When you are doing business in a state other than where incorporated, it may influence the tax implications at the state and local levels.
Understanding allocation and apportionment of taxes is key for corporations that do business in multiple states, as it helps to ensure accurate governmental reporting. Besides filing your earnings with the IRS, you must report to local and state governments and pay applicable taxes other than in the incorporated state. It is crucial to understand apportionment and throwback or throwout rules for each of the states in which your business operates, as these might influence double taxation for your business.
Before expanding to another state, a business must plan to consider taxation consequences and related issues allocating income between states. First, we will discuss the meaning of allocation and apportionment, followed by the differences between the cost performance and market-based taxed apportionment. Business owners should understand tax implications, filing requirements, and tax rules for each state, including allocation and apportionment, and which apportion factors states consider. Additionally, entrepreneurs should consider whether or not a state is employing market-based sourcing or cost performance apportionment sourcing.
Cost of Performance: What is Apportionment in Tax?
In taxation, cost apportionment refers to determining the percentage of profits a corporation is subject to a specific jurisdiction’s corporate income and other taxes. Apportioning profits is based on US states combining the percentage of company property, payroll, and sales located within the territories.
Types of Apportionment
- Market-Based
- Cost of Performance
Apportionment Methodologies
- Single-factor: Sales
- Three-factor: Property, Payroll & Sales
Accounting for sales by employing the single sales factor is useful and benefits in-state production and export more of the tax burden to out-of-state businesses. The single sales method allocates revenue to a state based on the percentage of occurring total sales within a state. To determine the percentage amount, you may need to divide the amount of the receipts sourced within the state, under the cost performance or market-based sourcing, by your total receipts, inside the state and outside.
Some reasons for apportionment include corporate income double taxation prevention and reducing tax liabilities. Understanding corporate tax codes for each state, including the throwback tax or throwout rule, can be confusing and complex. Corporate taxation requires each state to apportion the income of corporations with locations in multiple jurisdictions and states. Under the throwback rule, generally, sales in a designated state are not apportioned and are thrown back into the original incorporated US state for taxation.
Differences Between Market-Based and Cost of Performance Apportionment
In most states, the market-based approach has been replacing the cost of performance sourcing method because of its efficiency. While the cost of performance receipts source the income from the location of performed services, the market-based method may source receipts based on the corporate location of the customers receiving the services. With mixed-use sourcing, the risk of double taxation can happen in some US states.
When states use market-based sourcing, they typically use a single-factor sales apportionment approach rather than the three-factor. The single sales method generally allocates revenue based on the percentage of total sales within the state divided by total sales everywhere.
Re-evaluating your tax planning and compliance is beneficial for avoiding over-allocation and under-allocation of your corporate income. It can result in paying too much or not enough taxes, which can result in penalties.
Understanding corporate tax is complex and not all entrepreneurs and business owners will have the required knowledge which may create challenges in conducting business in multiple states. At Fusion CPA, we understand interstate accounting and taxes and can set up the software to help with interstate accounting, to possibly save you money in deductions, penalties, and more. It is a risk for any business owner to experience tax issues at an interstate level, as it can cost millions of dollars in tax fines and a steep penalty. Accurate accounting setup to factor in a multi-state organization is significant for those businesses. Our CPA team can help explain the allocation and apportionment of taxes for businesses via a discovery call.
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This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
