In the area of state corporate income tax, determining the location of the income is critical for companies and states alike.  In general, a company takes its total income and determines, or “apportions” it, to a particular state depending on the amount of activity in that state that resulted in the corresponding income. 

Example:  Company ABC, Inc., has net income of $100 with half of its sales in state A and half in state B.  Assuming also that both states used sales to determine the amount of income to which they are entitled, each state would get ½ or $50 of net income attributable to its state.               

While determining where a “Sale” took place sounds relatively straightforward, it can be difficult to figure out in several situations.  Does the sale occur in the state where the company is headquartered?  Did it occur where the company performs the services related to the sale?  Should it be where the customer is located?  Often times, states will adopt rules that best suit its goal to receive as much revenue as possible, which can produce absurd results for the unsuspecting business. 

Generally, these rules fall into two categories: “cost of performance” or “market-based” sourcing methods.  

  1. Cost of Performance sources a sale to the state in which the performance of the company’s cost is incurred to perform the service or intangible sold.  Most states that use cost of performance look to where the preponderance of the costs is incurred, while others pro-rate the sale based on the proportion of those costs. 
  2. The Market Based approach, conversely, looks to where the customer receiving the service or intangible is located.  Often times the sale is prorated if there are multiple locations of the customer.  

Due to the differing views of many states as to how to identify the source of the income, similarly situated companies can often have very different income tax results depending on where they or their customers are located. 

Example: Company ABC, Inc., is located in state A and DEF, Inc., is located in state B.  Both provide the identical sole service and 75% of both companies’ sales are to state B and 25% to state A, which happen to be neighboring states.  State A utilizes market-based sourcing and State B utilizes cost of performance and treats the income as being generated in its state only if the preponderance of the costs occurs in its state. 

ABC, Inc, located in state A would owe income tax of roughly 25% of its net income to state A, based on its sales to the market sourcing state.  Being that State B is a cost of performance state, ABC, Inc., would avoid income tax in state B. 

Conversely, DEF, Inc., in state B would owe the same 25% of its income to State A, under the market-based approach.  However, being that all its costs are in state B, DEF may owe tax on close to 100% of its income in State B.  This could, and in many situations does,  result in more than 100% of the net income being taxed. 

In a recent ruling request, a Florida Taxpayer wrote to the Department of Revenue its concern for being overtaxed.  While the precise nature of the transaction was redacted, it appears the taxpayer provided some sort of financial service, like earning interest income.  The taxpayer wanted clarification to determine the proper sourcing of its income for Florida income tax purposes. 

Like most states, Florida imposes a corporate income tax for the privilege of doing business in the state.  I In this particular ruling, Florida relied upon two out of state cases, Heller Western v. Arizona Dep’t of Revenue, 775 P. 2d 1113 (Ariz. Sup. Ct. 1999) and Ameritech Publishing Inc. v. Wisconsin Dep’t of Revenue, 788 N.W. 2d 383 (Wis. Ct. App. 2010) for the proposition that the income producing activity occurred where the customer is located, not where the company incurred costs to deliver the services.  In short, the Department of Revenue believes that Florida is a market-based state.  Resultingly, the taxpayer’s income should be sourced to Florida and likely other states. 

As stated by the Department of Revenue, “Florida is a consumer state.”  As a consumer state, the maximum revenue will likely be generated by attributing the income to the customer rather where company costs are incurred, which can often be outside of Florida. Therefore, it is in the Florida’s best interest to adopt market-based sourcing, as they did in this recent ruling.  

Ultimately, states are motivated to get the maximum revenue possible and will exploit the ambiguities a modern economy has created in the longstanding corporate income tax structure to further their goal. Businesses providing intangible services across state lines are particularly vulnerable, as the source of the cost may be difficult to apportion and the location where the service is received may be particularly unclear. While a lack of clarity remains in the area of corporate income tax, one thing can be said for certain: states are aggressively pursuing taxpayers with no consideration for how their laws conflict with other states and the economy as a whole. As a result, taxpayers must prepare themselves for audits that conflict with one another and potentially produce ridiculous results. A qualified state and local tax attorney can work to help prepare a business before an audit and defend a business during one. States are not backing down no matter how incongruous their laws are with the emerging interstate economy. Taxpayers should not either.

Gerald “Jerry” Donnini II is a shareholder of the Law Offices of Moffa, Sutton, & Donnini, P.A. Mr. Donnini concentrates in the area of state and Federal tax matters, with a heavy emphasis on the tobacco, alcohol, motor fuel and related industries. He also handles a myriad of multi-state state and local tax issues. Mr. Donnini is a co-author for CCH’s Expert Treatise Library: State Sales and Use Tax and writes extensively on multi-state tax issues for  For more information please call us at 888-966-8216.