If you are a service provider who performs services across the country in many states, then a review of your apportionment factor may provide opportunities, and possibly, refunds.
In simple terms, the general practice or treatment by states in determining the apportionment factor (how companies determine the portion of taxable business income each state gets to tax) of service companies has been focused on where the service was performed; however, this treatment is changing.
More and more states are changing to the "benefit derived" treatment or "market-based sourcing" for sales of service providers. Meaning, sales related to services are sourced to where the benefit is being derived by the customer.
As you may guess, determining where the 'benefit is being derived' is not a simple task or interpretation. A simple solution would be to source it to the state where the customer is located; however, what if the customer uses the benefit of the service in other states or more than one state?
In any case, here is a brief summary of the current treatment by states regarding sales by service providers for apportionment purposes:
- Some states source sales to the state where the service was performed based on the "costs of performance" or "income-producing activity" tests. This can produce an all or nothing result, or a pro-ration of the sales.
- Some states have changed to "market-based sourcing" or "benefit derived" sourcing; sourcing sales to the state where the benefit of the service is being derived.
The change to "market-based" sourcing can result in favorable results when looking at your state tax position as a whole. You may pay more tax in one state and no tax in others. As always, it just depends.