Inequitable Barriers to Equitable Apportionment
When petitioning for equitable apportionment, taxpayers face motley state-imposed obstacles

Every state that imposes a corporate income tax requires multistate businesses to apportion business income. The states’ methods of apportioning income, however, vary considerably and can produce inconsistent results. The United States Supreme Court sanctioned these differences in Moorman Mfg. Co. v. Bair¹ when the Court allowed Iowa to deviate from the commonly used three-factor apportionment formula based on property, payroll, and sales.² The Court refused to mandate a specific apportionment formula, although perhaps it should have done so.

A dissenting opinion predicted that the Court’s decision would lead to inconsistent state apportionment formulas, a prediction that has proven to be prescient.³ Apportionment variations come in several forms. States have abandoned the three-factor apportionment formula, which was the benchmark method at issue in Moorman⁴ and which comprised the triad of property, payroll, and sales factors.⁵ Over time, states have shifted to either a heavily weighted sales factor formula or a single sales factor.⁶ Other apportionment models vary in how they define a “receipt” or a “sale” for sales factor purposes, how they situate an in-state sale to determine the numerator of the sales factor, and the availability (or requirement) to apply an equitable apportionment method. It is no wonder that taxpayers are increasingly confronted with inconsistent—and at times unfair—apportionment results.

The United States Supreme Court has noted that a generally applied apportionment method can lead to arbitrary or unfair results as applied to certain taxpayers.⁷ Significant unfairness could lead to unconstitutional results. For example, in Hans Rees’ Sons, North Carolina’s single-factor property apportionment formula resulted in North Carolina taxing between sixty-six and eighty-five percent of the taxpayer’s income for the tax period, even though the taxpayer showed that the income attributable to the state did not exceed 21.7 percent for any given year in the tax period.⁸ The US Supreme Court determined that North Carolina’s formula, as applied to the taxpayer during the tax period, “operated unreasonably and arbitrarily in attributing to North Carolina a percentage of income out of all appropriate proportion to the business transacted by the [taxpayer] in [the] State.”⁹ Thus, a taxpayer may have a right to equitable apportionment when faced with the results of unfair apportionment. A barrier to equitable apportionment is not only an administrative inconvenience but may also be illegal.

This article focuses on a relatively recent and troubling aspect of apportionment—the requirement to apply beforehand for equitable apportionment as a condition of using an apportionment method that fairly represents the taxpayer’s business activities.

Background on Equitable Apportionment

Irrespective of the apportionment formula that a particular state mandates, most states allow or require a “relief valve”: an “alternative” or “equitable” apportionment formula that rectifies unfairness that arises from the state’s statutory formula. For instance, the Uniform Division of Income for Tax Purposes Act (UDITPA), which forms the basis of several states’ apportionment rules, provides an alternative to the standard apportionment formula.¹⁰ Section 18(a) of UDITPA states:

If the allocation and apportionment provisions of this article do not fairly represent the extent of the taxpayer’s business activity in this state, the taxpayer may petition for or the tax administrator may require, in respect to all or any part of the taxpayer’s business activity, if reasonable:

• separate accounting;
• the exclusion of any one or more of the factors;
• the inclusion of one or more additional factors which will fairly represent the taxpayer’s business activity in this state; or
• the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income.¹¹

Limiting the availability of equitable apportionment can lead to significant challenges for taxpayers, in two ways. First, taxpayers must be aware of the requirement or limitation when they consider whether to deviate from the statutory method. Second, even if a taxpayer is aware of the requirement, it may not have the necessary data or information to comply with it. These issues erect barriers to claiming equitable apportionment, which undermines the important role it plays in state corporate taxation.

Notice Requirements

A taxpayer seeking an equitable apportionment formula generally applies the equitable formula on an originally filed return or on an amended return. Either way, taxpayers typically will provide a description with the return disclosing the equitable method and the rationale for claiming it. However, some states have added requirements—which often serve as barriers—to claiming equitable apportionment. For example, New Jersey¹² and Massachusetts¹³ require taxpayers to submit their returns using the statutory formula (in addition to the equitable formula) and to include attachments explaining the proposed equitable apportionment method. West Virginia requires taxpayers to petition to apply for an equitable apportionment method no later than the due date for an annual return.¹⁴ And Iowa requires taxpayers to submit a return using the statutory method and to pay the tax (using the statutory formula) before they can request an equitable apportionment method.¹⁵ Some states (so-called “prior approval states”) have installed even more onerous procedures, including those that require taxpayers to petition and receive approval/denial of an equitable apportionment method before they can file a return or amended return. Here is a review of some barriers to equitable apportionment.

