Apportionment—the method by which a multistate business divides its income among various taxing states—has always been complicated. In 2025, that complexity has reached new levels. As states continue to refine and expand their apportionment frameworks, taxpayers are facing conflicting methodologies, shifting definitions, and heightened audit scrutiny.

This article provides a comprehensive overview of key developments in state income tax apportionment, including what qualifies for inclusion in the sales factor denominator, how specific industries are treated, and when taxpayers can—and should—push back with claims of “alternative apportionment.”

Understanding the Denominator: What Counts and What Doesn’t

At the core of every apportionment formula is the sales factor, often part of a three-factor or single-sales factor model used to calculate the portion of a company’s income attributable to a given state. The denominator of that formula represents all apportionable receipts, and states differ sharply on what that includes.

Traditionally, the property factor reflects the average value of tangible property owned or rented, the payroll factor captures compensation paid to employees, and the sales factor includes gross receipts derived from transactions in the ordinary course of business.

But trouble starts with defining what receipts qualify for the denominator. For example:

• Dividends, hedging transactions, and securities are frequently excluded unless specifically included under state rules.

• Mobile property complicates the situs calculation for property factors.

• Common paymaster arrangements may distort the payroll factor.

Disputes arise when states selectively include income items in the numerator but refuse to include them in the denominator—effectively inflating the taxpayer’s in-state apportionment percentage.

Key Sales Factor Disputes Across States

California

In a 2023 decision, California’s tax tribunal held that foreign dividends received by a taxpayer that had made a water’s-edge election were fully includable in the sales factor denominator, even though 75% of those dividends were excluded from the income base. The ruling confirmed that receipts excluded from taxable income are not automatically excluded from the apportionment denominator if they arise in the ordinary course of business.

Oregon

A taxpayer challenged Oregon’s treatment of repatriated earnings under the Tax Cuts and Jobs Act. Although the earnings were deemed dividends and included in the tax base, Oregon initially excluded them from the sales factor. The court sided with the taxpayer, holding that since the earnings were derived from unitary operations, they must be included in the denominator to avoid distortion.

Minnesota

In a case involving forward exchange contracts, the Minnesota Tax Court acknowledged that while the gross receipts from these financial instruments technically qualified under the statutory definition, their sheer magnitude and disconnect from regular business operations justified their exclusion. This ruling underscored that even statutorily eligible receipts may be excluded if they overwhelm and distort the sales factor.

Texas

The Texas Court of Appeals rejected a taxpayer’s attempt to include gross proceeds from non-inventory securities in its franchise tax denominator. The court found that these securities were held for risk management, not for sale in the ordinary course of business, and thus only the net gain could be included.

Throw-Out Rules and Occasional Sales: Shrinking the Denominator

Some states apply throw-out rules that exclude receipts from the sales factor if the income-generating activity is not subject to tax in the destination state. But what does it mean to be “subject to tax”? Must the taxpayer actually pay tax, or is it enough to have nexus?

Additionally, “occasional sales”—typically one-time asset or stock sales—are often excluded from the denominator. These exclusions can significantly increase a taxpayer’s apportionment percentage. Courts have warned that such exclusions may violate the constitutional requirement of fair apportionment if they lead to gross distortion of taxable income.

Special Industry Apportionment: One Size Does Not Fit All

Industries with unique revenue structures—such as airlines, broadcasters, financial institutions, and transportation companies—often operate under special apportionment rules. These rules can differ not only from state to state, but also in how they interpret concepts like “revenue,” “mileage,” or “cost of performance.”

Recent cases include:

• An airline in Oregon was required to include all flight data for affiliated carriers in its departure ratio, despite filing amended returns using separate calculations. The court affirmed that consolidated reporting includes all group members.

• A broker-dealer in New York attempted to source commissions to the location of its ultimate investors. The state rejected this look-through approach, insisting that sourcing must be based on the location of the institutional intermediaries.

• A package delivery company in New Mexico successfully challenged the state’s mileage-based apportionment method. The court accepted an alternative, volume-based approach after finding that the statutory formula caused gross distortion.

• JetBlue in Florida challenged the state’s geographic boundaries used in its revenue mileage calculation, arguing that the statutory formula impermissibly includes mileage outside Florida’s taxing jurisdiction.

These cases highlight how special industry formulas, while intended to provide clarity, can themselves become sources of litigation—especially when applied rigidly or in ways that misalign with economic reality.

The Constitutional Mandate for Fair Apportionment

The U.S. Constitution imposes a fundamental requirement: state apportionment formulas must fairly reflect the extent of a taxpayer’s activity in the state. If a formula leads to “gross distortion”, the state must permit an alternative apportionment method.

Foundational cases like Hans Rees’ Sons, Inc. v. North Carolina and Container Corp. of America v. Franchise Tax Board set this standard. Under these rulings, a taxpayer may seek to:

• Exclude one or more factors,

• Include additional factors,

• Use separate accounting, or

• Propose any other method that fairly represents in-state activity.

Most states allow petitions for alternative apportionment under statutory authority modeled on UDITPA Section 18, but procedures vary widely.

Procedures for Petitioning Alternative Apportionment

Taxpayers seeking to challenge a state’s standard formula must follow strict procedures, which differ by jurisdiction:

• Connecticut permits filing an alternative method with the original return.

• Minnesota requires use of Form ALT, submitted with the return or amended return.

• Virginia only allows requests on amended returns.

• Georgia mandates a formal petition well before the return is due.

• California requires submission to the Franchise Tax Board under specific timelines.

The burden is on the taxpayer to prove both gross distortion and that the proposed method is a fair representation of in-state activity. Evidence must be “clear and cogent,” and courts are increasingly demanding detailed quantitative proof.

Alternative Apportionment: Recent Trends and Limitations

Recent rulings show that alternative apportionment is not a guaranteed fix:

• In Illinois, a taxpayer failed to convince the Department that excluding foreign royalties caused distortion. The request for alternative sourcing was denied on the grounds that the exclusion was not inherently unfair.

• In California, the Office of Tax Appeals rejected a state tax agency’s attempt to raise alternative apportionment arguments mid-appeal, holding that procedural requirements must be followed.

• South Carolina appears to be pushing alternative apportionment aggressively, using it as a tool to impose combined reporting in place of separate reporting where economic substance concerns are alleged.

These developments reflect growing tension between taxpayers seeking equitable treatment and states seeking to preserve revenue. Courts remain cautious, often requiring more than a showing of a lower tax result to approve alternative methods.

Conclusion: Apportionment in 2025 Requires Vigilance and Strategy

Apportionment is no longer just a back-office calculation—it is a front-line issue in state tax planning, compliance, and litigation. As states aggressively enforce single-sales factor models, apply throw-out rules, and resist broad denominator inclusion, taxpayers must actively assess whether apportionment methods fairly reflect their economic activity.

Industries with irregular or highly mobile income sources, multinational structures, or digital business models are especially vulnerable. Businesses must be prepared to defend their apportionment positions with data, and when necessary, challenge statutory formulas under both state law and the Constitution.

In 2025, fair apportionment is not just a principle—it’s a fight.

© 2025 Jeanette Moffa. All Rights Reserved.