment rule that equally depends on three different factors in determining the portion of a corporation’s business income (i.e. sales, rent & royalties, income arising from regular course of trade or business) that can be taxed by a state. These factors include the following:

  1. The percentage of a corporation’s nationwide payroll that is paid to the residents of a state.
  2. The percentage of a corporation’s nationwide sales that are made to the residents of a state.
  3. The percentage of a corporation’s nationwide property that is located within a state.

The UDITPA’s recommendation was to assign each of the three factors an equal weight in allocating a company’s business income among the states in which it operates.

However, over the past two decades, many states have chosen to increase the importance of the sales factor and decrease the importance of the payroll and property factors.  Therefore, the majority of states currently use apportionment formulas that give “double-weight” or more to the sales factor, meaning that a corporation’s in-state sales are at least twice as important as each of the other factors. At the extreme side of the spectrum, more than a dozen states rely entirely on the sales factor in determining at least some corporations’ tax liabilities. This approach is referred to as the “single sales factor” (SSF).

The following is an overview of the various apportionment formulas:

Formula Description
3-Factor Formula Average the 3 factors (payroll, sales, property)


Double Weighted Sales Factor


4-factor formula with the sales factor being doubled


Single Sales Factor


Only uses the sales factor

(California uses this)*


Other Many states use unique formulas



Allocation generally refers to the assignment of non-business income to the particular state in which it is earned.  Non-business income arises from activities outside a corporation’s regular course of business, which can include items such as:

  • Rent & Royalties
  • Capital Gains
  • Interest
  • Dividends

Composite Returns

Many states allow a pass-through entity to file a composite return on behalf of its nonresident individual owners in lieu of each owner filing his or her own nonresident return.  This saves the owners from having to report and pay tax on their share of state income from the entity.  Thus, nonresident owners do not have to file a tax return in any state a composite return was filed.

Multi-state taxation is a complex topic.  If your business is thinking about operating in multiple states, please contact us at 858-558-9200 so that we can further discuss the issues you may face.

Leave a Reply

SafeSend - a safe and easy solution for your tax engagements! Learn More >>