Advance Request Requirements

A growing number of states require taxpayers to petition for the right to apply equitable apportionment. For example, Alabama requires that, before a taxpayer uses an equitable method of apportionment on a return, it must “file a petition and such petition must have been approved or denied by the Department.”¹⁶ Similarly, Kansas taxpayers, before filing a return with an equitable method of apportionment, must file a petition with the Department of Revenue.¹⁷ And Tennessee requires taxpayers seeking to use an equitable method of apportionment to file a petition “on or before the statutory due date of the return.”¹⁸

In addition to a petition process, some prior approval states require that a petition to request equitable apportionment must be filed considerably in advance of filing a tax return. Wisconsin requires that a request be filed “no less than 60 days before filing the first original, timely filed return using the equitable method.”¹⁹ Other states require even earlier filing, including Michigan, which requires petitions to be filed ninety days prior to the due date of the return (including extensions).²⁰ Meanwhile, Georgia requires, for corporations whose income derives principally from business other than the manufacture, production, sale, or lease of tangible personal property, that petitions be filed “two and one-half months before the due date of the return (including extensions).”²¹ In contrast, Idaho requires a shorter deadline, requiring that petitions be filed “at least thirty days prior to the due date for filing the return.”²² But one state, Illinois, goes further than the others by requiring petitions to be filed an eye-popping 120 days before the date of the return!²³

Irrevocable Requirements

Even if a taxpayer promptly petitions for the right to apply equitable apportionment, its ability to apply equitable apportionment may be limited in other ways. New Hampshire requires that once an equitable method of apportionment is approved, it remains in effect for future tax years unless the taxpayer is granted approval of a modification to the equitable formula or the department’s commissioner orders a change to the formula.²⁴ Similarly, for Tennessee tax purposes, once the Department of Revenue approves an equitable method of apportionment, it remains in effect for future tax years as long as the circumstances justifying the variation remain substantially unchanged.²⁵ But unlike New Hampshire, Tennessee requires a taxpayer to include, with each subsequent tax return, information that establishes the fact that the circumstances remain substantially unchanged.²⁶

Sunset Requirements

Some prior approval states limit how long the approved equitable method of apportionment remains in effect before a taxpayer must reapply. Wisconsin requires taxpayers to apply the equitable method for “six taxable years following the first year for which the equitable method was approved[.]”²⁷ After that period, taxpayers must file a new petition to continue using the equitable method.²⁸ This renewal petition is subject to the same requirements as the original petition and includes certain calculations described in the statute.²⁹ Georgia requires an annual ritual—once permission is granted to use an equitable method, that permission lasts only one year unless the Commissioner specifies otherwise.³⁰ So, in theory, a taxpayer may be required to reapply for the same equitable method each year even if its circumstances do not change.

Onerous Equitable Apportionment Requirements

The preapproval requirements in prior approval states are burdensome and serve as a barrier to taxpayers seeking to ensure that their income is fairly apportioned to the state. Equitable apportionment serves an important purpose: it allows a taxpayer to avoid unconstitutional and unfair apportionment results. Erecting barriers to limit its availability is hard to justify. Certainly states have the right to audit—and challenge—a taxpayer’s claim of equitable apportionment just as it does with any other tax filing position. However, requiring taxpayers’ proposals for equitable apportionment to be examined before they even file their returns serves little purpose.

Consider, for example, a taxpayer that claims an equitable apportionment method on an original Illinois return. The taxpayer will have to anticipate making that claim four months before its return is due. At that stage, the taxpayer may not even know what data it needs to make such a determination, including the apportionment data that is the focus of the position. This “ready, fire, aim” requirement to assess an apportionment formula result may produce an unanticipated consequence for states—increasing the number of requests to claim equitable apportionment. Facing the prospect of being foreclosed from claiming equitable apportionment, some taxpayers may shoot first by filing a request and ask questions later.

The purported benefits—or rationale—for preapproval requirements are not entirely clear. As previously mentioned, many states do not require them. Any concern related to adequate disclosure of a claimed equitable apportionment method can be mitigated by a required schedule to be included with a return. Support for this notion comes from a look at one prior approval state, Illinois. As described earlier, one way a petition for equitable apportionment is considered “timely” is if it is filed 120 days prior to the due date of the tax return. However, Illinois also considers a petition timely if it is made “as an attachment to a return amending an original return which was filed using the statutory allocation and apportionment rules.”³¹ This secondary method of filing a timely petition does not include any requirement that the petition be submitted prior to the deadline for filing an amended return. Thus, this preapproval requirement does not appear to be especially critical from an administrative point of view.

