Alternative Apportionment Options of State Income

Alternative Apportionment Options of State Income

by Jonathan Liss | Dec 14, 2021


pa-cpa-journal-alternative-apportionment-options-of-state-incomeAny discussion of state corporate income tax apportionment formulas should always include the topic of “alternative apportionment.” In this column, I will briefly explain the concept of alternative apportionment and the purpose of this statutory relief mechanism.

State income taxes must be apportioned in a manner that reasonably approximates the relationship between a taxpayer’s income attributed to a state and its business activities in that state. Exact precision in apportionment is not required and a general approximation is permitted. A formula that incidentally taxes some out-of-state business activity is constitutionally permissible.1 An apportionment formula is valid if it does not attribute to the taxing state an unreasonable and arbitrary “percentage of the total income out of all appropriate proportion to the business transactions of the taxpayer in that state.”2

Under the U.S. Constitution, a state’s apportionment formula adequately reflects this relationship if it is internally consistent and externally consistent.

Internal consistency means that if the same formula is applied in every taxing jurisdiction, no more than 100% of the taxpayer’s business income would be taxed. A formula is externally consistent if it does not tax economic activity outside a state’s borders. If the standard apportionment formula fails either test, a taxpayer may challenge the constitutionality of the formula and seek the application of an alternative apportionment formula. Under the constitutional standard, an apportionment formula will only be invalidated if the “taxpayer has proved by ‘clear and cogent evidence’ that the income attributed to the state is, in fact, out of all appropriate proportion to the business transacted in that state, or has led to a grossly distorted result.”3

The Uniform Division of Income for Tax Purposes Act (UDITPA) sets forth a model for the allocation and apportionment of income of multistate businesses. Many states have adopted the entirety of UDITPA as Article IV of the Multistate Tax Compact, including the statutory relief provision (Section 18) that allows for alternative apportionment. Under UDITPA Section 18, if a state’s statutory allocation and apportionment provisions do not fairly represent the extent of the taxpayer’s business activity in the state, the taxpayer may petition for, or the tax administrator may require, the following, if reasonable:

  • Separate accounting identifying the income and expenses earned in a specific taxing jurisdiction
  • Exclusion of one or more of the factors, if not material to the income- producing elements of a taxpayer’s business
  • Inclusion of one or more additional factors if representative of activity that generates the taxpayer’s business income
  • Employment of any other method, such as combined reporting and inclusion of intangible property in the property factor

Alternative apportionment was originally intended by the drafters of UDITPA to apply only in unusual circumstances, as expressed by William Pierce, chair of the UDITPA committee: “Of course, departures from the basic [apportionment] formula should be avoided, except where reasonableness requires. Nonetheless, some alternative method must be available to handle the constitutional problem [arbitrary and unreasonable apportionment] as well as the unusual cases, because no statutory pattern could ever resolve satisfactorily the problems for the multitude of taxpayers with individual business characteristics.”4

Alternative apportionment should be equally available to taxpayers and taxing jurisdictions. Generally, a taxpayer’s request must be made in advance of filing the original state tax return. The burden of proving that the apportionment formula fails to fairly represent the taxpayer’s in-state business activity is on the party attempting to deviate from the plain reading of the statute.

Over the years, the trend in apportionment has been for states to shift to a heavier sales factor weighting or single sales factor. Currently, 29 states have adopted single sales factor apportionment. The United States has shifted from a manufacturing economy to a service economy (or knowledge economy), where businesses provide intangible deliverables. Arguably, focusing on a single element of a taxpayer’s income-producing activities – sales – would be more likely to result in unfair apportionment than a formula with multiple factors, such as a formula that would include intangible assets.

Alternative apportionment presents both opportunities and challenges to taxpayers and taxing authorities. In considering whether to invoke alternative apportionment, always keep in mind that the “factor or factors used in the apportionment formula must actually reflect a reasonable sense of how income is generated.”5

1 Moorman Mfg. Co. v. Bair, 437 US at 267 (1978).
2 Hans Rees’ Sons Inc. v. North Carolina, 283 US at 135 (1931).
3 Moorman Mfg. Co. v. Bair, ibid.
4 Taxes - The Tax Magazine, Vol. 35, No. 10 (Oct. 1957), page 748.
5 Container Corp. v. Franchise Tax Bd., 463 U.S. at 169.

Jonathan Liss is senior revenue policy analyst for the City of Philadelphia. He can be reached at


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