Wednesday, December 12, 2018

Does Your State Have a Throwback or Throwout Rule?

Katherine Loghead, Policy Analyst
This week’s state tax map examines states that have a throwback or throwout rule in their corporate tax code. Throwback and throwout rules are not widely understood, but they have a notable impact on business location and investment decisions.

For purposes of corporate taxation, multistate businesses are required to apportion their income among the states in which they operate. Most apportionment formulas assign weighting among three factors–property, payroll, and sales–to determine the amount of income taxed by each state in which the business operates. The goal of apportionment is to prevent double taxation of corporate income, but there is wide variation among states in how apportionment formulas are designed. For example, some states weight the three factors equally, while others weight the sales factor more heavily or use it as the only factor.

Varying state corporate income tax practices sometimes result in businesses having what is known as “nowhere income,” or income that is not taxed by any state. States with throwback or throwout rules seek to counter this phenomenon by requiring 100 percent of profits be apportioned among states. As such, businesses with nowhere income are required to “throw” that income “back” into a state where it will be taxed, even though that income was not earned in that state.

Although throwback rules are more common, three states adopt what are known as throwout rules. The difference is in how the “nowhere income” is treated. In both cases, the state is looking at a fraction: the amount of sales associated with the state over total sales. With a throwback rule, “nowhere income” is placed in the numerator (the amount apportioned to the state). With a throwout rule, it is removed from the denominator (the amount of total sales). Both increase in-state tax liability, though throwback rules are more aggressive than throwout rules.

Because two or more states can potentially stake claim to “nowhere income,” rules are needed to determine where that income should go, injecting another layer of complexity into already complicated state corporate tax structures. Throwback and throwout rules discourage investment and are inconsistent with the purpose of apportionment, which is to tax the share of a company’s income reasonably associated with that state—not to tax revenue clearly associated with other states just because those states choose not to tax that income.

States with corporate income taxes are nearly evenly divided between those that have a throwback or throwout rule and those that do not. The map below shows throwback rules in 22 states and the District of Columbia, as well as throwout rules in three states.

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