Conclusion

Administering state tax laws and processing returns are not easy undertakings. Revenue departments strive to maintain a balance between requesting the information they need to evaluate a return and imposing burdensome requirements on a taxpayer. But these restrictions on the availability of equitable apportionment are unjustified, and possibly illegal, hurdles that taxpayers still must navigate. State legislatures and revenue departments would be wise to consider whether these preapproval requirements are necessary or if they can be removed to streamline the equitable apportionment request process.

Jeffrey Friedman is a partner, and Sebastian Iagrossi is an associate, both at Eversheds Sutherland.

Endnotes

1. Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978).
2. Moorman Mfg. Co. v. Bair, 437 U.S. 273 (1978).
3. Moorman Mfg. Co. v. Bair, 437 U.S. 282–83 (1978) (“But with its single-factor formula now upheld by the Court, there is little reason why other States, perceiving or imagining a similar advantage to local interests, may not go back to the old ways. The end result, in any event, is to exacerbate what the Commerce Clause, absent governing congressional action, was devised to avoid”).
4. Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 170 (1983).
5. See Moorman, 437 U.S. at 276 (“Since most States use the three-factor formula that Illinois adopted in 1970, appellant argues that Iowa’s longstanding single-factor formula must be held responsible for the alleged duplication and declared unconstitutional”). Some states, however, adopted a single-factor formula during this time. See, for example, Moorman at 273. (Iowa’s formula was based on a single-factor sales formula. In the early twentieth century, Connecticut’s formula was based on a single-factor property formula.)
6. Ara Stepanyan, Evan Cohen, and Margaret McKeehan, “An Empirical Economic Framework for State Corporate Tax Apportionment,” Tax Notes (July 17, 2023).
7. The Supreme Court has acknowledged that a single-factor formula or a three-factor formula “will occasionally over-reflect or under-reflect income attributable to the taxing State.” Moorman, 437 US at 273. The Court has long held that the Constitution does not require a specific apportionment formula and that instead it is the Court’s job to determine whether a tax is fairly apportioned. Goldberg v. Sweet, 488 U.S. 252, 261 (1989).
8. Hans Rees’ Sons, Inc. v. North Carolina, 283 U.S. 128, 134 (1931).
9. Hans Rees’ Sons, Inc. v. North Carolina, 283 U.S. 135 (1931).
10. Uniform Division of Income for Tax Purposes Act, Section 18.
11. Uniform Division of Income for Tax Purposes Act, Section 18.
12. New Jersey Administrative Code 18:7-10.1(c).
13. Code of Massachusetts Regulations, Title 830, Section 63.42.1(3)(b).
14. West Virginia Code Section 11-24-7(h)(1)(D).
15. 701 Iowa Administrative Code 503.9.
16. Alabama Administrative Code r. 810-27-1.18(2)(a).
17. 103 Kansas Administrative Regulations 16:330(1).
18. Tennessee Compilation of Rules & Regulations 1320-06-01-.35(3).
19. Wisconsin Administrative Code Tax 2.64(2)(b).
20. Michigan Revenue Administrative Bulletin 2018-28 (December 19, 2018).
21. Georgia Compilation of Rules and Regulations 560-7-7-.03(5)(e)(3).
22. Idaho Administrative Code (IDAPA) 35.01.01.595.
23. 86 Illinois Administrative Code 100.3390(e)(1). There are other methods of petitioning for an alternative formula, including attaching a petition to an amended return and making a petition as part of a protest action. 86 Illinois Administrative Code 100.3390(e)(2)-(3). As described later, however, Illinois also considers a petition to be timely filed in certain other circumstances.
24. New Hampshire Administrative Code Part Rev 2404.07(j).
25. Tennessee Compilation of Rules and Regulations 1320-06-01-.35(3).
26. Tennessee Compilation of Rules and Regulations 1320-06-01-.35(3).
27. Wisconsin Administrative Code Tax 2.64(3)(a).
28. Wisconsin Administrative Code Tax 2.64(3)(a).
29. Wisconsin Administrative Code Tax 2.64(3)(a).
30. Georgia Compilation of Rules & Regulations 560-7-7-.03(5)(e)(3).
31. 86 Illinois Administrative Code 100.3390(e)(2).