Florida v. California: Florida’s Supreme Court Attack on California’s Single-Sales-Factor “Special Rule”

Florida v. California: Florida’s Supreme Court Attack on California’s Single-Sales-Factor “Special Rule”

Florida has filed an original-jurisdiction case in the U.S. Supreme Court challenging a key feature of California’s corporate income tax system. In Florida v. California, the state asks the Court to review Cal. Code Regs., tit. 18, § 25137(c)(1)(A), a regulation often called the “Special Rule.” Florida claims that this rule, when combined with California’s single-sales-factor apportionment, produces unconstitutional results for multistate businesses.

Under the Special Rule, California removes gross receipts from substantial, occasional sales of business property from the sales factor it uses to apportion business income. The gain from those sales, however, remains in the apportionable tax base. Florida argues that this design lets California tax income earned far from its borders while favoring businesses that keep their operations inside California.

California’s Single-Sales-Factor Formula and the Special Rule

California uses a sales-only formula to apportion corporate income. Instead of looking at where property and payroll are located, California focuses on where sales are made. The standard calculation is straightforward: determine apportionable business income, compute a sales factor based on California sales divided by total sales everywhere, and apply the corporate income tax rate.

The Special Rule in § 25137(c)(1)(A) modifies how the sales factor is computed. When a business completes a substantial, one-time sale of fixed assets or similar property used in its trade or business, California removes the gross receipts from that sale from the sales factor denominator. The rule applies to transactions that are both outside the company’s ordinary course of business and infrequent, and whose exclusion reduces the denominator by a specified percentage threshold.

Importantly, the gain on the transaction remains in apportionable business income. As a result, the Special Rule does not remove the transaction from taxation; it simply detaches the gain from the receipts that would otherwise affect the apportionment percentage.

Florida’s Example: One-Time Sale, Outsized California Apportionment

To show how this works in practice, Florida’s complaint presents a hypothetical involving a corporation based in Florida. The company has all of its officers, employees, and factories located in Florida. In a single year, it earns $900,000 from a one-time sale of its Florida factories and $100,000 from ongoing widget sales. Half of the widget sales are to Florida customers and half are to California customers.

Total business income is $1 million. Under the Special Rule, the receipts from the $900,000 factory sale are removed from the sales factor. Only the $100,000 of widget sales remain in the denominator, and $50,000 of those are sourced to California. The result is a California sales factor of 50 percent, which is then applied to the full $1 million of income. California therefore claims $500,000 of the income even though only five percent of total receipts relate to California customers.

Florida, which uses a three-factor formula including property, payroll, and sales, would attribute nearly all of the income to itself. The complaint calculates that Florida’s formula would apportion 97.5 percent of the business income to Florida. Taken together, the two states’ methods lead to nearly half of the income being taxed twice. When the facts are reversed and the factories are in California, Florida highlights a mirrored problem: a similar slice of income escapes taxation in both states, creating “nowhere income.”

Florida’s Claimed Injuries

Florida asserts multiple forms of harm. First, it claims a direct loss of tax base. According to the complaint, California’s single-sales-factor system, intensified by the Special Rule, encourages companies to maintain property and payroll in California, or move there, instead of relocating to Florida. That alleged distortion affects Florida’s ability to attract businesses and limits its potential corporate income tax revenue.

Second, Florida alleges harm as an investor. Its State Board of Administration manages large public funds invested in multistate corporations. The complaint states that many of these companies are headquartered outside California but do business there. If California over-apportions income to itself under the Special Rule, Florida argues that corporate after-tax earnings decline, reducing the value of the state’s investments and the returns to public funds.

Third, Florida raises a parens patriae theory. The state notes that many Floridians own stock in corporations subject to California’s tax rules. When those companies bear higher tax burdens under the Special Rule, the resulting economic impact is felt by shareholders living in Florida.

Commerce Clause Arguments and the Complete Auto Test

Florida’s first constitutional count relies on the dormant Commerce Clause. Applying the four-part test from Complete Auto Transit, Inc. v. Brady, Florida contends that California’s system fails each requirement when the Special Rule is layered onto a single-sales-factor formula.

On the nexus prong, Florida argues that California is taxing income connected to factories, employees, and customers located entirely in other states. On fair apportionment, Florida points to both double taxation and nowhere income in its examples and argues that excluding large, occasional sales from the sales factor does not reasonably reflect how income is earned.

On the nondiscrimination prong, Florida describes the combined regime as favoring businesses that keep their operations in California. In its view, a company with property and payroll in another state but sales into California can face a heavier effective tax burden than a similarly situated California-based company. On the final prong, Florida contends that the income California claims under the Special Rule is not fairly related to the services and protections California provides.

Import-Export Clause and Due Process Claims

Florida’s second claim is grounded in the Import-Export Clause. The complaint uses historical concerns about state tariffs on interstate commerce to argue that California’s system functions like a duty on goods and services moving into the state from other states. By focusing solely on sales and then selectively excluding certain receipts from the sales factor, Florida contends that California has created the modern equivalent of a tariff that has never been approved by Congress.

The third claim invokes the Due Process Clause. Under this doctrine, a state may not tax income earned entirely outside its borders unless there is a minimal connection between the activity and the state and a rational relationship between the income taxed and the in-state values of the enterprise. Florida argues that the Special Rule deliberately severs that connection for substantial occasional sales by ignoring where those transactions occur while retaining the gain in the tax base. In Florida’s view, that approach cannot be reconciled with due process limits on state taxing power.

Implications for Single-Sales-Factor States and Multistate Taxpayers

Florida v. California is not just a dispute about one regulation. It raises broader questions about how far states can go when designing single-sales-factor apportionment systems and when they may carve out specific categories of receipts from their sales factors. Many states have moved to sales-only formulas and experimented with special rules for extraordinary transactions.

A Supreme Court decision in this case could set important boundaries. If the Court agrees with Florida, states may be required to treat major asset and stock sales more consistently, either by including both the gain and the receipts in the apportionment formula or by excluding both. If the Court sides with California, states may feel more comfortable adopting their own versions of special rules for occasional sales.

For multistate businesses, the treatment of large one-time transactions can dramatically affect state income tax outcomes. The apportionment method used in states like California may determine how much of a large gain is taxed where the assets and employees are located and how much is taxed where customers reside. Whether they are planning restructurings, divestitures, or plant sales, corporate taxpayers and their advisors will want to follow Florida v. California closely to understand how the Supreme Court views the interaction between single-sales-factor apportionment and targeted rules like California’s Special Rule.