A Billion Reasons to Care about State Tax Apportionment

Published on January 6, 2015 by Cheryl Ganim in Tax Services

The Michigan Supreme Court’s July 2014 decision in International Business Machines Corp. v. Department of Treasury (IBM) that taxpayers could validly make an election to apportion business income under the MBT (2008-2011) using the Multistate Tax Compact’s (the Compact) 3-factor apportionment formula started an avalanche of Michigan MBT refund requests. The Michigan Supreme Court held that a taxpayer could elect to apportion its business income tax base and modified gross receipts tax base using the Compact’s 3-factor apportionment formula, since MBT was compatible with the Compact election formula.[1] The refund claims arising from the IBM decision were estimated to cost the state $1.1 billion in tax refund payments. In response, Michigan quickly repealed the Multistate Tax Compact on September 11, 2014[2] effective retroactive to January 1, 2008.

Both the Michigan Business Tax (Effective January 1, 2008 until December 31, 2011) and the Michigan (MBT) Corporate Income Tax (CIT) (effective January 1, 2012) require taxpayers to apportion their tax base using sales only. Therefore, taxpayers could not elect to use 3-factor apportionment under the Multistate Tax Compact but instead were required to apportion using Michigan’s sales-only apportionment.

Michigan and other states are questioning whether or not taxpayers have the right to elect to apportion income under the original 3-factor formula in a Compact state, despite a state’s statutory modification of the original apportionment version. Taxpayers have filed appeals in Michigan, and other states, seeking to use the 3-factor apportionment method. Due to ongoing litigation and uncertainty surrounding this issue in Michigan and elsewhere, multiple states have voted to repeal their Compact membership, or enact the Compact without the apportionment election provision. Taxpayers may yet have the opportunity to file for refund claims using a 3-factor apportionment methodology.

Multistate Tax Commission

The states created The Multistate Tax Commission (The MTC) in 1967 through the Multistate Tax Compact (The Compact), in response to the federal government proposal to create the Federal State Income Tax Division (FSITD), under which taxpayers would file a single state tax return, apportioning federal taxable income to each state using property and payroll factors. FSITD was an attempt to help make state interstate commerce tax systems fair, effective and efficient, and to protect state fiscal authority. Market based states were against federal limitations on their ability to tax the income of out-of-state companies selling into their state via a sales apportionment factor. States wanted to maintain control of their own revenues while providing a solution to the problem of double taxation of companies doing business in multiple states. Michigan had adopted the Multistate Tax Compact effective July 1, 1970.

The MTC is concerned primarily with obtaining uniformity in tax laws and regulations that apply to multistate and multinational enterprises. The advantages of uniformity include reducing compliance burdens for multistate businesses, maintaining a balance of neither under taxing nor over taxing interstate commercial transactions, and lessening the possibility that federal government intervention will be required.

The Compact is managed by the Multistate Tax Commission, composed of one member from each member state. The District of Columbia and 47 states currently participate in the Commission:

• 16 as “compact members” — Alabama, Alaska, Arkansas, Colorado, District of Columbia, Hawaii, Idaho, Kansas, Missouri, Montana, New Mexico, North Dakota, Oregon, Texas, Utah, and Washington;
• 7 as “sovereignty members” — Georgia, Kentucky, Louisiana, Michigan, Minnesota, New Jersey, and West Virginia; and
• 25 as “associate & project members” — Arizona, California (FTB) (SBE), Connecticut, Florida, Illinois, Indiana, Iowa, Maine, Maryland, Massachusetts, Mississippi, Nebraska, New Hampshire, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Vermont, Wisconsin, and Wyoming.
• Delaware, Nevada, and Virginia are nonmembers.

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