U.S. Supreme Court Denies Three-Factor Apportionment Review

The United States Supreme Court denied review of Gillette Co. v. California Franchise Tax Board, the California Supreme Court case holding that taxpayers may not use the Multistate Tax Compact’s three-factor apportionment method to apportion their income under the California Business Income Tax.  As is customary, the Court didn’t explain its reasons for denying review.  This means the Court will not weigh in on an issue that has arisen in many states, including Texas.  We discuss the issue in more detail, including what it means for Texas taxpayers and Texas tax law, below.


For state tax purposes, apportionment is the method by which a taxpayer determines how much of its income (or, in Texas, taxable margin) is taxable to a particular state as opposed to other states.  State tax laws specify which apportionment methods taxpayers may use.  The Texas franchise tax statutes specifies only one apportionment method, the single sales factor method.  Under this method, the percentage of sales a taxpayer makes to Texas residents is the percentage of its taxable margin that is taxable to Texas.

Another apportionment method is a three-factor apportionment method, which looks at (1) the percentage of a taxpayer’s property located in a particular state; (2) the percentage of a taxpayer’s sales that it makes to a particular state’s residents; and (3) the percentage of a taxpayer’s payroll paid to residents of a particular state.  The Multistate Tax Compact allows for this apportionment method.

States have moved away from three-factor apportionment to single factor apportionment in recent years.  Many states take the position that single factor apportionment encourages economic development in their states by not taxing businesses more for having property and payroll in a state.  Single factor apportionment tends to impose a higher tax burden on out-of-state companies that do business in a state, as it does not consider whether the taxpayer has property or payroll in a state.

Many U.S. states entered into an agreement known as the Multistate Tax Compact in the late 1960s.  Currently, 16 states, including Texas, are parties to this agreement.  These states agreed to make the provisions of the Multistate Tax Compact, which are uniform laws regarding matters such as tax administration and tax base apportionment, part of their state tax statutes.  One of the provisions of the Multistate Tax Compact states that, for the purposes of a state’s income tax, taxpayers may choose to apportion the tax base using either the method that the state’s own statutes provide, or the three-factor apportionment method provided in the Multistate Tax Compact.  The Multistate Tax Compact defines an “income tax” as “a tax imposed on or measured by net income including any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, one or more forms of which expenses are not specifically and directly related to particular transactions.”

Current Litigation

In several states in addition to Texas and California, including Michigan, Minnesota, and Oregon, taxpayers who previously filed using single factor apportionment filed for refunds, arguing that the Multistate Tax Compact allowed them to use three-factor apportionment.  As a result, some states withdrew from the Multistate Tax Compact.  Taxpayers claims so far have been ultimately unsuccessful, though some remain pending.  (Taxpayers initially prevailed at the Michigan Supreme Court, but Michigan’s legislature retroactively repealed the Multistate Tax Compact.  The Michigan Court of Claims and Court of Appeals both upheld the retroactive repeal, and the Michigan Supreme Court declined review of these decisions).

In Texas, in Graphic Packaging, the Third Court of Appeals found that Texas taxpayers may not use the Multistate Tax Compact’s three-factor apportionment method to apportion their taxable margin under the Texas franchise tax. (Note that Seay & Traphagan, PLLC does not represent Graphic Packaging and has had no involvement in this case).  The Third Court of Appeals stated that the Multistate Tax Compact’s three-factor apportionment method was not available under the Texas franchise tax because, according to the court, the Texas franchise tax doesn’t meet the Multistate Tax Compact’s definition of an “income tax.”  The Third Court of Appeals said that the Texas franchise tax didn’t meet this definition because taxpayers only have a limited amount of deductions available under the Texas franchise tax, which the court did not deem sufficient to constitute the amount of “expenses” required to be deducted to meet the definition of a net income tax.  Graphic Packing filed a Petition for Review with the Texas Supreme Court.  The Texas Supreme Court requested full briefing, and that briefing is now complete.  But, the Texas Supreme Court has yet to decide whether it will grant Graphic Packaging’s Petition for Review.

Unlike the other three-factor apportionment cases across the nation, Graphic Packaging raises a unique issue – whether the Texas franchise tax is a tax on net income.  This has implications for other areas of tax law — for example, Public Law 86-272, which states that, for the purpose of a state’s net income tax, merely entering a state for the purpose of soliciting orders is not enough contact to create nexus and therefore subject a business to that state’s net income tax.

Graphic Packaging is not yet final, as it’s current still subject to the Texas Supreme Court’s review, if it chooses to do so.  Therefore, taxpayers who filed their Texas franchise taxes using the single sales factor apportionment method may wish to determine whether they would be entitled to a refund if Texas allowed the three-factor apportionment method under the Texas franchise tax.  If so, these taxpayers may wish to seek the advice of a Texas tax professional, such as a Texas tax attorney, to determine whether they should file protective refund claims.


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